2025 (3) TMI 1638 - AT - Income Tax

Unrealised derivative gains are not taxable where no real accrual has occurred; book entries alone do not create income.

Unrealised mark-to-market gains on outstanding forward commodity derivative contracts were held not taxable under the Income-tax Act because income tax ... Taxability of unrealised mark-to-market gains - Real income theory - notional gain on mark to market forward contract in commodities derivatives Whether the notional gains made on MTM in respect of forward contract in commodities derivatives is taxable under the provisions of the Income Tax Act? - HELD THAT: - The Tribunal held that the only controversy was whether notional gains arising on mark-to-market valuation of unexpired forward commodity contracts could be taxed under the Act. It noted that, though the assessee had recognised the gain in its accounts and credited it to the profit and loss account, the gain remained unrealised at the balance-sheet date. Applying the settled principle that notional gains are not taxable, and relying on Woodward Governor India Pvt. Ltd. [2009 (4) TMI 4 - SUPREME COURT] and Godhra Electricity Co. [1997 (4) TMI 4 - SUPREME COURT] the Tribunal held that unrealised appreciation does not amount to real accrual of income. On that reasoning, the mark-to-market gain on the outstanding contracts was treated as hypothetical income and not chargeable to tax. [Paras 11, 12, 13] The addition on account of unrealised mark-to-market gains was directed to be deleted. Final Conclusion: The appeal was allowed. The Tribunal held that the unrealised mark-to-market gain on outstanding forward commodity contracts was only notional income and could not be brought to tax. Issues: Whether unrealised marked-to-market gains arising from outstanding forward commodity derivative contracts were taxable as income under the Income-tax Act, 1961.Analysis: The assessee recognised mark-to-market gains in its books on outstanding forward contracts entered to hedge gold price risk, but did not offer them to tax on the footing that the gains had not actually crystallised. The Tribunal applied the settled principle that income tax is levied on real income and not on mere hypothetical or notional accretions. It held that unrealised gains on unexpired forward contracts are in the nature of anticipated profits, and that commercial accounting treatment by itself does not make such gains taxable where no real accrual has occurred.Conclusion: The unrealised mark-to-market gains were not taxable, and the addition was liable to be deleted in favour of the assessee.Final Conclusion: The appeal succeeded and the assessment addition on account of mark-to-market gains was set aside.Ratio Decidendi: Unrealised gains on outstanding derivative contracts do not constitute taxable income unless they represent real accrual, as notional or hypothetical profits are outside the charge of income tax.