The Central Board of Direct Taxes (CBDT) has asked income-tax authorities to disallow the forex derivative loss claimed by companies on the basis of ‘marked to market’ valuation. Simply put, forex derivative loss, recognised on MTM basis, would be added back for the purpose of computing the taxable income of the company concerned (assessee).

This is the first time that CBDT, the apex body for income tax policy and administration, has spelt out its view on the tax treatment of forex derivative loss, say tax experts.

MTM is 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 period. MTM loss is basically a notional loss.

“In cases where no sale or settlement has actually taken place and the loss on MTM basis has resulted in reduction of book profits, such a notional loss would be contingent in nature and cannot be allowed to be set off against the taxable income. The same should be added back for the purpose of computing the taxable income of an assessee,” the CBDT said in an instruction sent out to its officers on Tuesday.

The CBDT has also asked the tax authorities to treat loss on forex derivatives arising on actual settlement/conclusion of contract as business loss. They can do this only where the contracts fall within the scope of exclusion provided for eligible derivative transactions in the definition of ‘speculative transaction’ under the income tax law.

This would mean that the actual loss may be disallowed as being speculative, where it does not qualify as an eligible derivative transaction, according to Mr Prashant Khatore, Partner, Tax and Regulatory Services, Ernst & Young. A speculative loss can be set off against speculative profits only. Mr Khatore also said that the CBDT instruction will result in significant litigation.

All derivative transactions put through a recognised stock exchange are excluded from the scope of speculative transactions.

Forex derivative transactions entered into by the corporate sector had witnessed a substantial growth in recent years. Most of these forex derivatives transactions were directly with the banks and not through recognised stock exchanges, disqualifying them from being characterised as eligible derivative transactions.

The extreme volatility seen in the foreign exchange market in 2008-09 had resulted in substantial loss to taxpayers on account of forex derivatives. A large number of taxpayers had reported such loss on MTM basis in terms of their compliance with the accounting requirements of the CA institute.

Please view the Instruction of CBDT at the link given below:-

CBDT instruction to its staff regarding allowing losses on account of forex derivatives

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