2017 (1) TMI 673 - AT - Income Tax

Loss arising out of fluctuation in forward foreign exchange contracts due to adverse movement of foreign currency exchange rate - Held that - Hon ble Supreme Court in the case of Woodward Governor India P. Ltd. (2009 (4) TMI 4 - SUPREME COURT) relied upon by the assessee will be applicable as the losses are towards hedging against export receivable in foreign currency outstanding as at year end towards export of polished diamonds undertaken by the assessee and cannot be categorized as notional loss or speculative loss as per provisions of Section 43(5) of the Act. CIT(A) has allowed the loss as deduction while computing income of the assessee being arising out of fluctuation in forward foreign exchange contracts due to adverse movement of foreign currency exchange rate at year end as the said forward foreign exchange contracts are backed by export receivables outstanding as on 31- 03-2009 and we donot find any perversity in the order of learned CIT(A) as learned DR could not point any defect/mistake in the finding of learned CIT(A) , which we confirm/sustain and the grounds raised in the Revenue appeal is dismissed. With Respect to the deduction disallowed by the learned CIT(A) arising out of fluctuation in foreign currency rates on forward foreign exchange contracts which are not backed by the export receivables but are stated to be backed with confirmed export orders against which the assessee had stated to have purchased stock and such stock being held by the assessee as on 31-03-2009 with respect to the confirmed export orders in hand , as against which the exports are stated to be made in subsequent financial year, needs verification by the AO of the contentions of the assessee , and hence interest of justice will be best served if the matter is set aside and restored to the file of AO for verification of contentions of the assessee and for fresh determination of the matter on merit in accordance with our directions as contained in this order .

Issues Involved:
1. Disallowance of business expenditure in the nature of mark-to-market loss on restatement of outstanding forward contracts.
2. Whether the 'Mark to Market' loss on valuation of forward exchange contracts is notional and speculative.

Issue-Wise Detailed Analysis:

1. Disallowance of Business Expenditure in the Nature of Mark-to-Market Loss on Restatement of Outstanding Forward Contracts:
The assessee, engaged in the manufacture and export of cut and polished diamonds, entered into forward foreign exchange contracts to hedge against currency fluctuations. The assessee claimed a mark-to-market loss of ?32,69,33,306/- on these contracts, revalued at the year-end exchange rate. The AO disallowed this loss, considering it notional and speculative since the contracts were not settled. The AO argued that such losses are unrealized and only due to valuation changes, not actual transactions.

The CIT(A) partially allowed the assessee's claim, permitting the loss to the extent of ?22,76,84,554/- backed by outstanding export receivables. However, the CIT(A) disallowed ?9,92,48,752/- as it was not backed by receivables but by confirmed export orders and stock held for future exports, deeming it speculative.

2. Whether the 'Mark to Market' Loss on Valuation of Forward Exchange Contracts is Notional and Speculative:
The Tribunal examined whether the mark-to-market loss on unsettled forward contracts should be considered notional and speculative. The assessee argued that the contracts were entered into as a business necessity to hedge against foreign exchange risks and were consistently accounted for as per AS-11 issued by ICAI. The assessee cited several judicial precedents supporting the recognition of such losses.

The Tribunal noted that the assessee's method of accounting for foreign exchange contracts was consistent and accepted by the Revenue in other years. It referred to the Supreme Court's decision in Woodward Governor India P. Ltd., which supports recognizing such losses if they are part of regular business activities. The Tribunal also considered the Bombay High Court's decision in CIT v. D. Chetan and Company, which upheld the allowance of such losses as business expenses.

The Tribunal found no perversity in the CIT(A)'s decision to allow the loss backed by export receivables. However, it remanded the issue of the disallowed loss of ?9,92,48,752/- to the AO for verification. The AO was directed to verify if these contracts were backed by stock held for confirmed export orders and to allow the loss if substantiated.

Conclusion:
The Tribunal dismissed the Revenue's appeal, confirming the allowance of ?22,76,84,554/- as business loss. It allowed the assessee's appeal for statistical purposes, remanding the issue of ?9,92,48,752/- to the AO for verification. The Tribunal emphasized that the loss should be allowed if it is backed by stock for confirmed export orders, ensuring the revenue impact is tax-neutral.

Order Pronounced:
The appeal filed by the assessee is allowed for statistical purposes, and the appeal filed by the Revenue is dismissed. Order pronounced in the open court on 7th November 2016.

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