2016 (6) TMI 283 - AT - Income Tax

Disallowance of loss - whether the unrealized gain, i.e., as may stand to arise on the basis of the market values (of the underlying shares) as at the close of the year on open contracts, prior to the settlement date, could be taken into account for the purpose of closing accounts and recognizing income for the relevant year? - Held that - The question of booking gain , i.e., on an appreciation of the contract value/s, as would be apparent, does not arise. Providing for a liability with reference to the market value, which is adopted as a surrogate measure for realizable value, net of cost, if any, toward realization, i.e., at net realizable value, where held on revenue account, is on the basis of the accounting principle of prudence which suggests booking of all known losses and liabilities. Providing for the same is on the premise that the enterprise following accrual method of accounting, the loss had accrued even though the liability may not have crystallized or its amount may not be quantifiable with exactness and, therefore, represents only an estimate thereof, based on the best available information. Such estimates are called accounting estimates, which inform and permeate the preparation and presentation of final accounts, the background facts with regard to which are generally communicated through the notes to the accounts. The price/s obtaining on the settlement date/s, subsequent to the valuation (balance-sheet) date, may well be different and not in agreement with that as at the year-end, anterior thereto. In fact, even if anticipated, the gain is proscribed for being booked, militate as it clearly does against the accounting principle of prudence, advocating the provision for all known liabilities while at the same time not recognizing any anticipated income. The said principle, prescribed per AS-I issued by the Board, since notified u/s. 145(2) of the Act, therefore acquires the force of law. Reference in this context may also be made to AS-9 (Recognition of income) issued by Institute of Chartered Accountants of India, which again assumes legal status in view of section 209 of the Companies Act, 1956. The statement of a trade liability, at current value, is on an entirely different footing. Finally, before parting, we may add that the loss on the basis of mark to market open derivative contracts, standing thus to be allowed in the facts and circumstances of the case, the A.O. shall be at liberty to withdraw the said loss on the settlement date/s, which the Revenue was otherwise bound to allow to the assessee, i.e., to that extent (Rs.11.54 lacs). Like-wise the gain on the balance (brought forward) contracts would stand to be taxed in its entirety on settlement. We state so in order to avoid any prejudice or double benefit to either side. - Decided in favour of assessee

Summary

Issues:
- Appeal against the Order by the Commissioner of Income Tax (Appeals) dismissing the Assessee's appeal contesting its assessment u/s.143(3) of the Income Tax Act, 1961 for the assessment year 2008-09.
- Disallowance of losses on open derivative contracts by the Assessing Officer.
- Applicability of the principle of real income and accounting standards in determining the treatment of derivative contracts.
- Decision by the ld. CIT(A) allowing the losses and enhancing the assessed income based on the market value of open derivative contracts.
- Challenge by the Assessee regarding the assessability of the corresponding gains on open derivative contracts.

Analysis:
The Assessee, a share broking, trading, and investment company, contested the disallowance of losses on open derivative contracts during assessment proceedings. The Assessee argued based on the principle of real income and accounting standards, citing various legal precedents and the Accounting Standard (AS-I). The Assessing Officer disallowed the losses, stating that derivative contracts did not constitute stock-in-trade and the liability had not crystallized by the balance-sheet date. The ld. CIT(A) allowed the losses, considering the derivative contracts as part of current assets held on revenue account, relying on Supreme Court decisions. The ld. CIT(A) enhanced the assessed income by the difference between disallowed losses and unobsorbed profits on open contracts.

The Tribunal noted that the ld. CIT(A) allowed the losses, rendering the Assessee's challenge on this aspect moot. The main issue was the assessability of corresponding gains on open derivative contracts. The Tribunal analyzed relevant legal judgments, including Woodward Governor India (P) Ltd. and Oil & Natural Gas Corporation Ltd. The Tribunal found that the accrual of income should be consistent with the principle of prudence and accounting standards. Unrealized gains on open contracts should not be recognized before settlement date to adhere to the principle of prudence. The Tribunal allowed the Assessee's appeal, directing the A.O. to withdraw the disallowed losses on settlement dates and tax the gains on settled contracts to avoid prejudice or double benefit.

In conclusion, the Tribunal allowed the Assessee's appeal, emphasizing adherence to accounting principles and the treatment of gains on derivative contracts. The decision aimed to maintain consistency and fairness in recognizing income and losses on open derivative contracts, ensuring compliance with legal standards and avoiding double benefits or prejudice to either party.