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2015 (12) TMI 47 - ITAT MUMBAI

2015 (12) TMI 47 - ITAT MUMBAI - [2016] 45 ITR (Trib) 57 - Disallowance of loss on eligible derivate transactions in foreign exchange - Held that:- The assessee company has entered into derivative transactions in foreign currency through recognised stock exchange and has complied with the other conditions as stipulated in Section 43(5) read with proviso(d) and explanation 1 to the said Section 43(5) of the Act for which cogent material is brought on record.

The contract for derivative .....

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erminable with reasonable certainty. The considerations for accounting the income are entirely on different footing.

As per AS-11, when the transaction is not settled in the same accounting period as that in which it occurred, the exchange difference arises over more than one accounting period.

The contract for derivative in foreign currency have all the trappings of stockin- trade.

In the ultimate analysis, there is no revenue effect and it is only the timing of .....

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s of Section 43(5) of the Act read with proviso (d) and explanation 1 of the Section 43(5) of the Act and is exempt to be categorised as speculation loss and further hold that the said loss as at the date of financial statement as at 31st March 2009 arising due to adverse movement in exchange rate between United States Dollars vis-avis in relation to Indian Rupee as on the date of Balance Sheet as at 31st March 2009 is not a notional or contingent loss rather it is a ascertained liability which .....

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p. Ltd. v. CIT (1996 (12) TMI 6 - SUPREME Court ) has clearly held that these stamp duties/fees to Ministry of Corporate Affairs, GOI paid towards the increase in authorized capital of the company is held to be for expansion of capital base of the company and hence these are capital expenditure and cannot be allowed. Respectfully following the above decisions of the Hon'ble Supreme Court, we uphold the orders of assessing officer as confirmed by the CIT(A) and decide this issue against the asses .....

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ndent : Shri Om Prakash Meena ORDER Per Ramit Kochar, Accountant Member This appeal by the assessee company is directed against the order dated 07.02.2013 of Commissioner of Income Tax (Appeals)-9, Mumbai (Hereinafter called "the CIT(A)") for assessment year 2009-10. The assessee company has raised following grounds of appeal:- "(A) Disallowance of loss on eligible derivate transactions in foreign exchange ₹ 1,09,98,560/-. On the facts and in the circumstances of the case th .....

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ich fully support the contentions of appellant on this issue. (i) CIT V/s. Woodward Governor India Pvt. Ltd. 312 ITR 254 (SC) (ii) Shree Capital Services Vs. ACIT 318 ITRI (ITAT Kolkatta) (iii) Oil and Natural Gas Corporation Ltd. Vs. DCIT 261 ITRI (ITAT Delhi). (iv) DCIT V/s. Bank of Bahrin & Kuwait 132 TTJ 550 (ITAT Mumbai Bench 'C') (B) Disallowance of Stamp Duty ₹ 2,59,000/- and fees paid to Ministry of Corporate Affairs ₹ 7,45,280/-. On the facts and in the- circumst .....

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iness of Revenue Cycle Management (RCM) for their clients across US. 3. During the course of scrutiny proceedings, the assessing officer observed that the assessee company has debited ₹ 1,09,98,560/- to the Profit & Loss Account on account of 'loss on derivative transaction' while the gross revenue was ₹ 5,83,80,537/- on account of services rendered to foreign clients. The assessee company was asked to explain such dis-proportionate loss as compared to gross revenue and t .....

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on account of underlying account receivables which are denominated in US Dollars. The assessee submitted that the loss on account of derivative transaction of ₹ 1,09,98,560/- representing loss arising out of restatement of foreign currency forward contract in accordance with Accounting Standard (AS-11) issued by the Institute of Chartered Accountant of India (ICAI) and mark to market losses on such foreign exchange derivative transactions as at the end of assessment year are booked in the .....

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over of the assessee company is only ₹ 5.83 crores for the assessment year and the receivables are ₹ 2.23 crores as at the end of the assessment year and the assessee company has incurred huge loss of ₹ 1.10 crores, which is totally disproportionate as compared to turnover and the accounts receivables and has not been entered into by the assessee company to hedge its foreign exchange positions. The assessing officer held these transactions of foreign exchange as speculative in .....

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ogent material to prove that its case falls with in the four corners of the beneficial provisions. The assessing officer relied upon the Judgments of Hon'ble Supreme Court in the cases of Bacha F. Guzdar v. CIT 27 ITR 1 (SC) & CIT v. Ramkrishna Deo 35 ITR 312 (SC). Relying upon the Judgment of Hon'ble Supreme Court in the case of Tuticorin Alkali Chemicals & Fertilizers Ltd v. CIT 227 ITR 172 (SC), the assessing officer held that accounting standard prescribed by ICAI cannot over .....

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ut of which ₹ 2,59,000/- was paid as stamp duty and ₹ 7,45,286/- was paid to Ministry of Corporate Affairs, New Delhi as fees for increase in authorized capital. The assessing officer disallowed the said expenses u/s 37 of the Act being capital in nature and added back the same to the total income of the assessee. 4. Aggrieved by the orders of the assessing officer, the assessee company carried the matter in appeal before the CIT(A) and reiterated its submissions, as made before the .....

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98,560/- represents loss arising on account of restatement of foreign currency forward contracts in accordance with Accounting Standard-11 issued by ICAI and accordingly the assessee company has booked a marked to market loss of such foreign exchange derivative transaction. The assessee company submitted that it had done hedging by way of derivative transactions to protect against the loss arising on account of fluctuation between Indian Rupee and United States Dollar as its revenue are earned i .....

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ces v. ACIT 318 ITR 1 2. CIT v.. Woodword Governor India Pvt. Ltd. 312 ITR 254 3. Oil and Natural Gas Corpn Ltd. v. DCIT 261 ITR 1 4. DCIT v.Bank of Bahrain & Kuwait 132 TTJ 505 The assessee company further submitted that these transactions are hedging transactions against the foreign currency loss on account of receivables in foreign currency and are not speculative transactions and they are mainly marked to market loss on these foreign exchange derivative contracts as on 31.03.2009. The as .....

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in the books of accounts as per prescribed accounting standards. The CIT(A) further held the same to be contingent in nature and not allowable in view of CBDT instruction no. 17/2008 dated 26.11.2008.Thus, the CIT(A) disallowed the assessee company claim of ₹ 1,09,98,560/- on account of marked to market losses on forward contact entered into by the assessee company in foreign exchange. Similarly for ground no. B regarding disallowance of payment to Ministry of Corporate Affairs of fee of .....

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tains the character of capital expenditure since it is directly related to the expansion of the capital base of the appellant. 5. Aggrieved by the order of CIT(A), the assessee company is in appeal before us. 6. The assessee company reiterated its submissions before us which were made before the authorities below. The assessee company submitted that the assessee company is a domestic company registered with the Development Commissioner, Vishakhapatnam Special Economic Zone as an approved SEZ and .....

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he assessee company submitted that it had done hedging by way of derivative transactions to protect against the loss arising on account of fluctuation between Indian Rupee and United States Dollar as its revenue are earned in US Dollars which are to be converted into Rupees, keeping in view its long term goals and achieved the turnover of ₹ 5.83 crores in the assessment year under consideration and ₹ 35 crores in the succeeding assessment year. Through hedging it covered the anticipa .....

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tions against the foreign currency loss on account of receivables in foreign currency and are not speculative and they are mainly marked to market loss on these foreign exchange derivative contracts as on 31.03.2009. The assessee company submitted that the said loss is not speculative as the same is carried on the recognized stock exchange and are not deemed to be speculative in view of proviso (d) to Section 43(5) of the Act and also having complied with explanation 1 to section 43(5) of the Ac .....

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assessee company by the decision of Special Bench of the Tribunal in the case of DCIT v. Bank of Bahrain & Kuwait (supra). The assessee company submitted that these transactions of foreign exchange contracts are duly covered u/s 43(5) of the Act and are eligible transactions as per Section 43(5) of the Act read with proviso (d) and explanation 1 to Section 43(5) of the Act and stated that these are not speculative transactions but they are being entered into to hedge against the possibility .....

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ore us. The assessee company submitted that these contract notes are of currency derivative segments of National Stock Exchange of India Limited and are derivative transactions in currency futures in United States Dollars entered into through MF Global Sify Securities India Private Limited who are Member, National Stock Exchange of India Limited holding SEBI Registration No. INE231250335, NSE TM Code No. 12503, CM 51102. The assessee company submitted that these transactions of currency derivati .....

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bove broker indicating the unique client identity number and PAN allotted under the Act as per mandate of Section 43(5) of the Act. The assessee company also relied upon the decision of Hon'ble Supreme Court in the case of CIT v. Woodword Governor India Pvt. Ltd. (supra) and contended that these losses should be allowed to be set off against nonspeculative business income being on revenue account as derivative contracts have foreign currency as underlying asset and these contracts are in the .....

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osses are speculative in nature and cannot be allowed to be set off against business income other than speculative income. 8. We have heard the rival submissions and carefully perused the relevant material on record and case laws relied upon by the parties.We have observed that the assessee company is a domestic company registered with the Development Commissioner, Vishakhapatnam Special Economic Zone as an approved SEZ and is a KPO primarily involved in the revenue cycle management for the clie .....

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t as at 31st March 2009 based on the movement of value of United States Dollar vis-à-vis in relation to Indian Rupees based on prevailing rate as on 31-03-2009. Before we proceed further, it would be relevant to analyse the provisions of Section 43(5) of the Act read with proviso (d) and explanation 1 to Section 43(5) of the Act which reads as under: "Definitions of certain terms relevant to income from profits and gains of business or profession. 43. In sections 28 to 41 and in this .....

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.… (c) ……..… 83[(d) an eligible transaction in respect of trading in derivatives84 referred to in clause 85[(ac)] of section 286 of the Securities Contracts (Regulation) Act, 1956 (42 of 1956) carried out in a recognised stock exchange; 87[or]] 87[(e) ………. shall not be deemed to be a speculative transaction. 89[90[Explanation 1].-For the purposes of 91[clause (d)], the expressions- (i) "eligible transaction" means any transaction,- (A) c .....

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ts or by banks or mutual funds on a recognised stock exchange; and (B) which is supported by a time stamped contract note issued by such stock broker or sub-broker or such other intermediary to every client indicating in the contract note the unique client identity number allotted under any Act referred to in sub15 clause (A) and permanent account number allotted under this Act; (ii) "recognised stock exchange" means a recognised stock exchange as referred to in clause (f) of section 2 .....

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provides that an eligible transaction in respect of trading in derivatives referred to in clause (ac) of Section 2 of the Securities Contracts(Regulation) Act,1956 carried out in a recognized stock exchange shall not be deemed to be a speculative transaction. We would also like to refer to the relevant definitions as contained in the Securities Contract (Regulation)Act,1956 as under: Section 2(ac) of the Securities Contract (Regulation)Act,1956 reads as under: Section 2 in The Securities Contra .....

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s under: Section 2 in The Securities Contracts (Regulation) Act, 1956 2 Definitions. -In this Act, unless the context otherwise requires,- (h) "securities" include- …….. 4 [(ia) derivative; ……. " From the above, it is clear that speculative transaction is a transaction in which contract for purchase and sale of any commodity is settled otherwise than by actual delivery. It is not in dispute that in case of transaction in derivatives, the transaction is .....

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us, derivative will be included in the definition of the word 'commodity' as held in Shree Capital Services Limited v. ACIT (2009)124 TTJ 0740(SBITAT Kol.). Hence, derivative transactions in foreign currency shall be exempted from purview of speculative transactions u/s 43(5) of the Act provided other conditions as contained in proviso (d) read with explanation 1 to Section 43(5) of the Act are fulfilled. Our view is fortified by the Memorandum explaining the provisions in the Finance Bi .....

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s are excluded from the purview of said provision. Further, the unabsorbed speculation losses are allowed to be carried forward for eight years for set-off against speculation profits in subsequent years. These restrictions were essentially designed as an antievasion measure to prevent claims of artificially generated losses in the absence of an appropriate institutional infrastructure. Recent systemic and technological changes introduced by stock markets have resulted in sufficient transparency .....

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d stock exchange shall not be deemed to be a speculative transaction. The proposed amendment also seeks to notify relevant rules etc. regarding conditions to be fulfilled by recognized exchanges in this regard. Further it is also proposed to amend sub-s. (4) of s.73 so as to reduce the period of carry forward of speculation losses from eight assessment years to four assessment years. These amendments will take effect from 1st April 2006 and will, accordingly, apply in relation to asst. ys 2006-0 .....

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a member National Stock Exchange of India Limited and these derivative transactions are carried on through National Stock Exchange of India which is a recognized stock exchange and these transactions are backed by time stamped contract notes carrying unique client identity number and PAN allotted under the Act. The reliance of the Ld. DR on the case of Araska Diamond Pvt. Ltd. is misconceived as in this case the assessee did not fulfill the conditions as stipulated under section 43(5) of the Ac .....

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that these transactions are covered by the exception as contained in proviso (d) to Section 43(5) of the Act and hence are not speculative transactions as defined under Section 43(5) of the Act. Thus, we hold that loss of ₹ 1,09,98,560/- incurred by the company on derivative transactions in foreign currency in the instant appeal is not a speculative loss within the definition as contained in Section 43(5) of the Act. Regarding contention of the Revenue that, these marked to market loss of .....

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transactions had not yet been squared/settled as on the date of Balance Sheet as at 31st March 2009, we are guided by the decision of Tribunal Special Bench, Mumbai in DCIT v. Bank of Bahrain and Kuwait (2010) 132 TTJ 0505 (SB) as detailed here in under: "32. Ground No.2 for the assessment year 1998-99 and Ground No.3 for the assessment year 1999-2000 in regard to which reference has been made to the Special Bench reads as under: "Whether on facts and circumstances of the case, can it .....

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xchange contracts, which were unmatured on the date of balance sheet, of an amount of ₹ 12,42,648/-. He noted that the assessee enters into forward contracts with clients to buy or sell foreign exchange at an agreed price on a future date. This future price was estimated according to certain norms such as forward premium rates for certain currencies. He noted that when such contract was entered into, the bank normally booked loss or profit depending upon the difference between the prevaili .....

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since in the forward contracts, the liability to purchase or sale of foreign exchange arises only on the date of maturity of the contract, therefore, the loss or gain depends upon the rate prevailing on that date and the contracted rate. Thus, he was of the opinion that the date of maturity of the contract is the relevant date for determining the profit or loss, accruing to an assessee, in pursuance to the forward foreign exchange contract. The assessee pointed out that as per RBI's guideli .....

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the market rate. The assessing officer did not agree with this modus operandi in regard to unmatured forward contracts. He further pointed out that in case foreign exchange is a current asset, the easier method of accounting would be to book the sale when it was done and the purchase when it was executed, which will determine gain or loss of the transaction. He further observed that the method followed by the assessee may be fair accounting principle to estimate the net worth but the principles .....

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g his profits. It is only the actual liability in present which is allowable and not liability in future which for the time being, is only contingent. It was also held that what a prudent trader sets apart to meet a liability, not actually present but only contingent, cannot bear the character of expenses till the liability becomes real. He also referred to the decision of the Hon'ble Supreme Court in the case of Indian Molasses' case (37 ITR 66), wherein also, it was held that where the .....

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ion 145 and the same could be disputed only if the profits or gains were not properly deducible from the same, the assessing officer pointed out that the accounting method followed does not have much relation to the accrual basis of accounting. He observed that in forward contracts, liability arises only on the date contract matures. He pointed out that before the sale, it is only a contingent liability as the assessee could not foresee the rate of exchange which would prevail on the date of mat .....

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onal loss. The assessing officer, however, allowed the amount which was disallowed on this count in earlier years. 34. Before ld Commissioner (Appeals), it was contended that the assessee was required to revalue its outstanding forward foreign exchange contracts as per the rates of exchange notified by the Foreign Exchange Dealer's Association of India on March 31, every year as per RBI guidelines. The gain or loss on revaluation of the outstanding contracts was booked in the profit and loss .....

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the assessee was offering profits resulting from such revaluation as and when they so arise and the assessing officer had never objected to the profits which was shown on revaluation of outstanding foreign exchange forward contracts. In this regard, ld Commissioner (Appeals) relied on the decision of ITAT Mumbai in the case of Deutsche bank A.G v DCIT, 86 ITD 431, wherein, it has been held that income/loss on revaluation of forward foreign exchange contracts is not notional in nature and, theref .....

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ncy at an agreed price on a future date in order to protect the interest of the bank. He submitted that it is a tool to safeguard the assessee's interest. Ld CIT D.R. submitted that these contracts are entered into in order to avoid wide fluctuation in foreign currency. He submitted that there is no dispute in regard to contracts which matured during the year in which they were entered into and the loss/profit was claimed as deduction/income, had been allowed/taxed, accordingly. The dispute .....

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dia, 218 ITR 371 relied upon by the assessee proceeded on the footing that the securities were stock-in-trade but as far as the forward contract is concerned, the same is not stock-in-trade and, therefore, those decisions are not applicable. He pointed out that there is no material to prove that forward contract to buy or sell foreign currency itself constitutes the stock-in-trade as the assessee does not trade in such forward contract. He, therefore, submitted that the decision which proceeded .....

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n-trade is considered. In this regard, Ld CIT D.R. referred to the decision of the Hon'ble Supreme Court in the case of CIT v. Woodward Governor of India, 312 ITR 254 (SC) and pointed out that in para 18, while considering the applicability of AS-11, the Hon'ble Supreme Court noted that exchange difference arising on foreign currency transaction have to be recognized as income or as expenses in the period for which they arise, except as stated in paras 10 & 11, which deals with excha .....

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rate difference. Ld CIT D.R. thus, submitted that the manner of holding foreign currency is relevant and if the same is held as stock-in-trade then in view of the decision of the Hon'ble Supreme Court in the case of Woodward Governor of India (supra), the exchange rate difference on the balance sheet date has to be considered for tax purposes. Ld CIT D.R. referred to the decision of the Hon'ble Bombay High Court in the case of CIT v. Kamani Metals and Alloys Ltd, 208 ITR 1017(Bom), wher .....

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. In the backdrop of these facts, the assessee made a provision amounting to ₹ 4,18,021/- for the anticipated loss in the purchase account representing the difference between the contract price and the market price on the date of receipt of the material as the market price of the copper cathodes was less than the contract price. The assessee's claim was allowed by the Tribunal. However, when the matter traveled before the Hon'ble High Court, it was held that under the contract in q .....

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he anticipated loss was disallowed by the Hon'ble High Court. Ld CIT D.R. relying on this decision submitted that this covers the issue before us and on same parity of reasoning; the forward foreign exchange contract remaining unsettled at the closing balance sheet date could not be treated as stock-in-trade. 36. Ld CIT D.R. further submitted that the decision in the case of Deutsche Bank A.G. (supra) relied upon by ld Commissioner (Appeals) is not applicable as the same proceeds on a wrong .....

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of Indian Molasses Co. Ltd v CIT, 37 ITR 66 (SC), wherein, the Hon'ble Supreme Court, inter alia, observed that income tax law does not allow as expenses all the deductions a prudent trader would make in computing his profits. It was further held that in finding out what profits there be, the normal accountancy practice may be to allow as expense any sum in respect of liabilities which have accrued over the accounting period and to deduct such sums from profits. He, therefore, submitted that .....

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nts. 38. Ld CIT D.R. further referred to the decision of the ITAT Calcutta Bench Third Member in the case of Eveready Industries India Ltd v. DCIT, 78 ITD 175 (Cal)',wherein, it was held that exchange fluctuation loss of un-matured forward covers (i.e. forward contract) could not be allowed on accrual basis. However, since the assessee claimed that such contract got settled during the year and only remittance was made, the issue was set aside to the assessing officer to ascertain the fact an .....

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ts and if the correct profits cannot be deduced from the accounts then he has to compute the profits on his own. Ld CIT D.R. further referred to the decision of the Hon'ble Calcutta High Court in the case of Bestobell India Ltd, 117 ITR 789 (Cal),wherein, the facts were that the loan of 37,500, being about ₹ 5 lakhs was taken by the assessee from its subsidiary company to be repaid at the expiry of one year or earlier. However, the loan could not be repaid within the stipulated period .....

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count in regard to unsettled forward foreign exchange contracts and, therefore, there is no question of its valuation being done at the end of the accounting year. (iii) The anticipated loss is primarily in the nature of notional liability and, therefore, does not accrue/arise at the end of the previous year and hence, not allowable. (iv) The liability accrues or arise only on the date of maturity of the contract and prior to that purely on the basis of estimated liability as per FEDAI guideline .....

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olasses Co. Ltd., 37 ITR 66 (SC) 39. Shri F.V.Irani, ld counsel for the assessee submitted that there is no dispute regarding allowability of assessee's claim and the only dispute is regarding timing i.e. year of allowability. The whole controversy is whether on the balance sheet date the estimated loss as per the FEDAI notification as per RBI guidelines is accrued loss or notional loss. Ld counsel for the assessee referred to page 8 para 5.3 of ld Commissioner (Appeals)'s order for A.Y. .....

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by the decision of the Hon'ble Supreme Court in the case of Woodward Governor of India Ltd., 312 ITR 254(SC). Ld counsel pointed out that the Hon'ble Supreme Court has affirmed the decision of the Hon'ble Delhi High Court in the case of CIT v. Woodward Governor of India Ltd., 294 ITR 451 (Del). In this regard, ld counsel referred to page 469 and pointed out that in regard to revenue account cases, the Hon'ble Delhi High Court has, inter alia, observed in para 32 that the liabili .....

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the assessee referred to the assessment order for the assessment year 1998-99 and pointed out that in para 5.2 at page 5, the assessing officer observed as under: "In case foreign exchange is a current asset, the easier method of accounting would be to book the sale when this is done and the purchase when it is executed." Ld counsel further referred to page 1 of the assessment order and pointed out that the assessing officer has taken note of the fact that the assessee was following me .....

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authorities on the view that he should have adopted a different method of keeping account or of valuation. The method of accounting regularly employed may be discarded only if, in the opinion of the taxing authorities, income of the trade cannot be properly deduced therefrom. He further referred to the decision of the Hon'ble Bombay High Court in the case of CIT v. TISCO, 106 ITR 363 (Bom), wherein also, similar view was taken. In support of this proposition, he also relied on the decision .....

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t profits and gains of the previous year required to be computed in accordance with the relevant Accounting Standard. It is important bear in mind that the basis on which stock-in-trade is valued is part of the method of accounting. It is well established, that, on general principles of commercial accounting, in the P&L account, the values of the stock-in-trade at the beginning and at the end of the accounting year should be entered at cost or market value, whichever is lower- the market val .....

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onths. Stock-in- trade is an asset. It is a trading asset. Therefore, the concept of profit and gains made by business during the year can only materialize when a comparison of the assets of the business at two different dates is taken into account. Sec. 145(1) enacts that for the purpose of section 28 and section 56 alone, income, profits and gains must be computed in accordance with the method of accounting regularly employed by the assessee. In this case, we are concerned with section 28. The .....

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sumed to be correct till the assessing officer comes to the conclusion for reasons to be given that system does not reflect true and correct profits. As stated, there is no finding given by the assessing officer the correctness of the Accounting Standard followed by the assessee(s) in this batch of civil appeals." 40.1 Ld counsel also relied on the decision of the ITAT Delhi Bench in the case of DCIT v Maruti Udyog Ltd., 99 ITD 666 (Del) and ONGC v DCIT, 83 ITD 151 (Del)(SB), wherein also, .....

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us year. (2) The loss claimed by the assessee is not a notional/contingent loss, but is an actual loss which it is entitled to as a deduction. 40.2 Ld counsel for the assessee pointed out this aspect is evident from the fact that the loss of ₹ 1,52,20,000/- disallowed by the assessing officer in A.Y. 1998-99 has been allowed by the assessing officer as a revenue deduction in assessment year 1999-2000. Ld counsel for the assessee referred to the written submissions filed by ld CIT (DR) and .....

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the foreign currency amount of the forward contract by the difference between the spot rate at the balance sheet date and the spot rate at the date of inception of the contract." "Agreement that obligates an investor to deliver a specified quantity of one currency in return for a specified amount of another currency. Forward exchange contracts. A forward exchange contract (or forward contract) is a binding obligation to buy or sell a certain amount of foreign currency at a pre-agreed .....

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ubmitted therefore, the minute forward exchange contract is entered into; the bank becomes liable to honour the same. A binding obligation arises against the bank which it is required to discharge. He, therefore, submitted that the physical delivery of foreign currency on the date of maturity does not wipe out the present liability incurred by the bank. He relied on the decision in the case of ONGC (supra), wherein, it was, inter alia, observed as under:- "Before concluding, we would like t .....

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in the value of foreign currency in relation to Indian currency has already taken place in the current year. Therefore, the loss incurred by the assessee is a fait accompli and not a notional one." 40.3 Ld counsel for the assessee pointed out that in these cases also, the loans were payable at some future date but the liability was allowed on the basis of revaluation of foreign exchange on the date of balance sheet. Ld counsel pointed out that the decision in the case of ONGC (supra) and Ma .....

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it has to be followed, particularly, because the Hon'ble Delhi High Court has considered the decision in the case of Indian Molasses and also in the case of Indian Overseas bank (supra). Ld counsel for the assessee also pointed out that similar view has been taken in the case of Silcon Graphics v ACIT, 105 TTJ 591 (Delhi) and CIT v. Brockhoven BV, (Mumbai ITAT). Ld counsel for the assessee submitted that from the above decisions, it is evident that the additional liability arisen on account .....

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allowable on the well recognized principle that an assessee's stock/circulating capital has to be valued at cost or market price, wherever is lower. 40.4 Ld counsel for the assessee submitted that in any event, forward foreign exchange contracts are in the nature of stock-in-trade and on this count also they have to be valued at cost or market price, whichever is lower and, therefore, any resultant loss on fluctuation of Indian Rupee has to be allowed as a deduction on normal principles of c .....

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v. ACIT (ITA No.5327/M/01). In this case, the Tribunal taking note of the fact that in assessee's own case the addition on account of notional profit on unsettled forward exchange contract had been taxed the loss claimed by the assessee on the same count was held allowable. (iv) Deutsche bank A.G. v DCIT, 86 ITD 431(Mum), wherein also, similar view was taken. (v) Shree Capital Services Limited, 121 ITD 498(Kol)(SB), wherein, it has been observed that the derivative derives its value from the .....

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, it should be taken as stock-in-trade. (4) The loss has to be allowed on the matching principle laid down by the Supreme Court in the case of Madras Industrial Investment Corporation. Ld counsel for the assessee referred to the following hypothetical example which is reproduced herein-below: "A" the Bank's method "matches" the total profit of ₹ 300 to the respective periods to which it relates viz Rs.100 to the year ended 31-3-1998 Rs.200 to the period ended 31 Mar .....

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(supra) has to be considered in the context in which the same is delivered. He pointed out that the Hon'ble Supreme Court in the case of Woodward Governor (supra) held that the foreign currency notes, balance in bank accounts denominated in foreign currency and receivables/payables and loans denominated in foreign currency as well as sundry creditors are all 'monetary items', which have to be valued at closing rate at the end of the accounting year as per AS-11. He pointed out that .....

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t such contracts indirectly represent stock-in-trade or trading assets of the assessee. Further, no accounting entry had been made before the settlement of contract. He submitted that the following decisions relied upon by ld counsel for the assessee proceeded on the assumptions that there was stock-in-trade: (i) Bank of India, 218 ITR 371 (Bom) - Here foreign exchange held in its foreign branches constituted stock-in-trade. (ii) Bank of Tokyo, 13 ITD 32 (Cal) - Proceeded on the assumption that .....

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355 (SC). The question was whether government securities held by bank are stock-in-trade or not. (vii) Brockhoven BV (ITA No.8344/B/90. In this case, the question before the Hon'ble Bombay High Court was loss on account of difference in foreign exchange rate in respect of amount due by the assessee to its head office, which was held to be allowable. 42. We have considered the rival submissions and perused the record of the case. There is no dispute that if the date of maturity of the contra .....

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tered into by the assessee. Forward Foreign exchange contract means an agreement to exchange different currencies at a forward rate. Forward rate is a specified rate for exchange of currency at a specified date. The assessee enters into forward contract with clients to buy or sell foreign exchange at an agreed price at a future date in order to hedge against the possible future financial loss on account of wide fluctuation in the rate of foreign currency. Thus, firstly, forward foreign exchange .....

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ree months on 15-5-2010. Suppose, on the date of contract, the value of Dollar vis-a-vis Rupee was ₹ 45. After three months, 'X & Co.', keeping in view the prevailing economic conditions etc., anticipated wide fluctuation in exchange rate. Therefore, it entered into with its bank (assessee) to purchase 1,00,000 $ on 15.5.2010 at say ₹ 47/-. Thus 'X & Co.' had hedged the loss at ₹ 2/- which it distributed over two periods. However, as far as the assessee .....

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into consideration on 31st March. Having considered the nature of contract, we will examine whether on account of existing obligation, a liability accrues as per I.T. provisions on 31st March or not. In order to find answer to this intricate issue, we have to keep in mind certain settled accounting propositions which have received judicial recognition. They can briefly be summed up as under:- (i) The income is to be accounted for only when right to receive the same has accrued in favour of a pe .....

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of accounting consistently followed by the assessee should not be discarded casually without giving strong reasons for the same. Merely because the assessing officer feels that other method of accounting would be better, the assessee's method of accounting cannot be rejected. 43. The assessee's contention is that this contract has to be revalued in accordance with FEDAI guidelines as notified by RBI and, therefore, the assessee had no option but to determine the profit/loss in regard to .....

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principle that deduction is allowable under the Income Tax Act in respect of those liabilities which crystalise during the previous year. Therefore, the concept of crystalisation of liability under Income Tax Act assumes significance vis-'-vis commercial principles in vogue. As per the commercial principles of policy of prudence, all anticipated liabilities have to be accounted for but as per I.T.Act, only that liability will be allowed which has actually accrued. As a matter of fact, Courts .....

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ng 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 43.1 We have to bear in mind that the issues relating to accrual of income cannot be decided on the same footing and considerations on which the issues relating to loss/expe .....

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se of Woodward Governor of India Pvt.Ltd. (supra). The revenue's main contention is that liability can arise only when the contract matures. This plea, in our humble opinion, is completely divorce of the principles of commercial accounting and, therefore, cannot be accepted. Both legal obligation and commercial principles have to be taken into consideration for deciding such issues. 44. From the above discussion, it is evident that the anticipated losses on account of existing obligation as .....

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harged at a future date. What should be certain is the incurring of the liability. It should also be capable of being estimated with reasonable certainty though the actual quantification may not be possible. If these requirements are satisfied the liability is not a contingent one. The liability is in praesenti though it will be discharged at a future date. It does not make any difference if the future date on which the liability shall have to be discharged is not certain. 5. In Metal Box Co. of .....

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y incurred by it on the employees putting in every additional year of service. The gratuity was payable on the termination of an employee's service either due to retirement, death or termination of service-the exact time of occurrence of the latter two events being not determinable with exactitude beforehand. A few principles were laid down by this Court, the relevant of which for our purpose are extracted and reproduced as under : (i) For an assessee maintaining his accounts on mercantile s .....

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nto account while working out the profits and gains of the business; (iii) A condition subsequent, the fulfilment of which may result in the reduction or even extinction of the liability, would not have the effect of converting that liability into a contingent liability. (iv) A trader computing his taxable profits for a particular year may properly deduct not only the payments actually made to his employees but also the present value of any payments in respect of their services in that year to b .....

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a conditional one; it was always open to the tax authorities concerned to arrive at a proper estimate of the liability having regard to all the circumstances of the case." 45. One more aspect which needs to be discussed with reference to commercial accounting principles is with reference to the arguments of Ld CIT D.R. that no transaction has been recorded in the books of account before the date of maturity of contract and, therefore, there is no question of any liability accruing on 31st .....

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t, the assessee has recorded the income/loss on the basis of difference between the contracted rate and the spot rate. Thus, to say that the contract was incapable of being recognized in the books of account, is not correct. The assessee recorded only the net effect of the transaction and not the entire transaction. Whether the deduction is allowable or not, therefore, cannot be guided by this factor. 46. With regard to observations of the assessing officer regarding method of accounting, we may .....

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ervations have been made by the assessing officer to this effect but actual disallowance has been made by treating the impugned amount as contingent liability. 47. Now, we will consider the issue with reference to Accounting Standard -11 (AS-11). The Hon'ble Supreme Court in the case of Chellapali Sugar Mills, 98 ITR 167 and the Hon'ble Delhi High Court in the case of Woodward Governor of India P. Ltd.(supra)observed that the accounting standards issued by the Institute of Chartered Acco .....

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andatory for preparation of financial statements and have to be followed inasmuch as the deviation from the same is to be reported in the audit report. Section 145(2) gives power to the Central Government to notify the accounting standards to be followed by any class of assesses or in respect of any class of income. 48. The Hon'ble Supreme Court in the case of Woodward Governor of India (P) Ltd.,((supra) has observed at page 265 para 17 that the Central Government has made AS-11 mandatory. T .....

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e carrying amount of the fixed assets. The carrying amount of such fixed assets should, to the extent not already so adjusted or otherwise accounted for, also be adjusted to account for any increase or decrease in the liability of the enterprise, as expressed in the reporting currency by applying the closing rate, for making payment towards the whole or a part of the cost of the assets or for repayment of the whole or a part of the monies borrowed by the enterprise from any person, directly or i .....

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or to the profit and loss statement in the event of inadequacy or absence of the revaluation reserve. 12. 12.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 arising from a foreign currency transaction. When the transaction is settled within the same accounting period as that in which it occurred, the entire exchange difference arises in that period. However, when the transaction is not settle .....

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facto imply that the same are always deductible for Income-tax purposes but at the same time its relevance does not, in any manner, gets mitigated. The Hon'ble Supreme Court in the case of Woodward Governor of India (P) Ltd.,((supra) with reference to working capital loan, which was also repayable after the end of accounting period, has held that loss occurred to the assessee, on account of fluctuation in the rate of foreign exchange, as on the date of the balance sheet, is an item of expend .....

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trade at the beginning and at the end of the year should be entered at cost or market price, whichever is the lower. This is how business profits arising during the year need to be computed. This is one more reason for reading section 37(1) with section 145. For valuing the closing stock at the end of a particular year, the value prevailing on the last date is relevant. This is because profits/loss is embedded in the closing stock. While anticipated loss is taken into account, anticipated profit .....

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ed profits in the shape of appreciated value of goods remaining unsold at the end of the accounting year and carried over to the following year's account in a continuing business are not brought to the charge as a matter of practice, though, as stated above, loss due to fall in the price below cost is allowed even though such loss has not been realized actually." Ld CIT D.R.'s submission is that this decision is with reference to monetary items as referred to in AS-11 and since forw .....

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so in view of decision of the the Hon'ble Supreme Court in the case of Woodward Governor India (P)Ltd., (supra), assessee's plea deserves to be accepted. 51. Now, coming to the objection of ld CIT D.R. with reference to various decisions relied upon by ld counsel for the assessee on the ground that in the said decisions, the issue was relating to stockin- trade but in the present case, there is no stock-in-trade. Admittedly, the assessee has not shown any closing stock of unmatured forwa .....

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olding of the foreign currency as current asset. Therefore, in substance, it cannot be said that the forward contract had no trappings of the stockin- trade. Ld counsel has rightly relied upon the decision of the Calcutta ITAT (SB) in the case of Shree Capital Services Limited (supra) in this regard and, therefore, the various decisions relied upon by ld counsel for the assessee as discussed in his submissions are applicable to the facts of the case. 52. Now coming to the argument of ld CIT (DR) .....

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when actual debt is created in favour of assessee but in case of anticipated losses, if an existing binding obligation, though dischargeable at a future date, is determinable with reasonable certainty, then the same is allowable. 53. Ld CIT D.R. has also heavily relied on the decision of the Hon'ble Bombay High Court in the case of CIT v. Kamani Metals and Alloys Ltd. (supra). This decision, in our opinion, is of little help to the department inasmuch as the same has been rendered with refe .....

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e, in our opinion, cannot be applied to the facts of the present case as in the present case, we are concerned about the anticipated loss booked by the assessee on account of foreign exchange rate fluctuation as on balance sheet date, which was in accordance with RBI guidelines as well as in accordance with AS-11. Moreover, a binding obligation arose the minute the contract was entered into. However, now the decision of the Hon'ble Supreme Court in the case of Woodward Governor India P. Ltd. .....

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en fulfilled. In the present case, we have already observed that the forward contract is incidental to the foreign currency held by the assessee as stock-in-trade and, therefore, the decision in the case of CIT v. Kamani Metals and Alloys Ltd (supra) is clearly distinguishable on facts. 54. Ld CIT D.R. has also relied on the decision in the case of Eveready Industries (supra). The view expressed in the said decision also cannot be upheld in view of the decision of the Hon'ble Supreme Court i .....

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corresponding liability being there as the liability was only contingent in nature. There cannot be any quarrel with the proposition that the liability in praesenti is an allowable deduction but a liability in futuro, which for the time being is only contingent, is not allowable. As already pointed out this principle is to be applied keeping in view the principles of prudence and applicable Accounting Standards. In our opinion, the complete answer has been given long back by the Hon'ble Sup .....

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India Ltd ((supra), which decision has been considered in detail by the Hon'ble Delhi High Court in the case of Woodward Governor India (P)Ltd (supra), wherein, it has been observed as under:- "The revenue relied upon the decision of the Calcutta High Court in Bestobell (India) Ltd.,(1979) 117 ITR 789 in support of the submission that the increased liability on repayment of a loan borrowed in foreign exchange for business purposes as a result of exchange rate fluctuation would be a cap .....

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said decision of the Calcutta High Court on this point and held that such liability would be treated as a trading loss. In that view of the matter, the reliance placed by the revenue on the judgment of the Calcutta High Court in Bestobell (India Ltd., (1979) 117 ITR 789 appears misplaced." 56. The controversy stands now resolved in view of the decision of the Supreme Court in the case of Sutlej Cotton Mills Ltd., 116 ITR 1 (SC), wherein, it has been held that fluctuation on account of forei .....

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nt or as a trading asset or as a part of circulating capital embarked in the business. But, if on the other hand, the foreign currency is held as a capital asset or as fixed capital, such profit or loss would be of capital nature(Emphasis, here italicized in print, supplied)" 57. At the end we may further observe that when profits are being taxed by the department in respect of such unmatured forward foreign exchange contracts then there was no reason to disallow the loss as claimed by asse .....

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ee's appeal for the following reasons:- (i) A binding obligation accrued against the assessee the minute it entered into forward foreign exchange contracts. (ii) A consistent method of accounting followed by assessee cannot be disregarded only on the ground that a better method could be adopted. (iii) The assessee has consistently followed the same method of accounting in regard to recognition of profit or loss both, in respect of forward foreign exchange contract as per the rate prevailing .....

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e. (vii) In view of the decision of Hon'ble Supreme Court in the case of Woodward Governor India (I) P.Ltd., the assessee's claim is allowable. (viii) In the ultimate analysis, there is no revenue effect and it is only the timing of taxation of loss/profit. 59. We, accordingly, hold that where a forward contract is entered into by the assessee to sell the foreign currency at an agreed price at a future date falling beyond the last date of accounting period, the loss is incurred to the as .....

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market losses of ₹ 1,09,98,560/- determined by the assessee company due to the movement in the prevailing exchange rate of foreign currency i.e. United States Dollar vis-à-vis in relation to Indian Rupee as on the date of Balance Sheet viz 31st March 2009 is not a notional or contingent loss rather it is an ascertained liability which has crystallized whereby a pending obligation of derivative contract on the balance sheet date i.e 31st March 2009 is determinable with reasonable cer .....

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ember 2008 is misconceived as in the instant case under appeal it is not a contingent or notional liability rather it is an ascertained liability which has crystallized and can be determined with reasonable certainty based upon the adverse exchange rate prevailing between United States Dollars vis-à-vis in relation to Indian Rupees as on the date of Balance Sheet as at 31st March 2009. Hence, We hold that the said loss of ₹ 1,09,98,560/- incurred by the assesee company on account of .....

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e assessment year which can be computed with reasonable certainty and accuracy and is a fait accompli as held in ONGC v. DCIT 261 ITR 1 - Delhi ITAT. 9. Thus in view of our above foregoing discussions, we allow the appeal of the assessee company on following reasons:- 1. That the assessee company has entered into derivative transactions in foreign currency through recognised stock exchange and has complied with the other conditions as stipulated in Section 43(5) read with proviso(d) and explanat .....

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rrency. 4. A liability is said to have crystallized when a pending obligation on the balance sheet date is determinable with reasonable certainty. The considerations for accounting the income are entirely on different footing. 5. As per AS-11, when the transaction is not settled in the same accounting period as that in which it occurred, the exchange difference arises over more than one accounting period. 6. The contract for derivative in foreign currency have all the trappings of stockin- trade .....

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Balance Sheet as at 31st March 2009 in derivatives in foreign currency complies with the provisions of Section 43(5) of the Act read with proviso (d) and explanation 1 of the Section 43(5) of the Act and is exempt to be categorised as speculation loss and further hold that the said loss as at the date of financial statement as at 31st March 2009 arising due to adverse movement in exchange rate between United States Dollars vis-avis in relation to Indian Rupee as on the date of Balance Sheet as .....

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