2016 (4) TMI 706 - AT - Income Tax

MTM losses disallowed - loss in respect of cancellation of forward contracts disallowed being speculative in nature - treatment of forex losses or gains - Held that - Assessee had recognized a loss of ₹ 2,13,43,725/- on forward foreign exchange contract of 83,45,000/- which were made in order to cover the loss due to fluctuation in exchange rate and were pending for maturity at the close of the year. At the same time the assessee also booked a gain of ₹ 4,48,05,788/- on the outstanding export receivable of 1,01,18,500/- following the same accounting system and accounting standard 11 which deals with the treatment of forex losses or gains which were not actually realized but a likely gain if the value of receivables are realized at the yearend. The same practice was being followed in the earlier year and was also accepted by the Revenue. The need to hedge is a commercial expediency and necessity which is practically followed in all the business houses engaged in import/export and these days specially the exchange rate is highly volatile. The special bench decision in case of DCIT Vs Bank of Bahrain and Kuwait (2010 (8) TMI 578 - ITAT, MUMBAI ) the special bench held that MTM losses in respect of forward foreign exchange contract debited to the profit and loss account are allowable and further held (i) a binding obligation is accrued against the assessee the moment it entered into forward foreign exchange contract(ii) consistent accounting method followed by the assessee to account for the forex gain and loss at the yearend based upon the current exchange rate cannot be disregarded(iii) the liability is said to have crystallized when a pending obligation on the date of balance sheet is determinable with reasonable certainty(iv) as per AS-11 when the transaction is not settled in the same accounting year as that in which it occurred , the exchange difference arises over more than one accounting period (v)in the ultimate analysis , there is no revenue effect and it is only timing of taxation of loss/profit. Following the decision of apex court in the case of Woolward Governor India Pvt. Ltd (2009 (4) TMI 4 - SUPREME COURT ) and special bench decision in the case of Bank of Bahrain and Kuwait(supra) , we are of the considered view that case of the assessee is fully covered by the decisions of the coordinate note benches and we therefore respectfully following the same allow the appeal of the assessee on the issue of MTM losses by deleting the disallowance - Decided in favour of assessee.

Summary

Issues Involved:
1. Whether the loss of Rs. 2,13,43,725/- on cancellation of forward contracts is speculative in nature under Section 43(5) of the Income Tax Act.
2. Whether the loss incurred on foreign exchange fluctuation on a marked-to-market basis is allowable as a business loss under Section 37(1) of the Income Tax Act.

Detailed Analysis:

Issue 1: Speculative Nature of Loss
The primary issue is whether the loss of Rs. 2,13,43,725/- incurred by the assessee on cancellation of forward contracts is speculative under Section 43(5) of the Income Tax Act. The assessee argued that the loss was due to the restatement of outstanding forward contracts at the year-end exchange rate and not from speculative transactions. The Assessing Officer (AO) and the Commissioner of Income Tax (Appeals) [CIT(A)] held that the loss was speculative because the transactions were settled without actual delivery, thus falling under the definition of speculative transactions as per Section 43(5). The CIT(A) referenced several judicial precedents, including the Karnataka High Court in V. N. Sarsety V/s CIT and the Supreme Court in CIT Vs Shantilal (P) Limited, to support this view.

Issue 2: Allowability of Loss under Section 37(1)
The second issue is whether the loss incurred on foreign exchange fluctuation on a marked-to-market basis is allowable as a business loss under Section 37(1). The assessee cited various judicial pronouncements, including the Supreme Court's decision in Woodward Governor (312 ITR 254) and the Mumbai ITAT Special Bench in Bank of Bahrain & Kuwait (2010) 5 ITR (Trib) 301, which held that such losses are not notional and are allowable as business expenses. The AO and CIT(A) distinguished these cases on the grounds that the losses were speculative and not crystallized liabilities.

Tribunal's Findings:
The Tribunal considered the rival submissions and reviewed the materials on record. It noted that the assessee had recognized a loss of Rs. 2,13,43,725/- on forward contracts to cover the risk of foreign exchange fluctuation, which were pending maturity at the year-end. Simultaneously, the assessee booked a gain of Rs. 4,48,05,788/- on outstanding export receivables, following the same accounting system and AS-11 standards.

The Tribunal referenced the Special Bench decision in DCIT Vs Bank of Bahrain and Kuwait, which held that marked-to-market losses on forward foreign exchange contracts are allowable. The Tribunal also cited various decisions from coordinate benches, including Venus Jewel, Rikin Exports, and Inter Jewel Private Limited, which supported the assessee's position.

The Tribunal concluded that the assessee's case was covered by these judicial decisions and allowed the appeal. It directed the AO to delete the disallowance of Rs. 2,13,43,725/-.

Conclusion:
The Tribunal allowed the appeal, holding that the loss of Rs. 2,13,43,725/- incurred on the restatement of forward contracts at the year-end exchange rate is not speculative and is allowable as a business loss under Section 37(1) of the Income Tax Act. The AO was directed to delete the disallowance.