2017 (2) TMI 923 - AT - Income Tax

Accrual of income - Addition made on account of notional gain on forward contract - speculation income / gains - Held that - From the record, we found that as per the practice followed by the assessee - company, the notional gain or loss on forward contract is debited or credited to the P&L account for the year in which the forward contract is settled. The fundamental principle of taxing income under the mercantile system of accounting is the time of accrual. It is not material whether the amount has been received at the time of accrual or not. The income is accrued when the assessee acquires the right to receive it. While deleting the addition made on account of notional gain on forward contract the CIT(A) had taken note of the fact that in case of Woodward Governor India Pvt. Ltd. (2009 (4) TMI 4 - SUPREME COURT )had dealt with the loss suffered by assessee in respect of revenue liability on account of exchange difference as on the date of balance sheet. Thereafter, considering the decision of Madras High Court in case of Indian Overseas Bank 1990 (2) TMI 43 - MADRAS High Court CIT(A) concluded that estimated, anticipated income arrived at on the basis of rate of exchange which prevailed on the last date of forward contract in foreign currencies only represents notional profit and could not be subject to tax. Respectfully following the proposition laid down by Madras High Court, we do not find any infirmity in the order of CIT(A) for deleting the addition made by AO on account of notional gain on forward contract. However, AO is at a liberty to verify that this gain has been offered for taxation in the subsequent years when it actually arose - Decided against revenue

Summary

Issues:
1. Taxability of notional gain on forward contracts not offered for taxation.
2. Justification for treating gain on forward contract as notional and not taxable.
3. Application of accounting standards and legal provisions to determine tax liability on notional gain.

Analysis:
1. The appeal pertains to the taxability of notional gain on forward contracts for the assessment year 2011-12. The Revenue contested the deletion of assessed speculation income of INR 45,47,858 on forward contracts not offered for tax by the assessee. The primary issue was whether the CIT(A) was justified in deleting the assessed speculation income.

2. The Revenue argued that the gain on forward contracts should be treated as speculative gain under section 43(5) of the IT Act and taxed in the same accounting year. The AO added the notional gain to the total income of the assessee based on the mercantile system and matching principle of accounting. However, the CIT(A) deleted the addition by relying on the company's practice of debiting or crediting notional gain or loss on forward contracts to the P&L account only when the contracts are settled.

3. The CIT(A) referred to the company's accounting policy regarding forward contracts and noted that the notional gain was not taken into account as per the regular practice followed by the company. The CIT(A) also cited the decision of the Hon'ble Madras High Court in Indian Overseas Bank vs CIT (1990) 183 ITR 200, emphasizing that notional profits based on exchange rates prevailing at the last date of the contract are not taxable until actual settlement. The CIT(A) concluded that the estimated profit on forward contracts represented notional income and could not be subjected to tax until realization.

4. The ITAT Mumbai upheld the CIT(A)'s decision to delete the addition of notional gain on forward contracts. The tribunal agreed that the notional gain should not be taxed until the contracts are settled, in line with the principles of accrual under the mercantile system of accounting. The ITAT directed the AO to verify the tax treatment of the gain in subsequent years when it actually materializes. Ultimately, the appeal of the Revenue was dismissed, affirming the CIT(A)'s order.

This detailed analysis highlights the key legal arguments, accounting principles, and judicial precedents considered in the judgment regarding the taxability of notional gain on forward contracts, providing a comprehensive overview of the case.