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Facts
The assessee, engaged in the retail jewellery business, had its original assessment for AY 2015-16 set aside by the PCIT u/s 263. Subsequently, the AO passed an order u/s 143(3) r.w.s. 263, making an addition of Rs. 55,62,57,716/- for marked-to-market (MTM) gains on gold forward contracts and disallowing Rs. 46,02,310/- u/s 80G. The assessee did not offer the MTM gains to tax, considering them notional and unrealized, but the AO and CIT(A) treated them as taxable income.
Held
The Tribunal held that unrealized MTM gains on forward exchange contracts are not liable to tax, applying the well-settled principle that notional gains do not constitute real income. Relying on Supreme Court judgments in Godhra Electricity Co. and CIT v. Woodward Governor India Pvt. Ltd., the Tribunal directed the AO to delete the addition related to MTM gains.
Key Issues
Whether unrealized Mark-to-Market (MTM) gains on forward commodity derivative contracts are 'real income' liable to tax under the Income Tax Act.
Sections Cited
263, 80GGB, 80G, 143(3)
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Income Tax Appellate Tribunal, COCHIN BENCH
Before: SHRI INTURI RAMA RAO, AM & SHRI SOUNDARARAJAN K., JM
O R D E R Per: Inturi Rama Rao, AM This appeal filed by the assessee is directed against the order of the Commissioner of Income Tax (Appeals)-3. Kochi [CIT(A)], dated 28.03.2023 for Assessment Year (AY) 2015-16.
Brief facts of the case are that the appellant is a company incorporated under the provisions of the Companies Act, 1956. It is engaged in the retail business of gold and diamond jewellery. The return of income for AY 2015-16 was filed on 27.11.2015 declaring Kalyan Jewellers India Ltd. total income of Rs. 79,76,910/-. Against the said return of income, the assessment was completed by the ACIT, Circle-1(1), Thrissur (hereinafter called "the AO") vide order dated 18.12.2017 accepting the returned income.
Subsequently the learned Pr. Commissioner of Income Tax had set aside the assessment in exercise of the powers vested with him u/s. 263 of the Income Tax Act, 1961 (the Act) vide order dated 28.10.2019 by directing the AO to redo the assessment in accordance with law after affording reasonable opportunity of being heard to the appellant by considering the following issues: - “i. The assessee had availed deduction of an amount of Rs. 81,30,000/- u/s. 80GGB and Rs. 60,00,000/- u/s. 80G. The excess claim of deduction, if any, needs to be disallowed. ii. Marked to Market (MTM) gain of Rs. 5562.79 lakhs were admitted in the P&L account in the AY under consideration. However, the same has been deducted while computing the total income chargeable to tax. The above issue needs to be considered in the assessment to be done afresh, in the light of the decision of the Mumbai ITAT in the case of Tata Consultancy Services (ITA No. 2794/MUM/2018).”
Being aggrieved by the order of revision, an appeal was filed before the Tribunal. The Tribunal, vide its order dated 14.09.2022 in found justification in the revision order. Accordingly dismissed the appeal.
Kalyan Jewellers India Ltd. 5. Pursuant to the order u/s. 263 of the Act passed by the PCIT, the AO passed assessment order u/s. 143(3) r.w.s. 263 of the Act vide order dated 12.07.2021 at a total income of Rs. 1,55,87,62,196/-. While doing so, the AO made addition of Rs. 55,62,57,716/- being the amount of gains on mark to market towards gold forward contract and also made disallowance u/s. 80G of Rs. 46,02,310/-.
The factual background leading to the above addition is as under: - Mark to Market (MTM) gains of Rs. 55,62,57,716/-
During the previous year relevant to assessment year under consideration, the appellant company had entered into Forward Commodities Contract in order to hedge the risk of price fluctuation of gold known as Commodities Derivative Contract with the State Bank of India. The accounting policies adopted on this transaction is stated by the appellant in its Financial Report as under: - “The Company uses derivative financial instruments to manage risks associated with gold price fluctuations relating to certain highly probable forecasted transactions, foreign currency fluctuations relating to certain firm commitments and foreign currency exposures relating to foreign currency derivative. The Company neither holds nor issues any derivative financial instruments for speculative purposes. The Company has adopted the accounting principles set out in the Guidance note on Derivatives for contracts entered into for hedging gold price and foreign currency Kalyan Jewellers India Ltd. fluctuations. As these contracts do not qualify for hedge accounting, the outstanding contracts as at the balance sheet date, are marked to market and gains or losses are recognized in the Statement of Profit and Loss.”
In terms of the accounting policy stated above, the appellant company reported gains of Rs. 55,62,57,716/- on account of Mark to Market of the outstanding contract and the same was accounted as income in compliance with the guidance note on accounting derivative as per accounting policy 2.2. However, the gains were not offered to tax by holding that the gains were analysed at the end of the Balance Sheet date and the same would be offered to tax on realisation. The unrealised gain is in the nature of notional gain which is not taxable on real income theory. However, the AO was of the view that the mark to market gains are to be taxed on accrual basis and accordingly brought to tax the notional gains of Rs. 55,62,57,760/-. On appeal before the CIT(A), the CIT(A) confirmed the action of the AO by passing a cryptic order holding that the Income Computation and Disclosure Standards (ICDS) issued by the CBDT are not applicable for the year under consideration.
Being aggrieved, the appellant is in appeal before us in the present appeal.
The learned counsel for the assessee submits that the appellant only merely made a notional gain on mark to market forward contract in commodities derivatives which is not real income and, Kalyan Jewellers India Ltd. therefore, not liable to tax. It is further submits that the gain from unexpired forward contract is notional income placing reliance on the decision of the Hon'ble Supreme Court in the case of Godhra Electricity Co. vs. CIT 225 ITR 746 and also placing reliance on ICDS that such income is not taxable. He also placed reliance on several decisions.
On the other hand, the CIT-DR vehemently opposed the above submissions and submits that no interference in the orders of the lower authorities is called for.
We have heard the rival contentions of both the parties and perused the material available on record. The only issue that is required to be determined by us is whether the notional gains made on MTM in respect of forward contract in commodities derivatives is taxable under the provisions of the Income Tax Act. The undisputed facts of the case are that the MTM gains from unexpired forward contract was recognised in the books of account and credited to the Profit & Loss A/c. However, the same was not offered to tax under the pleas that notional gains are not taxable. The nature of gains made by the assessee was explained supra. It is well settled position of law that the notional gains are not taxable whereas the notional losses are allowed as expenditure. In this connection the observations made by the Hon'ble Supreme Court in the case of CIT v. Woodward Governor India Pvt. Ltd. are extracted as under: - Kalyan Jewellers India Ltd. “For valuing the closing stock at the end of a particular year, the value prevailing on the last date is relevant. This is because profits/loss is embedded in the closing stock. While anticipated loss is taken into account, anticipated profit in the shape of appreciated value of the closing stock is not brought into account, as no prudent trader would care to show increased profits before actual realization. This is the theory underlying the rule that closing stock is to be valued at cost or market price, whichever is the lower. As profits for income tax purposes are to be computed in accordance with ordinary principles of commercial accounting, unless such principles stand superseded or modified by legislative enactments, unrealized profits in the shape of appreciated value of goods remaining unsold at the end of the accounting year and carried over to the following year’s account in a continuing business are not brought to the charge as a matter of practice, though, as stated above, loss due to fall in the price below cost is allowed even though such loss has not been realized actually.”
The Hon'ble Supreme Court in the case of Godhra Electricity Co. vs. CIT 225 ITR 746 held as under: -
"14. The question whether there was real accrual of income to the assessee company in respect of the enhanced charges for supply of electricity has to be considered by taking the probability or improbability of realisation in a realistic manner. If the matter is considered in this light, it is not possible to hold that there was real accrual of income to the assessee-company in respect of the enhanced charges for supply of electricity which were added by the ITO while passing the assessment orders in respect of the assessment years under consideration. The AAC was right in deleting the said addition made by the ITO and the Tribunal had rightly held that the claim at the increased rates as made by the assessee company on the basis of which necessary Kalyan Jewellers India Ltd. entries were made represented only hypothetical income and the impugned amounts as brought to tax by the ITO did not represent the income which had really accrued to the assessee-company during the relevant previous years. The High Court, in our opinion, was in error in upsetting the said view of the Tribunal."
Following the above principles the unrealized MTM gains made on forward exchange contract are not liable to tax and we direct the AO to delete the addition.
In the result, appeal filed by the assessee stands allowed.
Order pronounced in the open court on 21st March, 2025.