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TMI Blog2025 (5) TMI 495X X X X Extracts X X X X X X X X Extracts X X X X ..... d are being disposed of by way of this common consolidated order. For the sake of convenience, we shall be dealing with the facts in the case of the appeal of the assessee pertaining to the Asst. Year 2014-15 in ITA No. 362/Ahd/2020 and our decisions rendered therein will apply pari passu to the other appeal of the assessee as well. ITA No. 362/ Ahd/2020 Asst.Year 2014-15 3. The ld.counsel for the assessee pointed out that error noted by the ld.Pr.CIT in the assessment order was with respect to the allowance of loss incurred by the assessee on foreign currency derivative transactions ("FCDT" for amounting short) to Rs. 1,50,12,699/- which the ld.Pr.CIT found to be "marked to market" loss ("M2M" for short) and noting the same to be notional loss, contingent in nature and not allowable in terms of the CBDT Instruction No.3/2010 dated 23.03.2010 ("Board Instruction" for short), he found, the AO to have allowed this claim erroneously without examining the issue and conducting due enquiries with regard to the same. 4. The assessee when confronted with the same by the Ld.PCIT in the proceedings conducted under section 263 of the Act filed reply explaining the facts relating to the cl ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... y proceedings, thus holding the assessment order passed to be erroneous in gross violation of the principles of natural justice. 6. The ld.DR strongly supported the order of the ld.Pr.CIT, and made contentions at length on the issue of "FCDT" entered into by the assessee being not allowable in terms of provisions of law, referring to various judicial decisions in this regard. 7. We have heard contentions of both the parties carefully, and have gone through the order of the ld.Pr.CIT and various documents referred to before us by both the parties, as also, judicial decisions referred to during course of hearing before us. We shall now proceed to adjudicate the present appeals. 8. It is to be kept in mind that the appeal arises from the order of the ld.Pr.CIT in exercise of his revisionary powers,passed u/s 263 of the Act, holding the assessment order erroneous causing prejudice to the Revenue. And our scope of adjudication is therefore, confined to deciding, whether the ld.Pr.CIT has rightly found so, in accordance with law. The Ld.PCIT has held the assessment order erroneous on account of the AO not having examined the issue of allowability of claim of foreign currency derivativ ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... s) was mark to market loss giving effect of changes in foreign exchange rate as on 31.03.2015. However, such MTM loss of Rs. 136.40 lakhs is not an allowable in view of CBDT's Instruction No. 3/2010 dated 23.03.2010 which states that MTM loss is a notional loss and contingent in nature and therefore the same is not an allowable expense while computing the total income. 10. The ld.counsel for the assessee pointed out that with respect to both these types of "FCDT" a different explanation was furnished to the ld.Pr. CIT on account of the different nature of the loss, and it was also pointed out to him that in terms of position of law as laid down by courts in various decisions, both losses were allowable. 11. He stated that it was pointed out to the Ld.PCIT that the foreign currency derivative loss was on account of forward contracts and was not an "M2M" loss, but in fact it was an actual loss incurred by the assessee on settlement of the transactions, and therefore not covered by the CBDT instruction and thus allowable as per law. That the loss on exchange rate difference of creditors was pointed out to be not on account of any forward contract of foreign currency derivative, ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... required to follow the accounting standards issued by the Institute of Chartered Accountants of India ("ICAI"). * The reporting currency of the assessee is Indian Rupee hence, all the transactions entered into by it during the course of its business are recorded in Indian Rupees. * In respect of the accounting of the transactions entered into Foreign Currency, the assessee follows the following accounting treatment as prescribed under Accounting Standard - 11 "The Effects of Changes in Foreign Exchange Rates" issued by ICAI: * The transactions in foreign currencies on revenue accounts are stated at the rates of exchange prevailing on the dates of transactions. * The net gain or loss on account of exchange differences either on settlement or on translation is recognised in the statement of Profit and Loss. The foreign currency assets and liabilities including forward contracts are restated at the prevailing exchange rates at the year end. The premium in respect of forward contracts is accounted over the period of the contract. * In terms of the above, the transactions in respect of import of raw materials for its consumption/use in the normal course of business have been r ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 46,566 Unsettled marked to market profit Rs. 1,55,360 14. He also drew our attention to PB Page No. 14, pointing out to the ld.Pr.CIT that Instruction NO. 3 of 2010 did not apply to the impugned transaction, and that loss had been booked in accordance with AS- 11, as under: c) Since this particular loss is pertained to revenue transaction relating to import of goods, the Instruction No. 03/2010 dated 23.03.2010 is not at all applicable as it is related to 'Tax Implications Of Forward Foreign Exchange Contracts, only. d) The said loss has been accounted following the accounting treatment as prescribed under Accounting Standard -11 "The effects of Changes in Foreign Exchange Rates" issued by the Institute of Chartered Accountants of India. e) Thus, the assessee has rightly and consistently recorded the effect of exchange rate differences and as a result has claimed such loss arising due to changes in the exchange rate as an allowable business expense. 15. With respect to the loss claimed by the assessee on "FCDT" transaction of Rs. 82.91 lakhs, the ld.counsel for the assessee pointed out that this issue was also shown to have been examined by the AO during the assessment ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ciation for the purposes of clause (e) of the proviso to clause (5) of the said section 43 of the Income- tax Act, 1961 (43 of 1961) read with sub-rule (4) of rule 6DDD of the Income-tax Rules, 1962. Copy of the said notification is attached for your immediate reference marked as an Annexure-32B. Shareholders of the Exchange include India's top public sector banks, private sector banks and domestic financial institutions who, together hold over 88% stake in the Exchange. MSEI is subjected to CAG Audit and has an independent professional management. In line with global best practices and regulatory requirements, clearing and settlement is conducted through a separate clearing corporation, MCX-SX Clearing Corporation Ltd. (MCX-SX CCL). All the Foreign Currency derivative transaction carried out by a broker of MCX Stock Exchange Ltd. electronically and it is supported by time stamped contract note issued by such broker. Your honour has asked to provide copies of certain bills as mentioned below which are attached herewith as Annexure-32C (i) Loss of Rs. 29.66 lacs dated 22/05/2014 (ii) Loss of Rs. 13.45 lacs dated 02/07/2014 (iii) Loss of Rs. 25.78 lacs dared 14/08/2014 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... Act, 1996 (22 of 1996) and the rules, regulations or bye- laws made or directions issued under those Acts 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 sub-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 of the Securities Contracts (Regulation) Act, 1956 (42 of 1956) and which fulfils such conditions as may be prescribed and notified!9 by the Central Government for this purpose; Based on the documents placed on record, it is apperant that the currency derivative transactions carried out by the assessee on MCX-SX are eligible transactions and hence, not considered as speculative transaction. " In view of the above, the assessee has rightly claimed loss arising out of eligible currency derivative transactions as a business loss u/s 37 of the Income Tax Act, 1961." 16. The ld.counsel for the ass ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... rting such losses on 'marked to market' basis either suo motu or in compliance of the Accounting Standard or advisory circular issued by the Institute of Chartered Accountants. The issue whether such losses on account of forex derivatives can be allowed against the taxable income of an assessee has been considered by the Board. In this connection, I am directed to say that the Assessing Officers may follow the guidelines given below:- 'Marked to Market Losses' 2. "Marked to Market" is in substance a methodology of assigning value to a position held in a financial instrument based on its market price on the closing day of the accounting or reporting record. Essentially, 'Marked to Market' is a concept under which financial instruments are valued at market rate so as to report their actual value on the reporting date. This is required from the point of view of transparent accounting practices for the benefit of the shareholders of the company and its other stakeholders. Where companies make such an adjustment through their Trading or Profit/Loss Account, they book a corresponding loss (i.e., the difference between the purchase price and the value as on the valuation ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 39; or some similar head which may make it difficult to detect them. In such cases, the Assessing Officers should make a specific query asking the assessee to give a break up of any 'Marked to Market' loss on a forex-derivatives included in the Profit and Loss Account and examine whether such transactions are 'eligible transaction' in terms of section 43(5)(d). An adjustment to the taxable income may therefore be made, if necessary, keeping in view the provisions of law referred to above." 3.1 In the said instruction, the term "Marked to Market" has been used and therefore, I have tried to understand this term by visiting the relevant webpages available on the subject. This term has been explained as under :- "Understanding Mark to Market (MTM) and Mark to Market in Accounting i) Mark to market is an accounting practice that involves recording the value of an asset to reflect its current market levels. At the end of the fiscal year, a company's annual financial statements must reflect the current market value of its accounts. For example, companies in the financial services industry may need to make adjustments to the assets account in the event that some ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... y bullish, while the trader shorting the contract is considered bearish. If at the end of the day, the futures contract entered into goes down in value, the long account will be debited and the short account credited to reflect the change in value of the derivative. Conversely, an increase in value results in a credit to the account holding the long position and a debit to the short futures account. vi) For example, to hedge against falling commodity prices, a wheat farmer takes a short position in 10 wheat futures contracts on November 21, 2017. Since each contract represents 5,000 bushels, the farmer is hedging against a price decline of 50,000 bushels of wheat. If the price of one contract is $4.50 on November 21, 2017, the wheat farmer's account will be credited with $4.50 x 50,000 bushels = $225,000. Day Futures Price Change in Value Gain/Loss Cumulative Gain/Loss Account Balance 1 $4.50 225,000 2 $4.55 +0.05 -2,500 -2,500 222,500 3 $4.53 -0.02 +1,000 1,500 223,500 4 $4.46 -0.07 +3,500 +2,000 227,000 5 $4.39 -0.07 +3,500 +5,500 230,500 (Note that the Account Balance is marked daily using the Gain/Loss column, not ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ness expenditure. * During the year under assessment, it had made forward contracts of foreign currency derivative through MCX Stock Exchange Ltd in order to hedge its open exposure in respect of transactions entered into for import of raw material during normal course of business. * The transactions were carried out through recognized stock exchange as per the provisions of section 4 of the Securities Contracts(Regulation) Act, 1956 and also through notified stock exchange under section 2(39) of the Companies Act, 1956. The said stock exchange has also been a recognized association for the purpose of section 45(5)(e) of the Act read with Rule 6DDD(4) of the I.T. Act. * All the foreign currency derivatives transactions were carried out by a broker of MCX Stock Exchange Ltd electronically and it is supported by time stamped contract notes issued by such brokers. * The assessee has enclosed three copies of bills for the losses incurred on different dates in the month of June, 2013. The sample copy of one of the bills so raised is reproduced as under :- * Based on various documents placed on record during the course of assessment proceedings, the currency derivatives transac ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... of raw materials or merchandise entered into by a person in the course of his manufacturing or merchanting business to guard against loss through future price fluctuations in respect of his contracts for actual delivery of goods manufactured by him or merchandise sold by him; or (b) a contract in respect of stocks and shares entered into by a dealer or investor therein to guard against loss in his holdings of stocks and shares through price fluctuations; or (c) a contract entered into by a member of a forward market or a stock exchange in the course of any transaction in the nature of jobbing or arbitrage to guard against loss which may arise in the ordinary course of his business as such member; [or] [(d) an eligible transaction in respect of trading in derivatives referred to in clause [(ac)] of section 2 of the Securities Contracts (Regulation) Act, 1956 (42 of 1956) carried out in a recognised stock exchange; [or]] 87[(e) an eligible transaction in respect of trading in commodity derivatives carried out in a recognised association [, which is chargeable to commodities transaction tax under Chapter VII of the Finance Act, 2013 (17 of 2013).]] shall not be deemed to be ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... rates, a credit rating or credit index, or similar variable (sometimes called the 'underlying'); (b) that requires no initial net investment or little initial net investment relative to other types of contracts that have a similar response to changes in market conditions; and (c) that is settled at a future date. Actually, derivatives are assets, whose values are derived from values of underlying assets. These underlying assets can be commodities, metals, energy resources, and financial assets such as shares, bonds, and foreign currencies." 3.9 Since the assessee-company has explained that the provisions of section 43(5)(e) of the Act are applicable in its case i.e. in respect of trading of commodity derivatives, the meaning as assigned to this term by the Finance Act No.2-Chapter-VII of the Act has been referred to. The commodity derivative has been defined as :- "17.3-1 Commodities Derivative Section 116(5) of the Finance Act. 2013 defines the expression "commodity derivative" to mean: (i) a contract for delivery of goods which is not a ready delivery contract; or (ii) a contract for differences which derives its value from prices or indices of prices- ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... from house property", "Capital gains" and "Income from other sources"], or a company [the principal business of which is the business of trading in shares or banking for the granting of loans and advances) consists in the purchase and sale of shares of other companies, such company shall, for the purposes of this section, be deemed to be carrying on a speculation business to the extent to which the business consists of the purchase and sale of such shares.]" 3.12 Thus, under the deeming provisions of section 73(5) of the Act, the assessee-company would not be entitled to set off any loss on transactions of buy and sale of US $ through two brokers as mentioned above. 3.13 In view of the above detailed discussion, it is held that the Assessing Officer has wrongly allowed the amount of Rs. 1,54,19,301/- carried over from gain/loss on currency derivative transactions to the Exchange Rate Difference account so as to debit the entire exchange rate difference of Rs. 1,94,84,145/- in the profit & loss account without carrying out necessary inquiries and verifications. This omission on the part of the Assessing Officer has resulted into passing of an erroneous assessment order which is ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... of the Hon'ble Apex Court, not applicable in the present case. With respect to the loss on derivative transactions, he pointed out that the ld.Pr.CIT failed to appreciate that the assessee had not booked any speculative loss in the said case without settlement of transactions. He, therefore, contended that the finding of the error by the ld.Pr.CIT in the assessment order passed was incorrect, and therefore, order passed therefore to be quashed. 19. The ld.DR, however, heavily relied on the finding of the ld.Pr.CIT and made many arguments on the merits of the issue also, drawing our attention to various decisions, holding that the loss in commodity transactions are speculative and not allowable in terms of section 43(5) of the Act. 20. Having considered the contentions of the ld.counsel for the assessee, we find merit in the contention of the Ld.Counsel for the assessee that the finding of error by the Ld.PCIT in the order of the AO is not based on correct appreciation of both the facts of the case on record and the judicial interpretation of the provision of law in this regard. 21. Undoubtedly, the ld.Pr.CIT has found assessment order passed in the case of the assessee to b ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... n No. 3 of 2010 (supra). On the second issue also, we find, that the ld.Pr.CIT has failed to appreciate the correct facts of the case, while finding the assessment order erroneous. The assessee had demonstrated the loss claimed to be not an M2M loss, but a settled loss, and the ld.Pr.CIT, we find, however goes on to record fact to the contrary that it was an M2M loss. Basis this incorrect fact noted by him, the Ld.PCIT, we find, went on hold the assessment order erroneous causing prejudice to the Revenue for having allowed such M2M loss in contradiction/in violation of the Instruction issued by the CBDT in this regard. 25. Further, we find that the assessee had explained such loss to have been incurred while hedging its foreign currency transaction from fluctuations, which transactions were entered into in the course of carrying out its business activities for importing raw-material, and had also pointed out that in various judicial decisions such losses were held to be allowable. The ld.Pr.CIT, we find, has failed to appreciate this contention of the assessee, and has merely noted the fact that the loss booked by the assessee was a notional/contingent loss on account of unsettled ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... er sources", or a company [the principal business of which is the business of trading in shares or banking/or the granting of loans and advances). 3.11 To understand this more clearly, the explanation below section 43(5) of the Act is reproduced as under :- "Explanation .- Where any part of the business of a company [other than a company whose gross total income consists mainly of income which is chargeable under the heads "Interest on securities", "Income from house property", "Capital gains" and "Income from other sources"/, or a company [the principal business of which is the business of trading in shares or banking for the granting of loans and advances) consists in the purchase and sale of shares of other companies, such company shall, for the purposes of this section, be deemed to be carrying on a speculation business to the extent to which the business consists of the purchase and sale of such shares.]" 3.12 Thus, under the deeming provisions of section 73(5) of the Act, the assessee-company would not be entitled to set off any loss on transactions of buy and sale of US $ through two brokers as mentioned above." 28. The ld.Pr.CIT has merely reproduced the Explanatio ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... the extent to which the business consists of the purchase and sale of such shares." 29. A perusal of the said provision would reveal that it restricts the set off of loss in respect of a speculation business against the profits from another speculation business alone. Meaning thereby that, the loss incurred in speculation business are not allowed to be set off against any other income except profits from speculation business alone. Thus, the section 73 primarily deals with the treatment of set off of loss on speculation business. 30. In the facts of the present case, the ld.Pr.CIT has alternatively applied section 73 stating that if the "FCDT" transactions are not treated as speculative, then section 73 will be applicable. But since section 73 applies only to loss incurred in speculative business, this interpretation of the ld.Pr.CIT, we find, is incorrect. 31. Coming to the Explanation to section 73, which the ld.Pr.CIT has invoked, what it merely states is that if a company indulges in the business of trading in shares primarily, such transactions would be treated as speculative business. Thus, the Explanation to section 73 deems the transactions in trading of shares in speci ..... X X X X Extracts X X X X X X X X Extracts X X X X
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