2024 (3) TMI 1360 - HC - Income Tax

Disallowing the marked to Market (MTM) losses on account of fluctuation in foreign currency in respect of hedging of forward contracts claimed - Taxation of foreign exchange fluctuation - Scope of introduction of Section 43AA - HELD THAT - We find that the principal question which stands raised appears to be conclusively settled in light of Simon India Ltd. 2022 (12) TMI 358 - DELHI HIGH COURT as held undisputedly, the Forward Contracts, in the present case, are hedging transactions. Assessee has reinstated its debits and credits from the underlying transactions on the value of the foreign exchange on the due date. The corresponding losses/gains under the Forward Contracts, thus, were also required to be accounted for to arrive at the real profits. It would be anomalous if, on the one hand, debtors and creditors, in respect of current assets, are stated at the current value of foreign exchange and the corresponding loss on the hedging transaction is not accounted for. In essence, the Assessee has stated his income by taking into account the foreign exchange value as it stands on the due date. It is well settled that the CBDT Instructions and circulars which are contrary to law are not binding. We additionally take note of the legislative amendments which have been introduced pursuant to the view which was expressed in Woodward Governor India Private Limited 2009 (4) TMI 4 - SUPREME COURT and which has led to the introduction of Section 43AA with effect from 01 April 2017. It is thus manifest that Forward Exchange Contracts were clearly not covered within the ambit of the provisions concerned prior to 01 April 2017. We answer the questions posited in favour of the appellant.

Summary

Issues:
Whether ITAT was right in upholding the disallowance of 'marked to market' losses on account of fluctuation in foreign currency for hedging of forward contracts.
Whether the ITAT erred in contradicting and reviewing its own order in the first round of litigation.
Whether the ITAT ignored the principle of consistency by disregarding the settled law in the appellant's own case in AY 2008-09.

Analysis:
The appellant challenged the ITAT's decision disallowing 'marked to market' losses on foreign currency fluctuation for hedging forward contracts. The High Court referred to the case of Pr. Commissioner of Income Tax vs Simon India Ltd., where it was established that losses on forward contracts for hedging foreign exchange fluctuations are allowable under Section 37(1) and fall within the exceptions of Section 43(5)(a) of the Income Tax Act. The court emphasized that the appellant consistently followed accounting practices and recognized the losses on forward contracts as necessary. The court also highlighted the importance of recognizing exchange differences in foreign currency transactions as per AS-11. The appellant's actions were deemed to be in line with business exigencies, and the losses were allowed as business losses to ascertain correct taxable profits.

The High Court noted legislative amendments introduced post the Supreme Court's decision in Commissioner of Income Tax vs Woodward Governor India Private Limited, leading to the introduction of Section 43AA of the Income Tax Act. This section treats gains or losses arising from foreign exchange rate changes as income or loss and mandates their computation in accordance with income computation and disclosure standards. The amendments clarified that forward exchange contracts were not covered under the previous provisions before 01 April 2017.

In conclusion, the High Court ruled in favor of the appellant, setting aside the ITAT's order dated 29 May 2017. The appellant was granted consequential relief, and the appeal was disposed of accordingly. The judgment emphasized the legality of recognizing losses on forward contracts for hedging foreign exchange fluctuations and highlighted the significance of consistent accounting practices in such transactions.