2023 (11) TMI 75 - AT - Income Tax

Assessee's mark to market losses on unrealized foreign exchange forward contracts allowed as ordinary business loss

ITAT Delhi allowed assessee's claim for mark to market losses on unrealized foreign exchange forward contracts. AO had disallowed the losses treating them ... Mark to market loss on forward foreign exchange contracts - crystallisation of liability at the balance-sheet date - mercantile system of accounting and consistent accounting policy - recognition under Accounting Standard (AS-11) for foreign exchange - allowable expenditure under section 37(1) of the Income-tax Act - timing of taxation and tax neutralityMark to market loss on forward foreign exchange contracts - crystallisation of liability at the balance-sheet date - mercantile system of accounting and consistent accounting policy - recognition under Accounting Standard (AS-11) for foreign exchange - allowable expenditure under section 37(1) of the Income-tax Act - timing of taxation and tax neutrality - Allowability of mark-to-market loss on unmatured forward foreign exchange contracts debited in the books for AY 2012-13 - HELD THAT: - The Tribunal held that losses arising from revaluation of outstanding forward foreign exchange contracts at the balance-sheet date, though the contracts remained unmatured, are not merely notional or contingent but are incurred in the ordinary course of business and crystallise for accounting and tax purposes at year end. The assessee followed the mercantile system of accounting consistently and recognised gains and losses on such contracts on a mark-to-market basis in accordance with the relevant Accounting Standard (AS-11). Precedents of the Supreme Court and various benches, including Woodward Governor and related decisions, support that where a binding obligation exists on entering into forward contracts and the method of accounting is consistent and in conformity with accounting standards, such revaluation losses are deductible as business expenditure under section 37(1) of the Act. The Tribunal further noted that recognition of such losses in the relevant year is a matter of timing and tax-neutral, particularly where corresponding gains in subsequent year have been offered to tax, and therefore the addition made by the Assessing Officer disallowing the MTM loss was not sustainable. [Paras 8, 9, 10]The disallowance of mark-to-market foreign exchange loss was reversed and the loss debited for AY 2012-13 was held allowable.Final Conclusion: The Revenue's appeal is dismissed; mark-to-market losses on unmatured forward foreign exchange contracts debited in the books for Assessment Year 2012-13 are allowable as business expenditure, the timing of allowability being tax-neutral. Issues Involved:1. Disallowance of unrealized foreign exchange forward contract losses amounting to Rs. 161.37 lakhs, treating it as contingent in nature.Summary:Issue 1: Disallowance of Unrealized Foreign Exchange Forward Contract LossesThe Revenue filed an appeal against the order of the CIT(A) which allowed the assessee's claim of foreign exchange fluctuation losses amounting to Rs. 161.37 lakhs. The Assessing Officer (AO) had disallowed these losses, treating them as contingent liabilities and notional losses arising from assigning closing rates of foreign exchange on forward contracts that had not matured by the end of the financial year.The assessee, engaged in software development and IT solutions, argued that these losses were incurred in the ordinary course of business and were recorded in adherence to Accounting Standards issued by ICAI, specifically on a 'mark to market' (MTM) basis. The CIT(A) found merit in the assessee's claim, referencing the jurisdictional High Court's decision in Munjan Showa Ltd. vs DCIT and the Special Bench decision in DCIT vs Bank of Bahrain, which supported the allowance of losses on unmatured derivative contracts.The Tribunal noted that the issue was covered by multiple judgments favoring the assessee, including the Supreme Court's decision in CIT vs. Woodward Governor India Pvt. Ltd., which held that MTM losses on forward contracts are not notional or contingent but crystallized at the year's end. The Tribunal also observed that the assessee's method was consistent with ICAI's Accounting Standards and that similar gains were offered for taxation in subsequent years.Consequently, the Tribunal concurred with the CIT(A)'s view that the foreign exchange fluctuation loss is an ordinary business loss and not merely a provisional or notional loss. The appeal by the Revenue was dismissed, affirming the CIT(A)'s decision.Order was pronounced in the open court on 16.10.2023.