THE issues before the Bench are - Whether an assessee trading in derivative contracts can treat the same as regular stock in trade; Whether the normal rule of valuation of stock-in-trade that they are valued at cost or market price whichever is less at the end of the year can be applied to derivative contracts; Whether the ordinary principle of commercial accounting requires that while anticipated loss is taken into account, anticipated profit in the shape of appreciated value of the closing stock is not brought into account; Whether "mark to market loss" arising on such contracts can be allowed, even though when there is no actual loss and Whether derivative contracts are not purely contingent in nature rather loss or profit is somewhat ascertainable in view of constant watch on daily market value. Answers to all these questions were answered in favour of the assessee.
Facts of the case
The assessee company engaged in the business of granting of loans and advances against shares and securities, also traded in derivative segment by entering into future and option contracts. Some of the future contracts could not be squared up at the end of the financial year. However, the assessee booked the expected loss in such contracts on mark-to-market basis. However, any likely profit was ignored. The assessee thus claimed a loss as calculated on mark-to-market basis claiming that he was following this practice consistently and was also as per recognized Accounting Standards. However, the AO rejected the claim on the ground that the derivative contracts are not stock in trade as there is no cost of acquisition. The AO further held that in such type of contracts no stock is actually purchased and no sale of stock is made. So, he finally held that the loss on account of mark-to-market basis was thus notional loss and was contingent in nature and cannot be allowed to be set off against taxable income. On appeal, the CIT(A) allowed the same. The CIT(A) agreed with the contentions of the assessee and held that derivative contracts are like stock-in-trade and as per the normal rule of valuation of stock-in-trade that they are valued at cost or market price whichever is less at the end of the year. Therefore, the CIT(A) held that any such loss on such valuation which is called “Mark to Market Loss” has to be allowed, even though it may appear to be a notional loss.
Aggrieved, the Revenue filed an appeal before the Tribunal.
Having heard the parties, the Tribunal held that,
++ the daily market rate of the said stock in question is taken and the difference between the market rate and the predetermined rate is daily calculated and the difference margin, if any, is received/paid to the broker and finally on the stipulated date the contracts are squared off resulting into actual loss or profit. The contracts in such type of cases can be squared off before the arrival of actual performance date of contract, as the profit and loss are calculated on daily basis and the margins are settled accordingly. Such type of contracts are not purely contingent in nature rather loss or profit is somewhat ascertainable in view of constant watch on daily market value and even the quantum of profit or loss though not actually ascertainable, can be anticipated in view of the trends of the market. The difference between the predetermined price and market price is settled daily on mark-to-market basis. In such type of contracts, it is not the stock value which is subject matter of the contract rather the contract itself is the stock in trade which is purchased by paying/depositing the initial margins on percentage basis to the broker taking into consideration maximum anticipated rise or fall in the price of the stock in future. As observed above, the difference of margin in calculated and settled on daily basis in view of the market rates and trends. The Supreme Court in the case of CIT v. Woodward Governor India (P.) Ltd, while dealing with the question as to whether the additional liability arising on account of fluctuation in the rate of exchange can be allowed to be adjusted pending actual payment of the varied, has observed that “expenditure” as used in section 37 in Income Tax Act may in the circumstances of a particular case cover an amount which is a “loss” even though said amount has not been given from the pocket of the assessee;
++ it has been further observed that the ordinary principle of commercial accounting requires that in the Profit & Loss account the value of stock in trade at the beginning and at the end of the year should be entered at cost or market price, whichever is lower. While anticipated loss is taken into account, anticipated profit in the shape of appreciated value of the closing stock is not brought into account, as no prudent trader would care to show increase profits before actual realization. Profits for income-tax purposes are to be computed in accordance with ordinary principles of commercial accounting, unless, such principles stand superseded or modified by legislative enactments. Unrealized profits in the shape of appreciated value of goods remaining unsold at the end of the accounting year and carried over to the following years account in a continuing business are not brought to the charge as a matter of practice, though, as stated above, loss due to fall in the price below cost is allowed even though such loss has not been realized actually;
++ respectfully following the decision of the Tribunal in the case of Edelweiss Capital Ltd., which view has further been followed by another co-ordinate Bench of this Tribunal in the case of Shri Ramesh Kumar Damani vs. The Addl. CIT for A.Y. 2006-07, order dated 26.11.2010], it can be safely held that it is not only the actual stock but derivatives can also be held as stock in trade and the principle “cost or market price whichever is lower” has been rightly followed by the assessee in valuing the derivatives and further when the derivates are held as stock in trade then whatever rules apply to the stock in trade will have to apply to their valuation also. While anticipated loss is taken into account while valuation of closing stock, anticipated profit in the shape of appreciated value of the closing stock is not brought into account, as not prudent trader would care to show increased profits before actual realization. Respectfully following the law laid down by the authorities as mentioned above, we hold that the assessee has rightly claimed markto-market loss of Rs.1,38,93,853/- which is liable to be allowed. The CIT(A) has rightly allowed the claim of the assessee, his order is hereby upheld.
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