THE issues before the Bench are - Whether any loss made on the
last date of the accounting year on account of derivative contract outstanding
is allowable as per provisions of Sec 37(1); Whether assessee is entitled to
adjust the actual cost of imported assets acquired in foreign currency on
account of fluctuation in the rate of exchange at each of the relevant balance
sheet dates, pending actual payment of the liability u/s 43A and Whether losses
arising out of “Mark to Market” transaction can be considered as ascertained
losses and allowable as a business expenditure. And the verdict goes in favour
of the assessee.
The assessee company is a LTU,
whose assessment for the AY was completed u/s 143(3) on 31.8.2010. The CIT
issued show cause notice u/s 263 19.7.2011 stating as to why the assessment made
u/s 143(3) should not be recalled and fresh assessment be made in view of the
fact that the deduction claimed on forex derivative on account of losses arising
out of the “Mark to Market” transactions of Rs.43.78 crores, since these losses
were notional losses, as no such sale or settlement had taken place and
therefore, were contingent in nature. In response thereto, assessee had filed
reply giving details and stating that it had entered into derivative contract in
the nature of currency swaps and simple options. These derivative contracts were
entered for hedging currency related risk in connection with various foreign
currencies exposures like import of raw materials, export of finished products
etc. It was further stated that accounting treatment followed was in line with
AS-1 issued by ICAI. That assessee had been consistently following mercantile
method of accounting and as per commercial principle of accounting, “the profit”
was to be arrived at after taking into account all the accrued receipts and
expenses and comparing of trading assets between two different dates. That under
the mercantile system of accounting a revenue loss or expenditure incurred as a
result of devaluation was allowable in the year in which such devaluation takes
place and therefore relying on the said ratio, MTM margin losses were rational
and not contingent in nature. Hence they should be allowed as business
deduction. That the loss on account of derivative contract outstanding was an
allowable deduction while working out profits and gains of business as envisaged
in section 28(i) which was in accordance with principles of prudence and other
applicable guidelines as per Accounting Standards notified by the Companies
“Accounting Standards” Rules, 2006 read with Schedule -VI of the Companies Act,
1956. CIT had not accepted the contention of assessee and stated that MTM loss
was a notional loss as no sale/conclusions/settlement of contract had taken
place and the asset continues to be owned by the Assessee-Company. Such a
notional loss would be contingent in nature and cannot be allowed to be set off
against the taxable income. That the same should be added back for the purpose
of computing taxable income of assessee. The CIT stated that the order passed by
AO was erroneous to the extent of such loss considered to be an allowable and
also prejudicial to the interest of revenue. Hence, CIT directed the AO to
modify the order passed u/s 143(3) and make addition of Rs.43.78 crores to the
income of the assessee, since loss was contingent in nature and the same would
be considered in the year in which the transaction was settled.
Before Tribunal, the assessee's
counsel had contended that the above issue was squarely covered by the decision
of the Apex Court in the case of CIT V/s Woodward Governor India P.Ltd
(2009-TIOL-50-SC-IT),
wherein it was held that "Loss” suffered by the assessee on account of
fluctuation in the rate of foreign exchange as on the date of the balance-sheet
is an item of expenditure under section 37(1). It was further submitted that in
the case of DCIT V/s Kotak Mahindra Investment Ltd., 2013-TIOL-362-ITAT-MUM,
it had been held “mark to market loss”, arising on
derivative contract can be allowed, even though there was no actual loss. That
the derivatives contract were not purely contingent in nature where profit or
loss was ascertained in view of constant watch on daily market value. It was
also submitted that similar issue was considered by the SC in the case of ONGC
Ltd V/s CIT (2010-TIOL-20-SC-IT), wherein it
was held that “Loss on account of fluctuation in rate of foreign exchange as on
last date of balancesheet was allowable as deduction as explained u/s 37(1). It
was further submitted that similar issue was also considered by ITAT in the case
of M/s. Reliance Communications Limited V/s ACIT (2013-TIOL-134-ITAT-MUM) wherein
also the order passed by CIT u/s 263 on the issue as to whether loss on the
settlement day or reporting day on the acquired derivative instrument for
hedging was to be allowed or not. In the said case CIT stated that “Mark to
Market loss” on acquired derivative instrument by assessee for hedging on the
recognized reporting day were notional loss and hence contingent in nature, not
allowable for set off against the total income. CIT stated that AO was wrong in
allowing such set off. The AR submitted that the Tribunal after considering the
decision of the SC in the case of Woodward Governor India P.Ltd and also the
CBDT instruction of 3/2010 held that the action of the AO was not erroneous and
prejudicial to the interest of Revenue and order of CIT passed u/s 263 on the
above issue was quashed. AR submitted that since above issue was covered in
favour of the assessee by the above decisions, the order of CIT(A) be quashed.
On the 13th November, 2013, DR requested for time to go through the case laws
relied upon by AR and, the case was adjourned to 20.11.2013. On the date fixed
for hearing i.e.20.11.2013, the DR conceded that the issue was covered by the
aforesaid decisions in favour of the assessee that unrealized loss due to
foreign exchange fluctuation in foreign currency transactions as on the last
date of accounting year was deductible.
Held that,
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it is relevant
to state that in the case of Woodward Governor India (P.) Ltd., SC observed and
held that the assessee debited to its profit and loss account certain unrealized
loss due to foreign exchange fluctuation in foreign currency transactions
towards revenue items as on the last day of the accounting year. The A.O. held
that the liability as on the last date of the previous year was not an
ascertained but a contingent liability. Resultantly, the same was added back to
the total income. The CIT(A) echoed the assessment order. However, the Tribunal
held that the claim of the assessee for deduction of unrealized loss due to
foreign exchange fluctuation as on the last date of the previous year was
deductible. The said order of the Tribunal was upheld by the HC. On further
appeal by the department, the SC held that the loss suffered by the assessee is
on revenue account towards foreign exchange difference as on the date of balance
sheet and is an item of expenditure deductible u/s 37(1). It further observed
than an enterprise has to report outstanding liability relating to import of raw
material using closing rate of foreign exchange and any difference, loss or
gain, arising on conversion of said liability at closing rate should be
recognized in profit and loss account for reporting period. From the judgment of
the SC it can be clearly deduced that unrealized loss due to foreign exchange
fluctuation in foreign currency transactions on revenue item as on the last date
of the accounting year is deductible;
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the Tribunal in the case of Kotak Mahindra Investment Ltd. also considered a
similar issue. In the said case the assessee-company was 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 contract. Some of the
future contracts could not be squared up at the end of the financial year. The
assessee booked the expected loss in such contracts on MTM basis. The assessee
thus claimed a loss as calculated on MTM basis claiming that he was following
this practice consistently. That it was also as per recognized Accounting
Standard. AO rejected the claim on the ground that the derivative contracts were
not stock in trade as there was no cost of acquisition. He finally held that the
loss on account of “MTM” basis was thus a notional loss and was contingent in
nature and could not be allowed to be set off against taxable income. On appeal,
the CIT(A) allowed the same by agreeing with the contention of the assessee that
such loss on such valuation which is called “MTM” has to be allowed even though
it may appear to be a notional loss. The Tribunal while confirming order of
CIT(A) and allowing the said loss placed reliance on the decision of SC in the
case of Woodward Governor India (P.) Ltd. and also the decision of Tribunal in
the case of Edelweiss Capital Ltd V/s ITO in ITA No.5324/Mum/2007 (AY-2004-05)
dated 10.11.2010 and the decision in the case of Ramesh Kumar Damani V/s
Addl.CIT in ITA No.1443/Mum/2009 (AY-2006-07)dated 26.11.2010;
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similar issue was considered by SC in the case of ONGC Ltd. The assessee a
public sector undertaking was engaged in the capital intensive exploration and
production of petroleum products for which it had to heavily depend on foreign
loans to cover its expenses, both capital and revenue and for payment to
non-resident contractors in foreign currency for various services rendered. The
assessee made three types of foreign exchange borrowings i.e.(i) on revenue
account; (ii) on capital account, and (iii) for general purposes. Some of the
loans became repayable in the relevant accounting year and the date of payment
of some loans fell after the end of the relevant accounting year. The assessee
revalued its foreign exchange loans in foreign exchange on revenue account, on
capital account and for general purposes outstanding as on 31-3-1991, and
claimed the differences between their respective amounts in Indian currency as
on 31-3-1990 and 31-3-1991 as revenue loss under section 37(1) in respect of
loans used in revenue account. The assessee also treated the similar difference
in foreign exchange as an increased liability u/s 43A. The AO allowed the
deduction claimed u/s 37(1), taking into consideration the increased foreign
exchange liability and repaid in the accounting year for the purpose of
depreciation. He did not however, allow the claim for foreign exchange loss on
loans both in relation to capital as well as revenue account which were
outstanding on the last day of accounting year. On appeal, the CIT(A) affirmed
the view of AO in relation to deduction u/s 37 of the interest on loans
outstanding on the last day of the accounting year but allowed the benefit of
increased liability for computation u/s 43A in relation to loss outstanding on
the last day of the accounting year. Hence, the assessee as well as department
took the matter in appeal to the Appellate Tribunal. The Tribunal held that the
loss claimed by the assessee on revenue account was allowable u/s 37(1) and also
rejected the appeal of the department and held that the assessee was entitled to
adjust actual cost on imported assets acquired in foreign currency on account of
fluctuation in the rate of exchange in terms of section 43A. On appeal by the
department, the HC reversed the decision of the Tribunal on both the issues. On
further appeal to SC, the decision of HC was reversed and it was held that (a)
that the loss claimed by the assessee on account of fluctuation in the rate of
foreign exchange as on the date of the balance-sheet was allowable as an
expenditure u/s 37(1), and (b) that the assessee was entitled to adjust the
actual cost of imported assets acquired in foreign currency on account of
fluctuation in the rate of exchange at each of the relevant balance sheet dates,
pending actual payment of the liability u/s 43A, prior to its amendment by
Finance Act, 2002. In view of above decisions, it is clear that the loss due to
foreign exchange fluctuation in foreign currency transactions in derivatives has
to be considered on the last date of accounting year and it is deductible u/s
37(1). Therefore, in allowing the said claim of the assessee by AO, the action
of the AO is in consonance with the decisions of the Apex Court and also the
view taken by the Tribunal in the cases cited hereinabove. Hence, the view taken
by AO to allow loss of Rs.43.78 crores while making assessment u/s 143(3) on
account of derivative contract outstanding is not an erroneous view taken by AO,
nor the action of AO is prejudicial to the interest of revenue. Hence, the order
of CIT u/s 263 to hold that the action of AO is erroneous to the extent the loss
considered as allowable on account of derivative contracts outstanding as on the
date of balance sheet i.e. 31.3.2008 is neither justified nor in accordance with
law. Hence, we quash the said order of CIT by allowing the grounds of appeal
taken by the assessee. In the result, the appeal of the assessee is allowed
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