2017 (8) TMI 851 - AT - Income Tax

Mark-to-Market losses arising on revaluation of forward contract agreements on the closing date of accounting year - Held that - he assessee is into the business of import and export of diamonds and restate foreign denominated assets and liabilities at year-end in Indian rupees and recognize resultant profit or gain in the profit & loss account. This accounting methodology is consistently being followed by the assessee and further the same accounting treatment has been given to assets as well as liabilities. The Ld. CIT(A) has noted that the assessee has recognized gain in similar fashion for Rs. 331.86 Lacs in the impugned AY. The foreign exchange contracts have been entered into by the assessee to hedge against the foreign exchange risk arising against import / export transactions carried out by the assessee. It is also an admitted fact that quantum of foreign exchange contracts stands fully covered by the underlying business assets i.e. Sundry Debtors. Therefore on facts and circumstances we find that Ld. CIT(A) has clinched the issued in the right perspective. The matter stood in assessee s favor by several judicial pronouncements as rightly observed by Ld. CIT(A). Foreign currency forward contracts have expired in the next assessment year when actual loss on these transactions has been ascertained. Therefore in principal while upholding the decision of Ld. CIT(A) we deem it fit to restore the matter back to the file of Ld. AO for limited purpose of verifying the fact that the actual resultant loss on forward contracts has first been adjusted from the loss claimed by the assessee in the impugned AY and resultant gain if any has been offered to tax and there is no double deduction of the losses. The assessee is directed to provide the requisite information / documents to substantiate his claim in this regard failing which the Ld. AO shall be at liberty to decide the matter on the basis of material available on record.

Summary

Issues Involved:
1. Allowability of 'Mark-to-Market' losses on revaluation of forward contract agreements.
2. Consistency in accounting treatment of foreign exchange transactions.
3. Applicability of judicial precedents on the treatment of foreign exchange losses.

Issue-wise Detailed Analysis:

1. Allowability of 'Mark-to-Market' losses on revaluation of forward contract agreements:
The primary issue contested in the appeal is the disallowance of Rs. 57.18 Lacs as 'Mark-to-Market' (MTM) losses on revaluation of forward contract agreements. The assessee argued that these losses were consistent with Accounting Standard-11 (AS-11) issued by the Institute of Chartered Accountants of India. The Assessing Officer (AO) disallowed the losses, considering them notional and contingent. However, the CIT(A) allowed the losses, emphasizing that the assessee consistently restated foreign denominated assets and liabilities at year-end and recognized the resultant gain or loss in the profit and loss account. The CIT(A) underscored that the forward contracts were integral to the business and not speculative in nature, thus making the losses allowable as business losses.

2. Consistency in accounting treatment of foreign exchange transactions:
The assessee consistently followed the accounting policy of restating foreign denominated assets and liabilities at year-end and recognizing the resultant gain or loss in the profit and loss account. The CIT(A) noted that the assessee had recognized a gain of Rs. 331.86 Lacs in the same manner for the impugned assessment year. The CIT(A) concluded that the AO could not selectively disallow the losses while accepting the gains. The CIT(A) cited the principles laid down by the Hon. Supreme Court in the case of Woodward Governor India P. Ltd. and Bharat Earth Movers, which support the consistent application of accounting standards and recognition of liabilities even if they are discharged at a future date.

3. Applicability of judicial precedents on the treatment of foreign exchange losses:
The CIT(A) relied on several judicial precedents, including the decision of the Special Bench of the Tribunal in DCIT Vs. Bank of Bahrain & Kuwait and the Hon. Supreme Court's rulings in Woodward Governor India P. Ltd. and ONGC Vs. CIT. These precedents establish that MTM losses on forward foreign exchange contracts are allowable as business losses if they are consistently accounted for and are integral to the business operations. The Tribunal also referred to similar cases, such as ACIT Vs. Shree Balkrishna Exports and ACIT Vs. Sanghvi & Sons, where MTM losses were allowed.

Conclusion:
The Tribunal upheld the CIT(A)'s decision, recognizing the MTM losses on forward contracts as allowable business losses. However, it remanded the matter to the AO to verify that the actual resultant loss on forward contracts in the next assessment year had been adjusted from the loss claimed by the assessee in the impugned year and that there was no double deduction of the losses. The revenue's appeal was allowed for statistical purposes, with directions for the AO to verify the requisite information provided by the assessee.