2013 (7) TMI 355 - AT - Income Tax

Mark-to-market loss on account of trading in derivative transactions - CIT(A) deleted the addition made by the AO - assessee company engaged in the business of granting of loans and advances against shares and securities, also traded in derivative segment by entering into future and option contracts - Held that - Respectfully following the decision of in the case of Edelweiss Capital Ltd. (2012 (10) TMI 223 - ITAT, MUMBAI) & Shri Ramesh Kumar Damani vs. The Addl. CIT 2010 (11) TMI 851 - ITAT MUMBAI wherein held that it is not only the actual stock but derivatives can also be held as stock in trade and the principle cost or market price whichever is lower has been rightly followed by the assessee in valuing the derivatives and further when the derivates are held as stock in trade then whatever rules apply to the stock in trade will have to apply to their valuation also. While anticipated loss is taken into account while valuation of closing stock, anticipated profit in the shape of appreciated value of the closing stock is not brought into account, as not prudent trader would care to show increased profits before actual realization. Respectfully following the law laid the assessee has rightly claimed mark-to-market loss which is liable to be allowed. In favour of assessee.

Issues Involved:
1. Deletion of addition made by disallowing the mark-to-market loss claimed on account of trading in derivative transactions.
2. Determination of whether mark-to-market loss on open derivative contracts is notional or actual.
3. Consistency in the method of accounting followed by the assessee.

Detailed Analysis:
1. Deletion of Addition Made by Disallowing the Mark-to-Market Loss Claimed on Account of Trading in Derivative Transactions:
The revenue appealed against the order of the CIT(A) dated 22.12.2011, which deleted the addition of Rs. 1,38,93,123/- made by the AO. The AO had disallowed the mark-to-market loss claimed by the assessee, arguing that the loss was notional and would only crystallize at the time of settlement of the derivative transactions. The CIT(A) allowed the appeal of the assessee, recognizing the mark-to-market loss as per recognized Accounting Standards and consistent practice.

2. Determination of Whether Mark-to-Market Loss on Open Derivative Contracts is Notional or Actual:
The AO contended that the loss claimed by the assessee was contingent and not crystallized, as the future contracts were not settled by the end of the financial year. The AO argued that such contracts are in the nature of ready forward contracts, and the loss or gain is contingent upon market movements. The CIT(A) disagreed, stating that open-ended contracts in the derivative market are akin to stock-in-trade and should be valued at cost or market price, whichever is lower. This valuation method is consistent with the guidance note issued by the Institute of Chartered Accountants of India (ICAI).

3. Consistency in the Method of Accounting Followed by the Assessee:
The assessee consistently followed the practice of valuing derivative contracts on a mark-to-market basis, recognizing losses but not unrealized profits. This method was consistent with the principles of commercial accounting and recognized by the ICAI. The CIT(A) and ITAT upheld this practice, citing judicial precedents such as Edelweiss Capital Ltd. vs. ITO and Bank of Bahrain & Kuwait, which supported the recognition of mark-to-market losses.

Conclusion:
The ITAT upheld the CIT(A)'s decision to allow the mark-to-market loss claimed by the assessee. The Tribunal recognized that derivative contracts could be treated as stock-in-trade and valued at cost or market price, whichever is lower. The consistent accounting practice followed by the assessee was deemed appropriate, and the appeal of the revenue was dismissed. The judgment emphasized the principle that anticipated losses can be recognized in valuing closing stock, while anticipated profits should not be accounted for until realized.

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