2014 (1) TMI 1736 - AT - Income Tax

Mark-to-Market loss arising on valuation of forward exchange contracts on the closing date of accounting year is not a national loss and therefore allowable - Held that - As relying on the decision of DCIT vs. Bank of Bahrain and Kuwait (2010 (8) TMI 578 - ITAT, MUMBAI) to hold that the liabilities for foreign exchange was incurred during the normal course of assessee s business and in fact the gain earned on such revaluation having been accepted and brought to tax in the respective years, there is no reason to arrive at a different conclusion in this year merely because there is a loss. Thus directing the AO to delete the addition - Decided in favour of assessee.

Summary

Issues:
- Allowability of Mark-to-Market loss on valuation of forward exchange contracts for A.Y. 2009-10.

Analysis:
The appeal before the Appellate Tribunal ITAT Mumbai concerned the Revenue's challenge against the Ld. CIT(A)'s decision regarding the treatment of a Mark-to-Market loss of &8377; 38,09,880/- arising from the valuation of forward exchange contracts for the assessment year 2009-10. The Revenue contended that the Ld. CIT(A) erred in allowing this loss as deductible. The core issue revolved around whether such losses were notional and contingent, thereby not qualifying for deduction under the Income Tax Act, 1961.

Upon examination, it was revealed that the assessee, a trader and exporter of diamonds, regularly entered into Forward Contracts to hedge against exchange rate fluctuations. The assessee followed accounting standard-11, restating its US Dollar denominated assets and liabilities, including forward contracts, in its profit and loss account. The Revenue argued that Mark-to-Market losses were notional and contingent liabilities, hence not allowable for deduction. The AO emphasized that the Income Tax Act did not provide specific treatment for Mark-to-Market accounting and that reporting such losses based on accounting guidelines did not make them tax-deductible. The AO maintained that only crystallized liabilities were deductible, and as such, MTM losses were not allowable.

The Ld. CIT(A) considered various judicial decisions, including the Woodward Governor case and the ONGC case, which emphasized the importance of adhering to the mercantile system of accounting and recognizing liabilities with reasonable certainty, even if not yet discharged. The Ld. CIT(A) also referenced the decision of the Special Bench of Jurisdictional Mumbai ITAT in the Bank of Bahrain and Kuwait case, which supported the allowance of MTM losses on forward foreign exchange contracts. Ultimately, the Ld. CIT(A) upheld the allowance of the Mark-to-Market loss in line with the principles laid down in the aforementioned cases.

The Appellate Tribunal ITAT Mumbai, after thorough consideration, affirmed the Ld. CIT(A)'s decision, noting that the application of established legal principles and precedents supported the allowance of the Mark-to-Market loss in the case at hand. The Tribunal found no grounds for interference and dismissed the Revenue's appeal, thereby confirming the Ld. CIT(A)'s order. The judgment highlighted the importance of consistent accounting practices, adherence to accounting standards, and the recognition of liabilities based on the mercantile system, ultimately leading to the decision in favor of the assessee.

In conclusion, the judgment underscored the significance of following established accounting norms and principles in determining the deductibility of Mark-to-Market losses on forward exchange contracts, emphasizing the need for liabilities to be recognized with reasonable certainty, even if not yet settled, for tax purposes.