9911796707
TMI Blog2011 (8) TMI 246X X X X Extracts X X X X X X X X Extracts X X X X ..... uction of Rs. 10,10,92,000 being loss on interest rate swap valuations. In the course of ensuing examination of this claim by the Assessing Officer, it was submitted by the assessee that interest rate swap is a financial contract between two parties exchanging a stream of interest payments for a notional principal amount, on multiple occasions, during the contract period. It was also submitted that these contracts generally involve exchange of fixed rate of interest, with floating rate of interest, and vice versa. On each payment date, the interest is notionally paid on the agreed fixed or floating rate by one party to the other, by settling for the difference payments. Having so explained the nature of interest rate swap, the assessee submitted that the assessee had three ongoing interest rate swap contracts, for a notional principal amount of Rs. 185 crores, under which the assessee was to pay a fixed rate of interest and receive the floating rate of interest. It was then submitted that the deduction of Rs. 10,10,92,000 has been claimed on account of unrealized loss on the basis of valuation of interest rate swap. This valuation, according to the assessee was arrived at by workin ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... eable liability which could be enforced on or before the end of the relevant previous year. In support of this stand, a reference was made to Hon'ble Bombay High Court's judgment in the case of CIT vs. Phalton Sugar Works (162 ITR 622) and to Hon'ble Madras High Court's judgment in the case of CIT vs. Indian Overseas Bank (151 ITR 446). As for the Reserve Bank of India's guidelines and the accounting treatment, the Assessing Officer referred to Hon'ble Supreme Court's judgment in the case of Tuticorin Alkali Chemicals and Fertilizers Ltd vs CIT (227 ITR 172) in support of the proposition that merely because stand of the assessee is supported by RBI guidelines and accounting practices, it entitles assessee to get the deduction as 'income tax law does not match step by step with the divergent footprints of the accountancy profession'. As regards the judicial precedents cited by the assessee, the Assessing Officer was of the view that these decisions are fully distinguishable as the issue for consideration in these cases was valuation of stock. It was thus concluded that the claim of deduction in respect of loss on valuation of interest rate swap was not admissible, and it was, accord ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... party A to pay fixed rate of interest @ 4% on a notional principal amount of Rs. 100 crores, in consideration of receiving floating rate of interest on the same, for a period of one year. The settlements are to be done on half yearly basis beginning with 31st December of that year. There will be no cash flows as on the date of contracts, but, assuming that floating rate of interest is 4.50% on 31st December, the assessee will receive .50% interest on Rs. 100 crores for six months, as on that date. Similarly, if the floating rate of interest as on 30th June of the following year is 3.75% the assessee will pay .25% interest on Rs. 100 crores for six months on that date. Depending on whether the amount is receivable or payable under the interest rate swap contract, the amounts are booked as income or expenditure in the profit and loss account. There are no issues with regard to the income so disclosed or the expenditure so claimed for deduction. 6. The dispute, however, arises with respect to unsettled interest rate swap contracts as at the end of the year. 7. While computing the position of unsettled interest rate swap, it is also important to bear in mind the fact t ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... oss at this stage, is eventually reduced from the overall loss or added to overall profit taken into account, for tax purposes, in the subsequent assessment year in which the settlement date falls. There is no dispute that whatever is the loss on interest rate swap valuation as on the balance sheet date is to be squared up by transfer to the actual loss or profit on settlement. Its not really, therefore, the question as to whether the deduction is to be allowed or not, but only the assessment year in which deduction is to be allowed. Viewed in the long term perspective, thus, it is wholly tax neutral but for the timing of deduction. 9. Section 145 of the Income Tax Act, as it stands now, inter alia lays down that business income has to be computed "in accordance with the cash or mercantile system of accounting as regularly employed by the assessee". The only rider to this statutory requirement regarding method of accounting is that "the Central Government may notify, in the official gazette from time to time, accounting standards" and the applicable accounting standards will have to be followed by the assessee in the method of accounting followed. One of these mandatory acc ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... f this position and observed that "while anticipated loss is taken into account, anticipated profit...is not brought into account as no prudent trader would care to show increased profit before its actual realisation. This is the theory underlying the rule that the closing stock is to be valued at cost or market price whichever is lower, and it is now generally accepted as an established rule of commercial practice and accountancy". No doubt these observations were made in the context of valuation of stock but what is material is the theory underlying the principle of valuing closing stock and the fact that such a theory has the acceptance of the Hon'ble Supreme Court. Whichever way one looks at it, whether from the point of view of the impact of Section 145 and the mandatory accounting standards or from the point of view of pure accounting principles duly approved by Hon'ble Supreme Court, even an anticipated loss, even if it may not have crystallized in the relevant previous year, is to be allowed as a deduction in the computation of business profits. 10. It is important to bear in mind the fact that the interest rate swap was entered into as the assessee wanted to hedge ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... , this objection is not sustainable in law for the reason that the accounting principle of prudence, which has been relied upon by the assessee, is now binding in view of Section 145(2) read with notification no. 9949. As regards reliance upon Hon'ble Madras High Court's judgment in the case of Indian Overseas Bank (supra), in support of the proposition that when anticipated profits on unmatured contracts are held, to be non-taxable, there is no good reason as to why anticipated losses on unmatured contracts can be taken into account while computing business income, we find that there is an inherent fallacy in this approach inasmuch as anticipated losses and anticipated profits are not treated in the same manner in the computation of business profits. These dual standards in recognizing anticipated losses and anticipated profits are accepted accounting norms and in the case of Chainrup Sampatram (supra), Hon'ble Supreme Court has approved this duality in approach. Just because anticipated profits are not assessed to tax, it would not follow, as a corollary thereto, that anticipated losses cannot be allowed as deduction in computation of business income. In view of these discussions ..... X X X X Extracts X X X X X X X X Extracts X X X X
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