TMI Blog2011 (8) TMI 1257X X X X Extracts X X X X X X X X Extracts X X X X ..... 003-04. 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 ₹ 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 rate swap, the assessee submitted that the assessee had three ongo ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... sis 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 get the deduction as income tax law does not match step by step ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ns 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 ₹ 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 ₹ 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 ₹ 100 crores for six months on that date. Depending on whether the amount is receivable or payable under the interest rate swap contract, t ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... se 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 is the loss on interest rate swap valuation as on the balance sheet date is to be squared up by transfer to the actual loss or profit on settlement. Its not really, therefore, the question as to whether the deduction is to be allowed or not, but only the assessment year in which deduction is to be allowed. Viewed in the long term perspective, thus, it is wholly tax neutral but for the timing of deduction. 9. Section 145 of the Income Tax Act ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 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 underlying the rule that the closing stock is to be valued at cost or market price whichever is lower, and it is now generally accepted as an established rule of commercial practice and accountancy . No doubt these observations were made in the context of valuation of stock but what is material is the theory underlying the principle of valuing closing stock and the fact that such a theory has the acceptance of the Hon ble Supreme Court. Whichev ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 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 ble Madras High Court s judgment in the case of Indian Overseas Bank (supra) , in support of the proposition that when anticipated profits on unmatured contracts are held, to be non-taxable, there is no good reason as to why anticipated losses on unmatured contracts can be taken into account while computing business income, we find that there is an inherent fallacy in this approach inasmuch as anticipated losses and anticipated profits ar ..... X X X X Extracts X X X X X X X X Extracts X X X X
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