TaxTMI 
TaxTMI 
2018 (10) TMI 847
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....as asked to explain as to why M to M losses of Rs. 1,99,35,578/- should not be disallowed. Vide letter dated 27/01/2015, the assessee explained that all the forward contracts were booked against the underlying export receivables on a bill to bill basis to hedge against the risk associated with fluctuation in the value of foreign currency. They were recognizing both gain and loss on such conversion in its P & L account on a consistent basis from year to year. MTM loss was consistently reversed as income in the next year and on identical facts this loss was allowed by ITAT, Mumbai. AO did not accept the explanation stating that the forward contract loss is a notional loss on valuation of liability that has not yet crystalised and is contingent liability and the ITAT decision was not accepted by the Department and is pending before the Hon'ble High Court of Bombay. By saying so, AO disallowed the forward contract losses of Rs. 1,99,35,578/- claimed by the assessee and added to the total income of the assessee. 5. By the impugned order of CIT(A), Revenue is in further appeal before us. "I have given my careful consideration to the rival submissions, perused the material....
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....not allowable as deduction then corresponding translation gain booked on open receivables also should not be considered as income since forward contracts are entered only based on the strength of the underlying receivables / payables. 6.2.1 From the legal front, the appellant submitted that the assessee is regularly following mercantile system of accounting and is regularly following Accounting Standard No. 11 which deals with the Effects of Changes in Foreign Exchange Rates (AS 11) issued by the ICAI regarding accounting of foreign currency transactions. Para 11 of AS 11 requires foreign currency monetary items to be reported using the closing rate. Accordingly, outstanding sundry debtors / creditors in foreign currency is translated into Indian Rupees at the closing rate and the resultant profit/loss is accounted in the books and taxes thereon are paid. Profit/loss arising on re-statement of outstanding foreign currency transactions at the year-end rate is nothing but exchange difference. Para 14 of AS 11 states that an exchange difference results when there is a change in the exchange rate between the transaction date and the date of settlement of any monetary items ari....
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....to the Supreme Court decision in the case of Woodward Governor India Pvt Ltd (294 ITR 451). In this case, Assessee had debited to its Profit & Loss Account a sum of Rs.. 41,06,746 out of which a sum of Rs..29,49,088 was the unrealized loss due to foreign exchange fluctuation on the last date of the accounting year. The AO held that the liability as on the last date of the previous- year under consideration was a contingent liability, it was not an ascertained liability and consequently it had to be added back to the total income of the assessee. Accordingly, he added back Rs..29,49,088 being the unrealized loss due to foreign exchange fluctuation. In other words, the debit to the P&L account was disallowed. Supreme Court approved the claim of the Assessee and the appellant submits that the profit/loss accounted by the assessee in line with AS 11 on conversion of outstanding foreign exchange contract liability is nothing but the exchange difference relating to the year under consideration. In the case of Sutlej Cotton Mills Ltd. reported in 116 UR 1 Supreme Court has held assessee on account of appreciation or depreciation in the value of foreign currency held by it, on conversion i....
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....llowable which are contingent in nature but, if an anticipated liability is coupled with present obligation and only quantification can vary depending upon the terms of contract, then a liability is said to have crystalised on the balance sheet date. It is in conformity with the principles of prudence also. A contingent liability depends purely on the happening or not happening of an event whereas if an event has already taken place, which, in the present case, is of entering into the contract and undertaking of obligation to meet the liability, and only consequential effect of the same is to be determined, then, it cannot be said that it is in the nature of contingent liability. It is evident that the anticipated losses on account of existing obligation as on 31st March, determinable with reasonable accuracy, being in the nature of expenditure/accrued liability, have to be taken into account while preparing financial statements. 6.2.5 In view of the above, it is submitted that results of the appellant needs to be accepted as claimed by them and proper and consistent effect be given to gain/loss on account of forward contracts and relief be granted in respect of ground of ....
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....first place, the Id. AO has failed to appreciate the characteristics of a Forward contract. Each Forward contract is always assigned with a value that is contracted with creation of a fettered obligation on the assessee to execute and meet at a future contracted date. All the contracts are always enforceable, in as much as realisable. ii) The point that the Id. AO was making was that anticipated liabilities are not allowable, which are notional in nature. But, the distinction in case of Forward contracts is that if an anticipated liability is coupled with present obligation and only quantification can vary depending upon the terms of contract, then a liability is said to have crystallized on the reporting date i.e 31st March. iii) Argument of the Id. AO that an event of contract maturity can only quantify contract value is tenuous and weak. In reality, Forward contracts losses / profits accrue on daily basis depending on the fluctuation of US$ and Indian Rupee. Any prudent person would constantly monitor the position of forward contract value on daily basis to assess the impact of profit or loss. It may be appreciated that values of outstanding position of Forward....
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....n the correctness and completeness of accounts or any finding to the contrary that the assessee has not complied with the accounting standards. It was, inter alia, concluded as under: "......, in order to find out if an expenditure is deductible the following have to be taken into account: (i) whether the system of accounting followed by the assessee is mercantile system which brings into debit the expenditure amount for which a legal liability has been incurred before it is actually disbursed and brings into credit what is due, immediately it becomes due and before it Is actually received; (ii) whether the same system is followed by assessee from the very beginning and if there was a change in the system, whether the change was bona fide; (Hi) whether the assessee has given the same treatment to losses claimed to have accrued and to the gains that may accrue to it; (iv) whether the assessee has been consistent and definite in making entries in the account books in respect of losses and gains; (v) whether the method adopted by the assessee for making ;^ entries in the account books both in respect of losses and gains is as per n....
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....cy positions were hedged by entering into Forward contracts, and had incurred year-end forward contract conversion losses. Further reliance is placed on Bharat Earth Moversv. O7~[2000] 245 ITR 428/ 112 Taxman 61. 6.3.7 In the case of BHARAT EARTH MOVERS LTD (supra), the court has differentiated between what is accrued liability and contingent liability. The relevant portion of the principles laid down by the Hon'ble court is reproduced as under: For an assesses maintaining his account on the mercantile system, a liability already accrued, through to be discharged at future date would be a proper deduction while working out the profits and gains of his business, regard being had to the accepted principles of commercial and accountancy. It is t as if such deduction is permissible only in the case of amount actually expended or paid. Just as receipts though not actual receipts but accrued and due are brought in for income tax assessment so also liabilities accrued due would be taken into account while working out the profits and gains of the business. A condition subsequent, the fulfillment of which may result in the reduction or even extinction of the liability,....
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....ted that foreign exchange fluctuation gain has been earned by the assessee under the hedging contract which is duly backed by the sales and purchase contract /orders in respect of diamonds. The Id Sr counsel has further contended that dealing in foreign exchange being treasury transaction is not permitted by the RB1 and therefore, the gain arising from the forward contracts is part and parcel of operating profit of the assessee. In support of his contention he has relied upon the decision of the Bangalore Benches of the Tribunal in the case of SAP Labs India (P.) v ACIT in ITA No.398/Bang/O2; in the case of Bombay Diamond Co Ltd. v. Dy. CIT in ITA No.7488/Mum/O7; in the case of CIT v. Badridas Gauridu (P.) Ltd. f20O37 261ITR 256 /[20041134 Tax/nan 376 (Bom). He has further submitted that the premium or discount arising at the inception of forward exchange contracts is amortized as expense or income over the life of contract. The exchange difference on such contract are recognized in the profit & loss account for the year in which the exchange rate changes resulting in the profit or loss arising on cancellation or renewal of forward exchange contract is recognized as income or as ex....
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.... 10.2 In view of the facts that the assessee has entered into forward contracts for the purpose of hedging of foreign currency exposure on the export and import of diamond, the gain or loss arising of the said, will be treated as part and parcel of the operating profit" (Emphasis supplied) 6.3.9 In the decision rendered on 9th January, 2013 in the case of Society General (2013-ITS-737-ITAT), the Hon'ble Mumbai Tribunal has allowed a similar claim of the assessee for the loss of Rs. 9.16 crores on foreign exchange contracts outstanding as on 31-3-1998 holding that this issue is squarely covered in favour of the assessee by the decision of the Special Bench of HAT in the case of Bank of Bahrain & Kuwait (supra). 6.3.10. Hon'ble Mumbai ITAT "H" bench in the case of H. Dipak & Co., Mumbai I.T.A. No. 7629/Mum/2011 on 30 April, 2013 has held that- "We have heard the arguments of both the sides and also perused the relevant material available on record. It is observed that a simitar claim for marked to market loss claimed by the assessee in respect of forward foreign exchange contract debited to the P&L account has been allowed by the Special Benc....
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.... on the above issue when an identical question decided by the Special Bench of Tribunal in Bank of Bahrain and Kuwait(supra) has been accepted by the Revenue. Therefore, for the reasons indicated while dealing with Question (b) above, the appeal need not be entertained. 12. In any case, the Counsel are agreed that an identical question of law as Question (c) above in the Income Tax Appeal No. 1914 of 2011 and 5089 of 2010 by the Revenue, this Court by the orders dated 2^d March, 2013 and 1st February, 2013 repeatedly rejected the appeal on above issue as it stands covered against the Revenue and in favour of the Assessee by the decision of this Court in CITv/s. Bank of India 218 1TR 371. Thus, Question (c) does not raise any substantial question of law. Question (c) dismissed." 6.3.13 In the case of ONGC Vs GT 322 UR 180, Hon'ble Supreme Court has reiterated the principles laid down above while answering the question that when the assessee maintained their accounts on mercantile system of accounting and there was no finding by the Assessing Officer on the correctness or completeness of the account and when the assessee had complied with the accounting standard....