ITAT Mumbai Ruling on Forex Gains, Club Expenses, CSR Donations and Section 80JJAA Deduction

The Income Tax Appellate Tribunal, Mumbai Bench, in the case of Mahindra and Mahindra Financial Services Ltd Vs DCIT, examined multiple contentious issues for AY 2020-21, including:

  • Taxability of notional foreign exchange gains on derivative contracts
  • Allowability of club membership and facility expenses
  • Eligibility of Section 80G deduction on donations forming part of CSR
  • Admissibility of a belated Section 80JJAA claim not made in the return
  • Various computational and credit issues
  • Validity of deletion of penalty proceedings under Section 270A

The Tribunal dealt with cross-appeals filed by the assessee and the Revenue, and issued a consolidated order.

Background of the Case

The assessee, a registered NBFC engaged in financing vehicles, construction equipment, SME loans and distribution of financial products, filed its original return of income for AY 2020-21 on 15.02.2021, declaring income of Rs. 21,38,20,37,440/-. A revised return was filed on 31.03.2021, declaring the same income. The case was selected for complete scrutiny.

During assessment, the Assessing Officer (AO) made several additions and disallowances. In the course of assessment, the assessee also raised an additional claim in respect of foreign exchange gains on derivatives. In appeal before the Commissioner of Income Tax (Appeals), National Faceless Appeal Centre, Delhi (CIT(A)), the assessee further raised an additional claim for deduction under Section 80JJAA. The CIT(A) partly allowed the assessee’s appeal and also purported to quash penalty proceedings initiated under Section 270A. Both parties approached the Tribunal.

The Tribunal’s decision can be conveniently analysed under separate heads.

Forex Derivative Gains: Additional Claim Allowed in Principle

Factual Matrix

The assessee had raised foreign currency borrowings, namely:

  • External Commercial Borrowings (ECB); and
  • Foreign Currency Non-Repatriable (FCNR) loans

To hedge against foreign exchange fluctuation risk on these borrowings, the assessee entered into forward exchange/derivative contracts, normally with the same lenders.

Accounting treatment was as follows:

  1. Foreign currency borrowings were recorded at the exchange rate on the date of drawdown.
  2. At year-end (31 March), the outstanding borrowings were revalued at closing exchange rates and resultant gain/loss was routed through the Profit & Loss account.
  3. Similarly, the derivative contracts were revalued at year-end and mark-to-market gains/losses on these contracts were also taken through the Profit & Loss account.

For the relevant year:

  • Notional loss on reinstatement of foreign currency borrowings as on 31.03.2020 amounted to Rs. 1,50,19,15,854/-, debited under “Finance Costs”.
  • Net fair value movement on derivative instruments included notional gains of Rs. 1,09,50,68,169/- forming part of Rs. 1,19,72,85,169/- shown under “Net loss / gain in fair value of derivative financial instruments” in “Finance Costs”.

In the tax computation:

  • The assessee disallowed (added back) the notional foreign exchange loss on borrowings of Rs. 1,50,19,15,854/-.
  • However, due to an internal coding change in its accounting system, the assessee did not exclude the corresponding notional forex gains of Rs. 1,09,50,68,169/- on derivatives from taxable income in the return.

During assessment, the assessee:

  • Made an additional claim seeking reduction of Rs. 1,09,50,68,169/- from taxable income; and
  • Without prejudice, contended that if such gain was held taxable, then the earlier disallowed notional loss on borrowings of Rs. 1,50,19,15,854/- should be allowed as a deduction.

The AO rejected the claim, citing Goetz (India) Ltd. v. CIT (2006) 184 ITR 323 (SC), on the ground that no revised return was filed. The CIT(A) endorsed this approach, further stating that:

  • The assessee was aware of the notional character of the gain;
  • Accounting method was established and disclosed in the tax audit report; and
  • No adequate working or reconciliation for the sum of Rs. 1,09,50,68,169/- was provided.

Assessee’s Contentions before ITAT

The assessee argued:

  • It had adopted a consistent approach in earlier and subsequent years:
    • Not claiming notional loss on revaluation of ECB/derivatives; and
    • Not offering corresponding notional gains to tax.
  • The omission arose from bifurcating the earlier single general ledger code (GL Code 50925) into separate codes for ECB and derivatives from AY 2020-21 onwards. While preparing the return and tax audit report, the derivative-related code was inadvertently missed.
  • All detailed workings, ledgers and contract-wise statements were furnished before the AO, CIT(A) and Tribunal, and even a revised tax audit report was filed online on 18.08.2022 with an explanatory note.
  • Appellate authorities are empowered to entertain fresh claims even if not made in the original return, relying on:
    • National Thermal Power Co. Ltd. v. CIT, 97 Taxman 358 (SC)
    • Jute Corporation of India Ltd. v. CIT, 187 ITR 688 (SC)
    • CIT v. Pruthvi Brokers & Shareholders Pvt. Ltd. 349 ITR 336 (Bombay HC)
    • ITO v. Raj Mistry & Eskon Developer (2024) 163 taxmann.com 43 (Mumbai Tribunal)
  • Taxing the notional gain without corresponding deduction for notional loss would amount to taxation of pure book entries with no real income element, contrary to the settled principle that only real income can be taxed.

On the Tribunal’s direction, the assessee produced details for five assessment years (AY 2018-19 to AY 2022-23), including tax audit reports, computations and ledger extracts, showing a consistent pattern of:

  • Disallowing notional loss; and
  • Not offering notional gains to tax.

Tribunal’s Findings

The Tribunal held:

  1. Consistency in Tax Treatment

    • Documentary evidence over five years established a uniform practice: notional forex losses on year-end revaluation of ECB and derivative contracts were not claimed, and corresponding notional gains were not offered.
    • The Department had also followed the same approach by disallowing losses and not taxing gains.

  2. Inadvertent Omission Explained

    • The change in GL codes and the missed extraction of data from the derivative-specific code plausibly explained the omission. The Tribunal accepted the bona fides of the error.

  3. Rule of Consistency & Real Income Principle

    • In absence of any change in law or facts, consistent treatment should not be disturbed.
    • Taxing notional gains while disallowing notional losses would run counter to the real income concept.

  4. Fresh Claim Before Appellate Authorities

    • The Tribunal followed **National Thermal Power Co.