2023 (7) TMI 1584 - AT - Income Tax

Disallowance of conveyance expenses incurred by employees on tour under Rules 6D - CIT(A) deleted addition - HELD THAT - We note that the CIT(A) has deleted the addition by following inter alia the judgment of Gannon Dunkerly and Co 1993 (4) TMI 318 - BOMBAY HIGH COURT wherein it has been held that the local conveyance expenses and other actual expenses which are incurred by the employee while on tour for conducting the assessee s business cannot be considered as travelling expenses of the employee under Rule 6D of the Rules. Further the disallowance was made on ad-hoc basis. No infirmity in the order passed by the CIT(A) deleting the ad-hoc disallowance by invoking the provisions of Rule 6D of the Rules. Decided against revenue. Disallowance u/s. 37(2) - entertainment expenses incurred on assessee s employees - whether expenditure incurred on its employees was incurred at the place of their work and therefore not covered u/s. 37(2)? - HELD THAT - We note that the Appellant had disallowed amount of Entertainment Expenditure incurred by the Appellant in relation to visitors guests as per the Tax Audit Report. No disallowance was reported in the Tax Audit Report in relation to the entertainment expenditure incurred for the provisions of food beverages to the employees. AO has also not brought anything on record on the basis of which it can be concluded that the provisions of Section 37(2) would be attracted. CIT(A) had concluded that the entertainment expenditure were incurred by the Appellant on its employees for food and beverages while discharging their official duties and at their place of work where they have been sent by relying upon the judgment of Expo Machinery Ltd. 1991 (4) TMI 120 - DELHI HIGH COURT Therefore we do not find any infirmity in the order passed by the CIT(A) and hold that the CIT(A) was justified in deleting the disallowance of entertainment expenditure made by the AO under Section 37(2) of the Act. Accordingly Ground No. 2 raised by the Revenue is dismissed. Disallowance of club expenses - AO concluded that although it is true that club membership may facilitate interaction with customers it cannot be said that the entire expenditure incurred wholly and exclusively for the business of the Assessee - CIT(A) deleted addition - HELD THAT - Both the sides agreed that similar issue has been decided in favour of the Assessee in case of Assessee for the Assessment Year 1991-92 by following the judgment of Otis Elevator Co. India Ltd. 1991 (4) TMI 53 - BOMBAY HIGH COURT passed by the Tribunal rejecting the appeals preferred by the Revenue for the Assessment Years 1989-90 1990-91. It would be pertinent to note that Reference Applications filed by the Income Tax Department against the order of the Tribunal for the Assessment Years 1989-90 1990-91 was dismissed both by the Tribunal under Section 256(1) of the Act and by the Hon ble Bombay High Court under Section 256(2) of the Act - Decided against revenue. Addition made on account of unrealized forward profit - forward transaction in foreign exchange have not been actually settled and therefore income has not accrued to the assessee - CIT(A) deleted addition - HELD THAT - As per the judgment of Woodward Governor India Pvt. Ltd. 2009 (4) TMI 4 - SUPREME COURT the loss/gain arising on account of foreign exchange fluctuation is to be recognized in the Profit Loss Account for the relevant previous year. Accordingly the gain arising on account of revaluation of the outstanding forward contract as on the last of the previous year as per the provisions of Accounting Standard 11 would have to be recognized as profits of the relevant previous year. As per the accounting policy followed by the Assessee the gains/loss arising out of foreign exchange fluctuation is recognized as profit or loss accruing to the Assessee during the relevant previous year. Accordingly we reverse the order passed by the CIT(A) and reinstate the addition on account of foreign exchange fluctuation gains with the directions to the Assessing Officer to recompute the quantum of addition foreign exchange gain/loss on outstanding forward contracts after taking into account the profit/loss offered to tax by the Assessee on the date of actual settlement of the aforesaid forward contracts in order to avoid double taxation of the same foreign exchange gain or loss. Ground raised by the Revenue is allowed. Claim in respect of bad debts recovered - whether the bad debts recovered during the year cannot be subjected to tax as the provisions created for such debt in earlier years have not been allowed as deduction? - HELD THAT - We find that the factual findings returned by the CIT(A) to the effect that the deduction for the provisions for INR 70, 30, 360 was not allowed in the earlier years since the same was in excess of the limits specified under Section 36(1)(vii)(a) of the Act has gone uncontroverted in the appellate proceedings before us. Therefore we concur with the reasoning given by the CIT(A) on this issue. The amount of bad debts recovered during the year in respect of which provisions were created in earlier years but not allowed/claimed as deduction would not be taxable as income in the hands of the Assessee. Addition on account of penal interest charged by the RBI - whether it neither represent a penalty nor a penal interest but the differential interest on the CRR balance maintained with RBI? - CIT(A) deleted the above addition - HELD THAT - CIT(A) was correct in deleting the addition of INR 91, 402/- since the amount of interest not received could not be regarded as payment of penalty or penal interest in the facts and circumstances of the present case. Our view also draws support from the decision of case of the Assessee for the Assessment Year 1992-93. Addition on account of broken period interest paid on purchase of securities which were lying in stock at the end of the previous year - CIT(A) deleted addition as in case of trading in security total cost of purchase of security which included broken period interest and debited to P A A/c. is an allowable deduction - HELD THAT - The issue stands decided in favour of the Assessee in Assessee s own case for the Assessment Year 1989-90 1990-91 wherein the Tribunal by following the decision of American Express International Banking Corporation 2002 (9) TMI 96 - BOMBAY HIGH COURT allowed claim - Decided in favour of assessee. Addition on account of excess interest paid under Corporate Cash Deployment Scheme (CCDS) - CIT(A) deleted addition as the assessee has not claimed any deduction of expenses by way of interest and no penalty or prosecution has been imposed u/s. 46 or 47A of Banking Regulation Act or Sec. 58B of RBI Act and therefore infraction of law cannot be presumed for making disallowance of interest - HELD THAT - The factual finding retuned by the CIT(A) that the Assessee had not claimed deduction for interest/payments made to the investors has not been controverted. We note that the order of CIT(A) for the Assessment Year 1992-93 followed by the CIT(A) on this issue has been confirmed by the Tribunal as held assessee has earned only commission which is the difference between the inflow and the outflow in the CCD scheme. This commission income has been duly credited to the P L account of the assessee. The ITAT Delhi Bench decision which is in respect of Portfolio Management Scheme is clearly applicable to the facts of the assessee s case. In the present case also the assessee has not claimed any deduction for any loss arising under CCD Scheme Accordingly the addition is deleted. Decided in favour of assessee. Addition on account of loss in transaction with broker - According to the AO the aforesaid transaction were hit by the provisions contained in Section 15 of the Securities Contract (Regulation) Act 1956 (SCRA) as the same were undertaken by the broker with the Appellant as a counterparty without obtaining written consent of the Appellant - HELD THAT - The mere fact that the delivery contract provides for delivery of the securities to the broker is not sufficient and does not meet the requirements of Section 15 of SCRA. The Assessing Officer had returned a finding deal note did not disclose that the member was acting as a principal. This finding has gone uncontroverted in the appellate proceedings. Accordingly we hold that the transaction undertaken under consideration have been undertaken in violation of provisions contained in Section 15 of the SCRA. Therefore the Assessee would not be allowed to claim benefit of loss arising from such transaction. Since we have confirmed the order passed by the CIT(A) of deleting the addition made by the Assessing Officer in relation to CCDS while adjudicating Ground No. 8 above we direct the Assessing Officer to compute income of the Assessee without allowing set off of loss suffered in the transactions in GIC Rise II Units undertaken by the Assessee with C.Mackertich and Stewart Co. and the loss pertaining to sale transaction of units of the face value of INR 1 Crore. Ground No. 9 raised by the Revenue is allowed in terms of the aforesaid. Disallowance on account of losses in ready forward transaction - HELD THAT - On perusal of Assessment Order we find that the direction issued by the AO to file the aforesaid computation was given on the basis of apprehension harbored by the Assessing Officer. According to the Assessing Officer there was a possibility of involvement of a broker where the broker name was mentioned as Direct in the special audit report. There was no material on record to show the leg of the transactions shown to be direct actually involved a broker. The Assessing Officer did not have any basis to change the parameters of identifying Ready-forward transactions adopted by the special auditor and the computation of net/overall profits as computed by the special auditor. As per the computation by the special auditor the Ready forward transactions resulted in overall profit of INR 54, 06, 54, 475/-. Ready-forward transactions - HELD THAT - By placing reliance of Explanation to section 37(1) inserted by the Finance (No 2) Act 1998 with retrospective effect from 01/04/1962 the Revenue has contended that no deduction can be allowed for loss of INR 40, 21, 73, 018/- arising from Ready-forward transactions. We have already rejected the contention of the Revenue that the Ready-forward contracts resulted in overall loss and have accepted the contention of the Assessee that the Ready-forward transactions resulted in the overall/net profits. Therefore the question of claiming deduction of losses does not arise. Whether purchase/sale cost of the Ready-forward Contract must be disallowed as per Explanation 1 to Section 37? - Ready-forward transactions contain two inter-connected legs namely the first or the ready-leg consisting of purchase/sale of certain securities at a specified price and the second or forward leg consisting of the corresponding sale/purchase of the same of similar securities at a letter date at a price determined on the first date. The Hon ble Supreme Court has in the case of BOI Finance Limited Vs Custodian 1997 (3) TMI 457 - SUPREME COURT held that Section 16 of the Securities Contracts (Regulation) Act prohibited only the entering into of a forward contract i.e. sale at a future date. The first leg involving purchase/sale of securities was legal. The two legs of the Ready forward Transaction were severable. The adjudication of Ground No. 12.2. to 12.5. which have been raised for the first time before the Tribunal would require further investigation into the bifurcation of Ready-forward transactions into first leg and second leg transaction. Further investigation would be required to identify first-leg transaction involving purchase of securities since according to Explanation 1 to Section 37 of the Act only expenses incurred can be disallowed. Disallowance on account of losses in Securities transactions - whether the loss is allowable deduction u/s. 28 and 36(i)(vii)? - HELD THAT - We concur with the CIT(A) and hold that the transactions under consideration were regular transactions undertaken by the Assessee during the ordinary course of business. There is no dispute that the Assessee had written off the amount to this extent of deduction for loss allowed by the CIT(A) during the relevant previous year and therefore the CIT(A) was correct in holding that the losses can be said to have crystallized during the relevant previous year. CIT(A) has reduced the amount of losses written off by the amount of recoveries made and had not allowed deduction for losses of INR 337.18 Crores for the reason the same were either not written off during the relevant previous year or could not be considered as having become final during the relevant previous year. Further in our view the genuineness of the loss suffered by the Assessee cannot be doubted in view of the independent assessment of gross exposure made by the Janakiraman Committee. Given the facts and circumstances in the present case we are of the view that the loss suffered by the Assessee was a result of both the nature of arrangements Assessee had with the brokers and the misconduct on the part of the employees/ex-employees of the Assessee during. Thus we hold that the loss was suffered by the Assessee during the normal course of business. We hold that deduction allowed by the CIT(A) represented loss suffered by the Assessee on account of regular transactions undertaken in ordinary course of business which were written off during the relevant previous year. Thus no infirmity in the order passed by CIT(A) in allowing deduction for such loss under Section 28 or Section 36(1)(vii) of the Act. Accordingly Ground No. 11 raised by the Revenue is dismissed.

Summary

1. ISSUES PRESENTED and CONSIDERED

The core legal questions considered by the Tribunal include:

(a) Whether conveyance expenses incurred by employees on tour are includible under Rule 6D of the Income Tax Rules, 1962 for disallowance purposes.

(b) Whether entertainment expenses incurred on employees are deductible under Section 37(2) of the Income Tax Act, 1961.

(c) Whether club expenses paid by the assessee are wholly and exclusively for business and hence deductible.

(d) Whether unrealized forward profits on foreign exchange contracts are assessable as income.

(e) Whether bad debts recovered during the year are taxable when provisions for such debts were not allowed as deduction in earlier years.

(f) Whether penal interest charged by RBI on CRR shortfall is deductible or constitutes penalty.

(g) Whether broken period interest paid on purchase of securities held as stock-in-trade is allowable as revenue expenditure.

(h) Whether excess interest paid under Corporate Cash Deployment Scheme (CCDS) is disallowable.

(i) Whether losses arising from transactions with brokers without written consent under Section 15 of the Securities Contract (Regulation) Act, 1956 (SCRA) are allowable.

(j) Whether losses from ready-forward transactions, including those considered illegal, are deductible or disallowable.

(k) Whether losses in securities transactions related to the securities scam are allowable as business losses or bad debts under Sections 28 and 36(1)(vii) of the Act.

(l) Admissibility and applicability of additional grounds raised by the Revenue relating to Explanation to Section 37(1) regarding illegal expenditure.

2. ISSUE-WISE DETAILED ANALYSIS

a) Conveyance Expenses on Tour (Ground 1)

The Assessing Officer (AO) disallowed INR 10,00,000 on the ground that conveyance expenses incurred by employees on tour must be included under Rule 6D for disallowance of travelling expenses. The Assessee contended that local conveyance expenses on tour are not covered under Rule 6D. The CIT(A) deleted the disallowance relying on the Bombay High Court ruling in CIT v. Gannon Dunkerly & Co. that local conveyance expenses incurred by employees on tour are not travelling expenses under Rule 6D. The Tribunal upheld the CIT(A) order, noting the disallowance was ad-hoc and the legal position that local conveyance expenses are excluded from Rule 6D disallowance. The Revenue's ground was dismissed.

b) Entertainment Expenses on Employees (Ground 2)

The AO disallowed INR 16,72,890 under Section 37(2) treating entertainment expenses on employees as non-deductible. The Assessee argued that expenditure on food and beverages to employees at their place of work is excluded from disallowance under Section 37(2), supported by CBDT Circular No. 644/1993 and the Delhi High Court decision in CIT v. Expo Machinery Ltd. The CIT(A) deleted the disallowance applying these principles. The Tribunal agreed, emphasizing that the AO failed to appreciate the distinction and that the expenditure was genuine, reasonable, and incurred at the place of work during official duties. The Revenue's appeal was dismissed.

c) Club Expenses (Ground 3)

AO disallowed INR 5,00,000 on ad-hoc basis from club membership expenses, questioning whether the entire expenditure was wholly and exclusively for business. The CIT(A) deleted the disallowance following Bombay High Court precedent in Otis Elevators Co. India Ltd. v. CIT and prior Tribunal decisions in the Assessee's own case. The Tribunal found no infirmity in the CIT(A) order and dismissed the Revenue's ground.

d) Unrealized Forward Profit on Foreign Exchange (Ground 4)

The AO added INR 1,15,75,022 as unrealized forward profit from foreign exchange contracts, contending income had accrued. The Assessee maintained that profit was notional until actual settlement. The CIT(A) deleted the addition relying on Madras High Court decision in Indian Overseas Bank v. CIT, which held that notional profits on unsettled forward contracts are not taxable. However, the Tribunal revisited this in light of the Supreme Court decision in CIT v. Woodward Governor India Pvt. Ltd., which held that exchange differences, including unrealized gains or losses on monetary foreign currency items, must be recognized in the Profit & Loss Account as per Accounting Standard 11 (AS-11). The Tribunal noted the Assessee's consistent accounting policy recognizing such gains/losses and reinstated the addition, directing the AO to recompute taking into account actual settlement profits/losses to avoid double taxation. The Revenue's ground was allowed.

e) Bad Debts Recovered (Ground 5)

The AO added INR 70,30,360 recovered on bad debts, contending it was taxable income. The Assessee argued that provisions for these bad debts were not allowed as deduction in earlier years, so recovery should not be taxed to avoid double taxation. The CIT(A) agreed and deleted the addition. The Tribunal concurred, noting the factual finding that provisions were disallowed under Section 36(1)(vii)(a) limits was uncontroverted. The Revenue's ground was dismissed.

f) Penal Interest Charged by RBI (Ground 6)

The AO added INR 91,402 as penal interest on CRR shortfall, treating it as penalty and disallowing deduction. The Assessee contended the amount represented differential interest not received, not a penalty. The CIT(A) deleted the addition, a decision upheld by the Tribunal relying on its earlier ruling for the Assessee and the factual circumstances showing no penalty was levied under RBI Act provisions. The Revenue's ground was dismissed.

g) Broken Period Interest on Securities (Ground 7)

The AO disallowed INR 5,17,32,848 broken period interest paid on securities held as stock-in-trade, treating it as capital expenditure. The Assessee contended it was revenue expenditure allowable as deduction. The CIT(A) allowed the deduction following Bombay High Court decision in American Express International Banking Corporation v. CIT and Tribunal precedents. The Tribunal affirmed this view, noting the issue is settled law that broken period interest paid on trading securities is allowable revenue expenditure. The Revenue's ground was dismissed.

h) Excess Interest Paid under CCDS (Ground 8)

The AO added INR 14,23,38,910 as excess interest paid under Corporate Cash Deployment Scheme, alleging violation of RBI guidelines. The Assessee argued no interest deduction was claimed and no penalty imposed. The CIT(A) deleted the addition relying on Tribunal decision in the Assessee's earlier years and Delhi Bench ITAT decision in ANZ Grindlays Bank case. The Tribunal confirmed the deletion, noting the CCDS was operated in fiduciary capacity and expenses were not debited to Profit & Loss Account. The Revenue's ground was dismissed.

i) Losses in Transactions with Broker under Section 15 of SCRA (Ground 9)

The AO disallowed losses of INR 74,86,000 plus INR 4,91,500 from transactions with brokers acting as principals without written consent, violating Section 15 of SCRA. The Assessee contended that delivery orders indicated broker acted as principal with consent and that Section 15 did not apply as the Assessee was not a stock exchange member. The CIT(A) deleted the disallowance. The Tribunal analyzed Section 15, which restricts members of recognized stock exchanges from acting as principals with non-members without written consent and disclosure. The Tribunal held Section 15 applies to members of recognized stock exchanges, and the Assessee, not being a member, was not covered. However, the Assessing Officer's finding that deal slips did not disclose broker acting as principal was uncontroverted. The Tribunal held the transactions violated Section 15 and disallowed the losses, directing AO to exclude these losses from computation. The Revenue's ground was allowed.

j) Losses in Ready Forward Transactions (Ground 10 and Additional Grounds 12.1 to 12.5)

The AO disallowed INR 40,21,73,018 losses from ready-forward transactions, treating them as illegal based on Janki Raman Committee findings and special audit report. The Assessee contended that all ready-forward transactions constitute a single class of business and inter-se set off of profits and losses is permissible, relying on CBDT Instruction dated 28/02/1995 and CIT(A) order deleting disallowance. The Tribunal upheld the CIT(A) order, holding the CBDT instruction binding and that all ready-forward transactions, legal or illegal, form a single class of business for set-off purposes, and only net profit is taxable. The Tribunal rejected the Revenue's contention that losses from illegal transactions cannot be set off against profits from legal transactions, noting the revised computation submitted by the Assessee was at the AO's direction and not conclusive. The Tribunal declined to admit additional grounds raising disallowance of purchase cost of securities in ready-forward transactions under Explanation to Section 37(1) as it required further investigation and facts not on record. The Revenue's grounds on ready-forward losses were dismissed.

k) Losses in Securities Transactions Related to Scam (Ground 11)

The Assessee claimed loss of INR 1,427.59 Crores on securities transactions due to fraud and embezzlement discovered by Janakiraman Committee and CBI investigations. The AO allowed deduction of INR 333.45 Crores only, disallowing INR 1,094.14 Crores on grounds of irregularity and non-crystallization. The Assessee contended losses were genuine, crystallized during the year, and allowable under Sections 28 and 36(1)(vii), relying on CBDT Circular No. 35-D/1965 and judgments including Supreme Court decision upholding the Special Court ruling that transactions under 15% Arrangement were not against public policy. The CIT(A) allowed deduction of INR 756.96 Crores after adjusting recoveries and disallowed balance for non-crystallization or non-finality. The Tribunal upheld the CIT(A) order, rejecting Revenue's contention that losses were illegal or not crystallized. The Tribunal noted the Supreme Court's binding observations affirming no public policy violation and accepted that losses due to embezzlement are incidental to business and deductible. The Revenue's ground was dismissed.

l) Additional Grounds on Explanation to Section 37(1)

The Revenue sought to raise additional grounds that losses from illegal ready-forward transactions are disallowable under Explanation to Section 37(1) inserted retrospectively. The Assessee opposed admission on grounds of delay, fresh facts, and new claims not before lower authorities. The Tribunal declined to admit these grounds due to lack of factual material and need for further investigation, rendering them infructuous. The Assessee's cross-objections were dismissed.

3. SIGNIFICANT HOLDINGS

"The local conveyance expenses and other actual expenses which are incurred by the employee while on tour for conducting the assessee's business cannot be considered as travelling expenses of the employee under Rule 6D of the Rules."

"The expression 'Entertainment Expenditure' under Section 37(2) excludes expenditure on food or beverages provided by an assessee to employees in office, factory or other place of their work, and expenditure incurred on employees during working hours even at places other than place of work is not disallowable if genuine and reasonable."

"Broken period interest paid by a bank on securities acquired as stock-in-trade is allowable as revenue expenditure and not capital expenditure."

"Unrealized profits on foreign exchange forward contracts, being notional in nature, are not taxable until actual settlement, but exchange differences on monetary foreign currency items must be recognized as income or expenditure as per AS-11 and Supreme Court ruling."

"Bad debts recovered during the year are not taxable if provisions for such debts were not allowed as deduction in earlier years, to avoid double taxation."

"Penal interest charged by RBI on CRR shortfall, when no penalty is levied, is not disallowable as penalty but is differential interest not received."

"Corporate Cash Deployment Scheme operated in fiduciary capacity with no interest expense claimed is not liable to addition on account of excess interest paid."

"Section 15 of SCRA applies to members of recognized stock exchanges and requires written consent for brokers acting as principals with non-members. Transactions without such consent are illegal and losses therefrom are disallowable."

"All ready-forward transactions, legal or illegal, constitute a single class of business and inter-se set off of profits and losses is permissible; only net profit is taxable and net loss is not allowed to be set off against other business income."

"Losses suffered due to securities scam and embezzlement by employees are incidental to business and deductible under Sections 28 and 36(1)(vii) if crystallized and written off in the relevant year, supported by Supreme Court and CBDT circulars."