2010 (8) TMI 578 - AT - Income Tax

Losses on forward foreign exchange contracts maturing after year-end are deductible when measured at the balance-sheet date

ITAT, MUMBAI held that losses on forward foreign exchange contracts maturing after year-end are allowable when measured at the balance-sheet date, because ... Income arising from securities and on debenture - Whether, can it be said that where a forward contract is entered into by the assessee to sell the foreign currency at an agreed price at a future date falling beyond the last date of accounting period, the loss is incurred to the assessee on account of evaluation of the contract on the last date of the accounting period i.e. before the date of maturity of the forward contract - HELD THAT:- There is no dispute that if the date of maturity of the contract falls within the same financial year then the difference between the exchange rate as prevailing on the balance sheet date and contracted rate is an allowable deduction. The moot point for consideration is whether keeping in view the nature of contract, can it be said that a liability accrued on 31st March in respect of unmatured forward foreign exchange contract on account of fluctuation in rate of foreign currency or not. Therefore, it is necessary to first examine the nature of contract entered into by the assessee. Forward Foreign exchange contract means an agreement to exchange different currencies at a forward rate. Forward rate is a specified rate for exchange of currency at a specified date. The assessee enters into forward contract with clients to buy or sell foreign exchange at an agreed price at a future date in order to hedge against the possible future financial loss on account of wide fluctuation in the rate of foreign currency. Thus, firstly, forward foreign exchange contract creates a continuing binding obligation on the date of contract against the assessee to fulfill the same on the date of maturity and secondly, it is in the nature of hedging contract because it is a contract entered into against possible financial losses As per the commercial principles of policy of prudence, all anticipated liabilities have to be accounted for but as per I.T. Act, only that liability will be allowed which has actually accrued. As a matter of fact, Courts have time and again given due weightage to commercial principles in deciding such issues. However, those anticipated liabilities are not allowable which are contingent in nature but, if an anticipated liability is coupled with present obligation and only quantification can vary depending upon the terms of contract, then a liability is said to have crystalised on the balance sheet date. It is in conformity with the principles of prudence also. A contingent liability depends purely on the happening or not happening of an event whereas if an event has already taken place, which, in the present case, is of entering into the contract and undertaking of obligation to meet the liability, and only consequential effect of the same is to be determined, then, it cannot be said that it is in the nature of contingent liability . Thus, we allow the assessee’s appeal for the following reasons:- i) A binding obligation accrued against the assessee the minute it entered into forward foreign exchange contracts. ii) A consistent method of accounting followed by assessee cannot be disregarded only on the ground that a better method could be adopted. iii) The assessee has consistently followed the same method of accounting in regard to recognition of profit or loss both, in respect of forward foreign exchange contract as per the rate prevailing on March 31. iv) A liability is said to have crystalised when a pending obligation on the balance sheet date is determinable with reasonable certainity. The considerations for accounting the income are entirely on different footing. v) As per AS-11, when the transaction is not settled in the same accounting period as that in which it occurred, the exchange difference arises over more than one accounting period. vi) The forward foreign exchange contracts have all the trappings of stock- in-trade. vii) In view of the decision of Hon’ble Supreme Court in the case of Woodward Governor India (I) P. Ltd.[2007 (4) TMI 118 - DELHI HIGH COURT], the assessee’s claim is allowable. viii) In the ultimate analysis, there is no revenue effect and it is only the timing of taxation of loss/profit. We, accordingly, hold that where a forward contract is entered into by the assessee to sell the foreign currency at an agreed price at a future date falling beyond the last date of accounting period, the loss is incurred to the assessee on account of evaluation of the contract on the last date of the accounting period i.e. before the date of maturity of the forward contract.” In the result, appeals filed by the revenue are partly allowed for statistical purposes. Issues Involved:1. Taxation of income from securities and debentures.2. Disallowance of broken period interest on securities.3. Deferred guarantee commission.4. Interest attributable to investments in shares.5. Loss on forward exchange transactions.Detailed Analysis:1. Taxation of Income from Securities and Debentures:The primary issue was whether the income arising from securities and debentures should be taxed on a due basis or on a day-to-day accrual basis. The assessee recognized income from interest on securities on a day-to-day basis in its books but claimed that interest not due for payment during the previous year should not be included as income. The Assessing Officer (AO) disagreed, stating that income accrues as and when the right to receive it becomes vested. The CIT(A) allowed the assessee's appeal, relying on the Karnataka High Court's decision in Canara Bank and the ITAT Jaipur Bench's decision in State Bank of Bikaner and Jaipur, which held that interest on government securities does not accrue from day to day but only on fixed dates. The Tribunal upheld the CIT(A)'s decision, noting that the issue was covered by precedents in the assessee's own case for previous years.2. Disallowance of Broken Period Interest on Securities:The AO disallowed the broken period interest on securities lying in stock-in-trade, treating it as part of the capital cost of the asset. The CIT(A) allowed the assessee's appeal, distinguishing the facts from the Vijay Bank case and aligning with the American Express International Banking Corporation case. The Tribunal upheld the CIT(A)'s decision, noting that the securities were held as trading assets and the profit on their sale was taxed as business profit, not capital gain.3. Deferred Guarantee Commission:The AO treated the entire guarantee commission as income in the year the guarantee was given, while the assessee spread it over the period of the guarantee. The CIT(A) allowed the assessee's appeal, relying on the Supreme Court's decision in Madras Industrial Investment Corporation Ltd. and the Calcutta High Court's decision in Bank of Tokyo Ltd., which supported spreading the commission over the guarantee period. The Tribunal restored the matter to the AO to verify if the commission was refundable on premature revocation of the guarantee, which would determine whether it should be spread over the period or taxed in the year of the guarantee.4. Interest Attributable to Investments in Shares:The AO disallowed proportionate interest on borrowed funds used for investments in shares, as the dividend income was exempt from tax. The CIT(A) allowed the assessee's appeal, noting that the investment was made from non-interest-bearing funds. The Tribunal restored the issue to the AO for reconsideration in light of the Special Bench decision in Daga Capital Management, which held that section 14A and Rule 8D are retrospective.5. Loss on Forward Exchange Transactions:The AO disallowed the loss on revaluation of unmatured forward foreign exchange contracts, treating it as notional. The CIT(A) allowed the assessee's appeal, relying on the ITAT Mumbai's decision in Deutsche Bank A.G., which held that such losses are not notional and should be considered for tax purposes. The Tribunal upheld the CIT(A)'s decision, noting that a binding obligation accrued against the assessee on entering the contracts, and the consistent method of accounting followed by the assessee could not be disregarded. The Tribunal also emphasized that the anticipated losses on account of existing obligations, determinable with reasonable accuracy, should be accounted for as per prudent commercial accounting principles and AS-11.Conclusion:The Tribunal's judgment addressed each issue comprehensively, considering relevant precedents and accounting principles. The appeals filed by the revenue were partly allowed for statistical purposes, with some matters restored to the AO for further verification.