TaxTMI 
TaxTMI 
2011 (8) TMI 1257
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....al issues n this case in pari materia with the assessment year 2003-04. Vide our order of even date, we have upheld assessee's grievance in and observed as follows: 2. The assessee is engaged in the business of dealing in government securities, bonds, debentures and providing services of arranging and underwriting the issue of debentures and bonds etc. During the course of the assessment proceedings, the Assessing Officer noticed that the assessee has claimed a deduction of Rs. 10,10,92,000 being loss on interest rate swap valuations. In the course of ensuing examination of this claim by the Assessing Officer, it was submitted by the assessee that interest rate swap is a financial contract between two parties exchanging a stream of interest payments for a notional principal amount, on multiple occasions, during the contract period. It was also submitted that these contracts generally involve exchange of fixed rate of interest, with floating rate of interest, and vice versa. On each payment date, the interest is notionally paid on the agreed fixed or floating rate by one party to the other, by settling for the difference payments. Having so explained the nature of interest ....
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....ay, or may not, actually occur. The Assessing Officer, on the basis of this reasoning, concluded that what has been claimed as deduction is only a contingent liabil ity and a provision made for a liability which may arise in future. It was also observed that as the assessee was following mercantile method of accounting, "no deduction can be made in respect of a liability which has not definitely arisen" and that deduction can only be allowed in respect of ascertained and enforceable liability which could be enforced on or before the end of the relevant previous year. In support of this stand, a reference was made to Hon'ble Bombay High Court's judgment in the case of CIT Vs. Phalton Sugar Works (162 ITR 622) and to Hon'ble Madras High Court's judgment in the case of CIT Vs. Indian Overseas Bank (151 ITR 446). As for the Reserve Bank of India's guidelines and the accounting treatment, the Assessing Officer referred to Hon'ble Supreme Court's judgment in the case of Tuticorin Alkali Chemicals & Fertil izers Ltd Vs CIT (227 ITR 172) in support of the proposition that merely because stand of the assessee is supported by RBI guidelines and accounting practices, it entitles assessee to g....
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.... rate of interest is at the mercy of the market forces, When market expectations of the floating interest rate is low, the agreed fixed rate of interest under the swap contract rate is also low. However, many factors affect the variable rate and the rates could move either way; it is this risk of significant variations in the floating rate which is sought to be mitigated by the assessee by entering into interest rate swapsFor example, on 30th June, assessee enters into an agreement with party A to pay fixed rate of interest @ 4% on a notional principal amount of Rs. 100 crores, in consideration of receiving floating rate of interest on the same, for a period of one year. The settlements are to be done on half yearly basis beginning with 31st December of that year. There will be no cash flows as on the date of contracts, but, assuming that floating rate of interest is 4.50% on 31st December, the assessee will receive .50% interest on Rs. 100 crores for six months, as on that date. Similarly, if the floating rate of interest as on 30th June of the following year is 3.75% the assessee will pay .25% interest on Rs. 100 crores for six months on that date. Depending on whether the amount....
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.... number) i.e. 4,00,00,000 X 4% X 6/12 X 0 .9434 1,76,88,750 8. The net negative value of this contract, as on 31st March, is Rs. 11,79,250 because that is the amount the assessee will have to pay under the contract if the contracts are to be settled at the floating rates prevail ing as on 31st March. In plain words, this figure represents the loss on interest rate swap contracts if these contracts were to be settled as on 31st March, or, to put in differently, market value of these contracts as on that day. The issue requiring our adjudication is whether this loss on valuation of interest rate swap contracts can be allowed as a deduction or not. 9. In plain words, the valuation of interest rate swap as on the balance sheet date only indicates computation of profit or loss on account of these profits as on that date. It is also important to bear in mind the fact that whatever is claimed as a loss at this stage, is eventually reduced from the overall loss or added to overall profit taken into account, for tax purposes, in the subsequent assessment year in which t....
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....espect of anticipated losses, as a measure of prudent accounting principles, cannot be declined. It is only elementary that the accountancy principle of conservatism, which has been duly recognized by the Courts, mandates that anticipated losses are to be provided for in the computation of income but it does not permit anticipated profits to be taken into account till the profits actually arise. That is the underlying reason that in the case of unsold stock, when market rate is higher than the purchase price, the market price is ignored in computation of value of stock, and, as a result, anticipated profit on sale of such stock is ignored. However, when the market price of stock is lower than the purchase price, the market price is taken into account, and, accordingly, anticipated loss is taken into account. These dual standards in recognizing anticipated losses and anticipated profits are accepted accounting norms. In the case of Chainrup Sampatram vs. CIT (1953) 24 ITR 481 (SC), Hon'ble Supreme Court took note of this position and observed that "while anticipated loss is taken into account, anticipated profit...is not brought into account as no prudent trader would care to show i....
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....s a double edged sword in the sense in case floating rate comes down even further, the assessee's losses may even go up, and it is not the loss but recovery which is contingent upon factors beyond assessee's control. Loss having been incurred is a reality, its recoupment or aggravation is contingent. It is contingent upon future happenings is whether or not loss the assessee will be able to recoup the losses till settlement date, and such recoupment or aggravation of loss will fall in period beyond the end of the relevant previous year. Viewed thus, and bearing in mind the fact that the real issue in this appeal before us is not the deductibility but only timing of the deduction, we are of the considered view that the loss computed vis-à-vis the variation as on the end of the relevant previous year, the loss is deductible in the relevant previous year. As regards Assessing Officer's objection that accounting principles need not govern the deductibility, and reliance on judicial precedents in support thereof, this objection is not sustainable in law for the reason that the accounting principle of prudence, which has been relied upon by the assessee, is now binding in view of ....