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2015 (5) TMI 606 - ITAT MUMBAI

2015 (5) TMI 606 - ITAT MUMBAI - TMI - Mark to market loss - revlauation of forward contract agreements on the closing date of accounting year - not a notional loss therefore allowable as per CIT(A) - Held that:- The Hon’ble Supreme Court in the case of ONGC Vs. CIT, [2010 (3) TMI 81 - SUPREME COURT], has reiterated the principles laid down in the case of Woodward Governor India Pvt (2007 (4) TMI 118 - HIGH COURT , DELHI) and observed that when the assessee maintained their accounts on mercantil .....

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in the rate of foreign exchange had occurred and finally decided that the loss incurred on account of restatement of the liabilities in foreign exchange is allowable deduction. The detailed finding recorded by CIT(A) to the effect that loss on account of revaluation of pending forward contracts was revenue in nature, as per para 5 & 6, has not been controverted. Accordingly, we do not find any reason to interfere in the order of CIT(A) deleting the disallowance of loss on account of revaluation .....

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evenue relates to CIT(A) s action in holding that mark to market loss arising on revlauation of forward contract agreements on the closing date of accounting year is not a notional loss and, therefore, allowable. 3. Rival contentions have been heard and record perused. Facts in brief are that assessee is engaged in the business of import and exports of diamonds. During the course of scrutiny assessment, the AO disallowed the loss arose on account of revaluation on forward contract agreement on t .....

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r, sale denominated in foreign currency is RS.384.85 Cr. Similarly, out of total purchases of RS.325.11 Crs, purchase denominated in US $ is of RS.302.50 Cr and almost all of the trade creditors of RS.53.74 Crs are payable in dollar terms. Further, out of receivables for goods of RS.67.65 Cr., US $ receivable account for RS.67.62 Crs. Thus it is evident that appellant is exposed to risk arising out of fluctuation in Exchange rate and as a prudent businessmen likely to hedge its risk. Appellant h .....

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imilarly outstanding forward contract are marked to market and resulting loss or gain is being recognized as expenses or income in profit & loss account. It may be mentioned that this method of recording the transactions denominated in foreign currency is as per AS-11 is consistently followed. 5.3 In the above back ground, it is undisputed that appellant is in the business of exports and has certain receivables in foreign exchange at any point of time during the year. It is also a fact that .....

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needs to be seen is whether the risk which appellant has hedged by way of a forward contract has an underlying asset or a liability by way of debtors or creditors. It is only in this sense of the matter, courts have held that the profit or loss arising out of forward contracts either on maturity or on cancellation of such contracts forms part of the business income. In other words, the forward contract entered during the course of business creates a legal liability irrespective of the fact that .....

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that rate on 5th May i.e., beyond the accounting year. On 5th March the exchange rate was at ₹ 48 per dollar and therefore to hedge the risk of fluctuation in exchange rate appellant entered into forward contract for an amount of 10000 US dollars at the spot rate of ₹ 48 and the maturity of contract falls on 5th May i.e., beyond the accounting year. In this situation a legally enforceable contract was entered and a liability was created against the appellant to sell 10000 US dollars .....

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r into the contract with bank. Now, appellant has to revalue his foreign debtors/ creditors on 31st March for the purpose of closing his books and as a matter of prudence he has to provide for the income or loss arising out of his transactions in foreign currency. The closing foreign exchange rate is RS.50 per dollar. Appellant has valued his debtors of 20000 US dollars at the rate of RS.50 per dollar and recognized a gain of ₹ 100000. Similarly, appellant has also recognized a loss of  .....

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0. 5.5 The impugned transactions are two sides of the same coin and by ignoring one side the coin loses its value. Therefore, in my considered opinion, the AO cannot determine the nature and effect of a transaction based merely on its presentation, without going into its substance. When a legally tenable contract is in existence, duly supported by an underlying asset and the contract having been entered during the course of business and further that the exchange rate as on date of entering the c .....

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gainst the exporter/importer. In other words, the entire gamut of the impugned transactions is integral to the appellants business and it cannot be called a contingent transaction. There is no merit in the AO's argument in treating the impugned transaction as independent to that of appellants business and state that the flow of benefit is not known or it depends on anyone of the various events listed by him. In fact the AO has failed to see that such events are part and parcel of the appella .....

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, which may be in case of lumpsum forward contracts. Appellant's AR has explained that whenever a lumpsum forward contract was entered, it was immediately covered by the value of subsequent exports and the sum of such forward contracts never exceeded the value of the underlying debtors at any point of time during the year. Appellant has placed on record the month wise position of debtor's vis-a-vis the forward contracts in dollar terms to demonstrate the above position. Further, to reite .....

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of the payment to different date cannot extinguish the liability and render it notional or contingent. The decision of Hon'ble Supreme Court in Bharat Earth Movers settles the position. That decision explains that what should be certain is the incurring of the liability and it being estimated with reasonable certainty even if the exact quantification is not feasible. Even if the liability is discharged at a future date, it will nevertheless be a liability which is certain and not contingent .....

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g 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 the assessee from the very beginning and if there was a change in the system, whether the change was bona fide; (iii ) whether the assessee has given the same treatment to losses clai .....

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n. 5.9 In the case of DCIT vis. Bank of Bahrain and Kuwait (ITA Nos. 4404 & 1883/Mum.l2004) the Special Bench of Jurisdictional Mumbai ITAT while holding that MTM losses in respect of forward foreign exchange contracts debited to profit and loss account is allowable, observed as under: (i) A binding obligation accrued against the Appellant the minutes it entered into forward foreign exchange contracts. (ii) A consistent method of accounting followed by the Appellant cannot be disregarded. Th .....

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ore than one accounting period. (v) In view of the decision of the Supreme Court in the case of Woodward Governor India (I) P. Ltd., the Appellant's claim is allowable. (vi) In the ultimate analysis, there is no revenue effect and it is only the timing of taxation of loss/profit. 5.10 In the case of ONGC Vs CIT 322 ITR 180, Supreme Court has reiterated the principles laid down above while answering the question that when the assessee maintained their accounts on mercantile system of accounti .....

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uation in the rate of foreign exchange had occurred and finally decided that the loss incurred on account of restatement of the liabilities in foreign exchange is allowable and answered the question in favour of the assessee. 6. Thus the judicial decisions of the Hon. Supreme Court and various other Authorities are clearly in favour of the appellant on this issue. That apart, as discussed earlier, the liabilities in foreign exchange were incurred during the normal course of the appellant's b .....

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applicable to the facts of the case. It is not out of place to mention that the Hon. Supreme Court, in the case of ONGC cited above, upheld the same principles that were laid down in the case of Woodword Governor, and the loss was held allowable in similar circumstances, where the business of ON GC is not f at of a foreign exchange dealer. Further, it is not the nature of business or the stock dealt with i.e., currency or commodities or goods like diamonds in the present case that matters. What .....

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010 dated 30/3/2011 for AY 2006-07 and the said loss was allowed as business loss and the issue was held to be covered by special bench decision in the case of DCIT Vs. Bank of Bahrain. Therefore, in my considered opinion the facts of the appellant's case are fully covered by the above cited decisions of the Hon. Supreme Court and the ITA T Mumbai bench. Accordingly I hold that the loss incurred by the appellant on restatement of pending forward contract agreements at the year-end is an allo .....

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ted in foreign currency. It also carries currency risk in respect of its stock as it is most likely to be sold by way of exports. So, forward contracts in the instant case are entered into to hedge these currency risk associated with normal business transaction. These derivative contracts are entered within the framework of relevant RBI guidelines (including quantum limits set by RBI). The intent of entering into derivative contracts was to safeguard itself against exchange fluctuation risk on f .....

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eign currency receivables/payables. Assessee has been consistently following the accounting method where in end restatement of Mark to Market gain or loss in respect of all assets or liabilities denominated in foreign currency i.e. Debtors, Creditors, Loan & Forward Contract, is being recognized as gain or loss in profit & loss account. 6. As per assessee s nature of business being export, it has certain receivables on foreign exchange at any point of time during the year, thus, consiste .....

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egal liability irrespective of the fact that whether it matures during the accounting year or beyond the accounting year. Since legally tenable forward contract is in existence, dully supported by an underlying asset and the contract having been entered during the course of business and further that the exchange rate as on date of entering the contract and as at the year-end being ascertainable, due effect of the contract at the year end has to be considered while assessing assessee s income. It .....

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, 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 the assessee from the very beginning and if there was a change in the system, whether the change was bona fide; (iii ) whether the assessee has given the same treatment to losses claimed to have accrued and to the gains that may a .....

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