Tribunal allows Revenue's appeal on derivative contracts loss deduction for business necessity.

The Tribunal allowed the Revenue's appeal, overturning the CIT(A)'s decision to disallow marked to market loss on open derivative contracts for the assessment year 2008-09. The Tribunal held that the losses were allowable deductions as they were integral to the assessee's business operations and not merely notional, in line with the Supreme Court precedent in CIT v. Woodward Governor India Pvt. Ltd. and the assessee's consistent accounting practices. The decision emphasized the business necessity of the forward contracts for import activities, supporting the allowance of the losses as business expenses.

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Issues:
Disallowance of marked to market loss on open derivative contracts for assessment year 2008-09.

Analysis:
The appeal by the Revenue challenges the deletion of disallowance of marked to market loss on open derivative contracts by the CIT(A). The Revenue contended that such losses are not allowable under section 37(1) of the Income-tax Act, 1961. The Revenue also argued that the disallowance was made in accordance with CBDT's Instruction No.3/2010 dated 23.03.2010. However, the CIT(A) accepted the assessee's contentions, emphasizing that the foreign exchange loss was a business loss accrued due to fluctuation in exchange rates. The CIT(A) relied on the decision of the Supreme Court in CIT v. Woodward Governor India Pvt. Ltd. and the Tribunal's decision in Mashreq Bank v. DDIT to support the allowance of the loss.

The core issue revolves around the treatment of foreign exchange rate losses on unsettled forward contracts. The assessee, engaged in the business of tiles and sanitary ware, claimed the losses as business expenses due to fluctuation in foreign exchange rates. The AO disallowed the losses, citing them as notional and relying on CBDT's Instruction No. 3/2010. However, the CIT(A) upheld the assessee's claim, highlighting the accrual basis of accounting followed by the assessee and the statutory requirement under the Companies Act to value open forward contracts at year-end exchange rates. The CIT(A) emphasized that the losses were allowable deductions, in line with the Supreme Court's decision in Woodward Governor India Pvt. Ltd. case.

The Tribunal, after considering both parties' contentions, found that the forward contracts were integral to the assessee's import activities for raw materials, serving as a hedge against foreign exchange rate fluctuations. The Tribunal emphasized that the losses were not notional but incurred as part of the business operations. Referring to the Woodward Governor India Pvt. Ltd. case and the assessee's consistent accounting practices accepted by the Revenue, the Tribunal allowed the Revenue's appeal for statistical purposes, indicating that the losses were allowable deductions for the assessment year 2008-09.

In conclusion, the Tribunal's decision overturned the CIT(A)'s order and allowed the Revenue's appeal, emphasizing the integral nature of the forward contracts to the assessee's business activities and the applicability of the Woodward Governor India Pvt. Ltd. case in allowing the foreign exchange losses as business deductions for the assessment year 2008-09.

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