2018 (10) TMI 847 - AT - Income Tax

ITAT Mumbai upholds mark-to-market loss on forward contract liability as deductible business expense

Assistant Commissioner of Income Tax- 19 (1), Mumbai Versus M/s. Dharamchand Paraschand Exports

Assistant Commissioner of Income Tax- 19 (1), Mumbai Versus M/s. Dharamchand Paraschand Exports - TMI Issues Involved:1. Allowability of mark to market loss on account of outstanding forward contract liability.2. Nature of forward contract loss as notional or contingent liability.3. Compliance with Accounting Standards (AS-11) and its implications.4. Judicial precedents and their applicability to the case.Detailed Analysis:1. Allowability of Mark to Market Loss on Account of Outstanding Forward Contract Liability:The primary issue in this appeal is whether the loss of Rs. 1,99,35,578/- on account of revaluation of outstanding foreign exchange forward contracts as on 31-03-2012 should be allowed as a deduction. The Assessing Officer (AO) disallowed this loss, considering it as a notional loss on valuation of a liability that had not yet crystallized and termed it as a contingent liability. The CIT(A) allowed the claim, leading to the Revenue's appeal.2. Nature of Forward Contract Loss as Notional or Contingent Liability:The AO's stance was that the forward contract loss is a notional loss and a contingent liability. The appellant argued that forward contracts are binding legal contracts, and the loss arising from such contracts is real and quantifiable, not contingent. The appellant emphasized that forward contracts are entered into to hedge against currency fluctuations and are consistent with the mercantile system of accounting and AS-11. The appellant cited various judicial decisions, including the Supreme Court's decision in Woodward Governor India Pvt Ltd, which recognized such losses as deductible.3. Compliance with Accounting Standards (AS-11) and Its Implications:The appellant consistently followed Accounting Standard AS-11, which mandates the valuation of foreign currency monetary items at the closing rate, recognizing exchange differences as income or expense in the period they arise. The appellant argued that the loss on forward contracts is an exchange difference and should be treated as a business loss. The CIT(A) accepted this argument, noting that the appellant's accounting practices were consistent and compliant with AS-11.4. Judicial Precedents and Their Applicability to the Case:The CIT(A) and the ITAT relied on several judicial precedents to support the allowance of the forward contract loss. Key cases cited included:- Woodward Governor India Pvt Ltd (Supreme Court): Recognized exchange differences on the balance sheet date as deductible.- Bank of Bahrain and Kuwait (Special Bench, ITAT Mumbai): Held that losses on revaluation of forward contracts are not notional and are allowable.- Bharat Earth Movers Ltd (Supreme Court): Differentiated between contingent and accrued liabilities, allowing deductions for accrued liabilities.- Rusabh Diamonds (ITAT Mumbai): Treated foreign exchange gains/losses on forward contracts as part of operating profit.- Society General (ITAT Mumbai): Allowed similar claims for losses on foreign exchange contracts.- H. Dipak & Co. (ITAT Mumbai): Affirmed the allowance of marked to market losses on forward contracts.- D. Chetan & Co. and London Star Diamonds Co. (India) Pvt. Ltd. (Jurisdictional High Court): Supported the consistent application of AS-11 and allowed the deduction for forward contract losses.The ITAT concluded that the issue was squarely covered by these judicial precedents, and the appellant's treatment of forward contract losses was in line with AS-11 and judicial decisions. The ITAT upheld the CIT(A)'s order, dismissing the Revenue's appeal.Conclusion:The ITAT Mumbai dismissed the Revenue's appeal, affirming the CIT(A)'s decision to allow the mark to market loss on outstanding forward contract liability. The ITAT found that the appellant's accounting practices were consistent with AS-11 and supported by various judicial precedents, recognizing the forward contract loss as a deductible business expense. The appeal was dismissed, and the order was pronounced on 27/08/2018.