2013 (8) TMI 941 - AT - Income Tax

marked to market loss on forward covers outstanding as on 31-3-2008 - assessee is entitled to claim the loss

Issues Involved:
1. Allowability of "marked to market" loss on forward contracts.
2. Applicability of Section 43(5)(d) of the Income Tax Act.
3. Applicability of Section 37(1) of the Income Tax Act.
4. Relevance of CBDT Instruction No.3 of 2010.
5. Interpretation of judicial precedents.

Issue-Wise Detailed Analysis:

1. Allowability of "Marked to Market" Loss on Forward Contracts:
The assessee, engaged in the business of manufacturing and sale of cigarettes, claimed a "marked to market" loss of Rs. 40,00,107 on forward contracts as of 31-3-2008. The Assessing Officer disallowed this loss, treating it as notional, based on CBDT Instruction No.3 of 2010. The assessee argued that the loss was real and related to hedging foreign currency exposure, and thus should be allowed as a business expenditure under Section 37(1). The CIT (A) upheld the disallowance, considering the loss as notional and contingent. However, the ITAT found that the forward contracts were entered into in the ordinary course of business for underlying export/import transactions, and thus the loss was not notional but real and allowable as a business expenditure.

2. Applicability of Section 43(5)(d) of the Income Tax Act:
The Assessing Officer and CIT (A) considered the loss on forward contracts as speculative under Section 43(5)(d). However, the ITAT noted that Section 43(5)(d) excludes eligible transactions in derivatives carried out in recognized stock exchanges from being treated as speculative transactions. Since the forward contracts were linked to the assessee's export/import business, they did not fall under speculative transactions as per Section 43(5)(d).

3. Applicability of Section 37(1) of the Income Tax Act:
The Assessing Officer argued that the loss could not be allowed under Section 37(1) as it was not an actual expenditure. However, the ITAT observed that the loss was incurred in the ordinary course of business and was a binding obligation. The ITAT relied on judicial precedents, including the Supreme Court's decision in CIT vs. Woodward Governor India Pvt. Ltd., which allowed such losses as business expenditures under Section 37(1).

4. Relevance of CBDT Instruction No.3 of 2010:
The Assessing Officer and CIT (A) relied on CBDT Instruction No.3 of 2010 to disallow the loss, considering it as notional. However, the ITAT found that this instruction was not applicable to the assessee's case, as it related to derivative transactions, whereas the assessee's forward contracts were linked to actual business transactions. The ITAT emphasized that CBDT instructions cannot override settled legal principles and judicial precedents.

5. Interpretation of Judicial Precedents:
The ITAT relied on several judicial precedents, including the Supreme Court's decision in CIT vs. Woodward Governor India Pvt. Ltd. and the Special Bench decision in DCIT vs. Bank of Bahrain and Kuwait, which supported the allowability of such losses as business expenditures. The ITAT also referred to decisions of the Gujarat High Court and Bombay High Court, which held that losses on forward contracts linked to business transactions are not speculative and are allowable as business losses.

Conclusion:
The ITAT concluded that the assessee's claim of Rs. 40,00,107 as "marked to market" loss on forward contracts was allowable as a business expenditure under Section 37(1). The forward contracts were linked to the assessee's export/import business and were not speculative transactions under Section 43(5)(d). The ITAT set aside the order of the CIT (A) and directed the Assessing Officer to delete the addition of Rs. 40,00,107. The appeal was allowed in favor of the assessee.

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