2014 (2) TMI 836 - AT - Income Tax

Tribunal allows business deduction for MTM losses, quashes tax notice under section 263

The Tribunal held that the notice under section 263 was not justified, and the MTM losses claimed by the assessee were allowable as business deductions. ... Revision u/s 263 - Deductibility of expenses u/s 37(1) of the Act – Fluctuation in rate of exchange - Held that:- The decision in CIT v. Woodward Governor India (P.) Ltd. [2009 (4) TMI 4 - SUPREME COURT] followed – the loss suffered by the assessee is on revenue account towards foreign exchange difference as on the date of balance sheet and is an item of expenditure deductible u/s 37(1) - The loss due to foreign exchange fluctuation in foreign currency transactions in derivatives has to be considered on the last date of accounting year and it is deductible u/s 37(1) of the Act - the view taken by AO to allow loss while making assessment u/s 143(3) on account of derivative contract outstanding is not an erroneous view taken by AO, nor the action of AO is prejudicial to the interest of revenue - the order of Commissioner of Income Tax u/s 263 of the Act to hold that the action of AO is erroneous to the extent the loss considered as allowable on account of derivative contracts outstanding as on the date of balance sheet i.e. 31.3.2008 is neither justified nor in accordance with law – the order of the CIT set aside – Decided in favour of Assessee. Issues Involved:1. Validity of the notice under section 263 of the Income Tax Act.2. Disallowance of losses arising out of 'Mark to Market' (MTM) transactions.Issue-wise Detailed Analysis:1. Validity of the notice under section 263 of the Income Tax Act:The assessee challenged the validity of the notice issued under section 263 of the Income Tax Act, arguing that it was 'bad in law, illegal, ultra-virus, in excess of and/or in want of jurisdiction and otherwise void.' The notice was issued by the Commissioner of Income Tax (CIT) to modify the assessment order under section 143(3) of the Act. The CIT's contention was that the assessment made was erroneous and prejudicial to the interest of revenue due to the allowance of MTM losses, which he deemed notional and contingent in nature.The Tribunal observed that the CIT's notice was based on the premise that MTM losses are notional and contingent, and therefore, should not have been allowed as a deduction. However, it was noted that the CIT did not consider the consistent accounting practices followed by the assessee, which were in line with Accounting Standards and commercial principles of accounting.2. Disallowance of losses arising out of 'Mark to Market' (MTM) transactions:The primary issue was whether the MTM losses of Rs. 43.78 crores claimed by the assessee were allowable as business deductions. The CIT held that these losses were notional and contingent, as no actual sale or settlement had taken place.The assessee argued that the MTM losses were ascertainable and not contingent, citing that they were incurred in the ordinary course of business for hedging currency-related risks. The assessee relied on the decision of the Hon'ble Supreme Court in CIT v. Woodward Governor India (P.) Ltd. (312 ITR 254), which held that 'Loss suffered by the assessee on account of fluctuation in the rate of foreign exchange as on the date of the balance-sheet is an item of expenditure under section 37(1) of the Act.' Additionally, the assessee referred to similar decisions by the Mumbai Bench of the Tribunal in the case of Dy. CIT v. Kotak Mahindra Investment Ltd. and the case of Reliance Communications Ltd v. Asstt. CIT.The Tribunal considered these precedents and noted that the Hon'ble Supreme Court in the Woodward Governor case had clearly established that unrealized losses due to foreign exchange fluctuations are deductible under section 37(1). The Tribunal also referred to the ONGC Ltd. v. CIT (322 ITR 180) case, where it was held that losses on account of foreign exchange fluctuations as on the last date of the balance sheet are allowable as deductions.The Tribunal concluded that the assessee's claim for MTM losses was in line with established legal principles and accounting standards. The action of the Assessing Officer (AO) in allowing the MTM losses was not erroneous or prejudicial to the interest of revenue. Therefore, the CIT's order under section 263 to disallow the MTM losses was quashed.Conclusion:The Tribunal held that the notice under section 263 was not justified, and the MTM losses claimed by the assessee were allowable as business deductions. The appeal of the assessee was allowed, and the order of the Commissioner of Income Tax was quashed. The Tribunal's decision was pronounced in the open court on November 20, 2013.