IT is turning out to be a double whammy of sorts for companies that have taken a hit on account of mark-to-market (MTM) losses due to their exposure to forex derivatives. These companies may find it difficult to convince the income tax (I-T) department to allow MTM losses as deduction. 

Sources in the I-T department pointed out that there are no specific provisions in the Income Tax Act dealing with this issue. Moreover, there are no precedents or case laws that clearly define the treatment of losses incurred by companies.

As a result, these companies might not be allowed to set off such losses against profits to reduce their tax liability. “Judicial opinion is divided on the MTM issue. However, logically it should be allowed as a normal business loss,” PricewaterhouseCoopers (PwC) executive director Ketan Dalal said.

I-T sources, however, have a different view. “There are no specific provisions under the Income Tax Act, 1961, or direct judicial precedents, dealing with the treatment of losses or gains resulting from derivative contracts. Hence, this issue would need to be examined on the basis of general principles relating to deductibility of losses or taxability of gains. “

“As a general rule, items, which are ‘revenue’ in nature, are taxable or deductible, and items, which are ‘capital’ in nature, are not taxable or deductible,” the source added.

However, there is a view that a case-to-case basis approach may be adopted in such cases. Deduction against such losses, which are notional, can be allowed only in the year in which actual liability to pay arises, sources said.

A large number of firms, even small- and mid-sized, had taken exposure to derivatives following large-scale volality in the Indian currency. Many of these companies have to shown MTM losses on their books due to the new accounting guidelines issued by the Institute of Chartered Accountants of India.

“I-T law makes a distinction between an actual liability which a company faces at present and a potential liability in the future, which for the time being is only contingent. Contingent liabilities do not constitute expenditure and cannot be subject matter of deduction. Deduction can be allowed only in the year in which the liability to pay accrues, and it accrues only when the liability crystallises or becomes ascertained,” the source said.

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