Forward contract loss from hedging for foreign exchange fluctuation is allowable deduction

CA Suraj R. Agrawal

Facts of the case:

• After taking note of the claim of forward contracts and the accounting policies, i.e. AS-11 (revised) and applying the ratio laid down by the Apex Court in the case of Woodward Governor India Pvt. Ltd. (supra) the claim of the assessee was allowed by the CIT (A), against which the Revenue is in appeal.
• The AO disallowed the claim of the assessee as the same had not been settled at the year end and hence the losses were not actual losses.
• The AO rejected the claim of the assessee because it has entered into mark to market loss on forward exchange contracts and disallowed a sum of `66,51,21,162/-.
• The said transaction of entering into forward contracts was claimed by the assessee to be an integral part and incidental to export business undertaken by the assessee
• On such revaluation the assessee had claimed mark to market loss on the said forward exchange contracts amounting to `66,51,21,162/
• The assessee had entered into forward exchange contracts, which were revalued by it on the closing day of the accounting year.
• The assessee was engaged in the business of import and export of diamonds.
• The assessee has field cross objections against the appeal filed by the Revenue relating to assessment year 2010-11 against the order passed under section 143(3) of the Act.
• Two appeals filed by the Revenue are against the consolidated order of the CIT(A) dated 16.09.2013 relating to assessment years 2009-10 and 2010-11 against the order passed under section 143(3) of the Act.

Issue put before ITAT Mumbai:

Whether n the facts and circumstances and in law, the Ld. CIT(A) has erred in holding that ‘Mark to Market’ loss of Rs.66,51,21,162/- arising on valuation of forward exchange contracts on the closing date of accounting year is not a notional loss and, therefore allowable?

Whether n the facts and circumstances and in law, the Ld. CIT(A) was right in not taking cognizance of the decision of the ITAT, ‘E’ Bench, Mumbai in ITA No. 506/Mum/2013 dated 3.05.2013 in the case of M/s. S. Vindokumar Diamonds Pvt. Ltd.?

The Ld CIT (Appeal) grossly erred on facts in not-c0nfirming disallowance of mark to market loss of Rs.66,51,21,162/- on account of outstanding forward contracts.”

Contentions of Appellant:

• The issue in the present appeal is squarely covered by various orders of the Mumbai Tribunal in favour of the assessee and also by the order of the Apex Court in the case of CIT vs. Woodward Governor India Pvt. Ltd. 294 ITR 451 (SC).
• The CIT(A) had allowed the appeal of the assessee following the said ratio laid down by the Apex Court.
• The assessee has consistently offered profit from foreign exchange differences in the earlier and later years to tax.
• ITAT attention was drawn to the order of the CIT(A) at page 26 and it was pointed out that only in the year under consideration there was loss on account of foreign exchange fluctuations whereas in each of the year there was foreign exchange gains.
• The Tribunal in M/s. S. Vinod Kumar Diamonds Pvt. Ltd. (sura) had addressed the issue whether the loss on foreign exchange fluctuations was speculation loss or business loss and the issue was not regarding allowability of mark to market loss.

Contention by Revenue:

• The facts of the present case are at variance, i.e. the AO had noted that there were pending contracts which had not concluded and as such the ratio of the earlier decision was not applicable.
• Contrary view has been taken by the Mumbai Benches of the Tribunal in the case of M/s. Vinod Kumar Diamonds Pvt. Ltd. in ITA No. 506/Mum/2013 dated 03.05.2013.

Ruling of Honorable ITAT Mumbai::

• In the result, the appeals of the Revenue as well as the cross objections of the assessee are dismissed.
• Coming to the cross objections filed by the assessee, the learned A.R. for the assessee submitted that the same may be dismissed. In view of ITAT dismissing the appeals of the Revenue the cross objections raised by the assessee do not survive and the same are dismissed.
• The learned D.R. for the Revenue had placed reliance on M/s. Vinod Kumar Diamonds Pvt. Ltd. (supra). The said decision is contrary to the view taken in Badridas Gauridu P. Ltd. 261 ITR 256 (Bom). ITAT find no merit in the said reliance. Allowing the claim of the assessee, ITAT dismiss the grounds of appeal raised by the Revenue.
• The grounds of appeal raised by the Revenue are thus dismissed.
• The issue arising in the present appeal before ITAT is identical to the issue before the Tribunal and also in view of the ratio laid down by the Hon’ble Supreme Court in the case of CIT vs. Woodward Governor India Pvt. Ltd. (supra) which squarely covers the issue in favour of the assessee, ITAT uphold the order of the CIT(A) in deleting the addition made on account of disallowance of the loss incurred on forward contract in foreign exchange.

Key Take Away :-

Loss on account of forward contract entered into by the assessee to hedge against the loss arising on account of fluctuations in foreign exchange is an allowable deduction. Contrary view in Vinod Kumar Diamonds is not good law.