ITAT affirms CIT(A) decision on mark-to-market loss in derivative transactions (A)

The ITAT upheld the CIT(A)'s decision to allow the mark-to-market loss claimed by the assessee in derivative transactions. The Tribunal considered derivative contracts as stock-in-trade, valuing them at cost or market price, whichever is lower. The consistent accounting practice of recognizing losses but not unrealized profits was deemed appropriate. The appeal of the revenue was dismissed, emphasizing the recognition of anticipated losses in valuing closing stock, while profits should only be recognized when realized.

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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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