TMI Blog2011 (8) TMI 246X X X X Extracts X X X X X X X X Extracts X X X X ..... P.J. Pardiwala for the Appellant Usha Nair for the Respondent ORDER Pramod Kumar: 1. By way of this appeal, the assessee appellant has challenged correctness of CIT(A)'s order dated 18th August 2006, in the matter of assessment under section 143(3) of the Income Tax Act, 1961 for the assessment year 2003-04, on the following ground: Based on the facts of the case and in law, the CIT(A) erred in confirming the action of the Assessing Officer in disallowing the loss of Rs. 10,10,92,000 being loss on account of valuation of interest rate swap on the basis that the same is a notional or imaginary loss. 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 exchangin ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... putation of business income. He noted that whatever losses had actually incurred in connection with these interest rate swap contracts, and debited to the profit and loss account upon their becoming payable, have already been allowed as a deduction. However, what has been claimed as deduction in the impugned claim is the loss which would have occurred if the swaps are to be squared up as on the balance sheet date. It was thus an unrealized loss which may, 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 liability 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 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... om other banks. Let us say assessee has an obligation to pay floating rate of interest on bonds of a value of Rs. 100 crores but, since the assessee perceives the markets as volatile and not fit for open risk being taken, the assessee hedges against this obligation by entering into an interest rate swap at 4% which he finds reasonable at that point of time. The fixed rate of interest in such cases is a negotiated rate, while floating 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 swaps for 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 o ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... using a discount curve which is publicly known 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 prevailing 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 the settlement date falls. There is no dispute that whatever i ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... rinciples, 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 increased profit before its actual realisation. This is the theory ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ven 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- -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 Section 145(2) read with notification no. 9949. As regards reliance upon Hon' ..... X X X X Extracts X X X X X X X X Extracts X X X X
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