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Income Tax Appellate Tribunal, MUMBAI BENCH “E”, MUMBAI
Before: SHRI C.N. PRASAD & SHRI RAJESH KUMAR
Per Rajesh Kumar, Accountant Member:
The present appeal has been preferred by the Revenue against the order dated 09.05.2014 of the Commissioner of Income Tax (Appeals) [hereinafter referred to as the CIT(A)] relevant to assessment year 2010-11.
The only issue raised by the Revenue is against the deletion of Rs.1,25,73,083/- by Ld. CIT(A) as made by the AO towards disallowance of marked to market loss claimed by the assessee on trading in derivative transactions on the ground that the said losses were merely notional losses and the actual loss or the profit in respect of such derivative transactions would get crystallized only at the time of settlement.
2 M/s. ECL Finance Ltd.
The facts in brief are that the AO, during the course of assessment proceedings, observed that assessee charged to the P & L account during the year a sum of Rs.1,25,73,083/- on account of mark to market loss on NCDs and accordingly issued a show cause notice to the assessee as to why the same should not be disallowed. The assessee submitted before the AO that assessee is engaged in the business of non banking finance activities after obtaining due registration with the RBI and is engaged primarily in the business of financing and corporate lending against security of shares, stock, bonds, debenture or other similar instruments on short, medium and long term basis besides trading in securities and debentures. It was submitted before the AO that NCDs are in the nature of stock in trade of the assessee and as per accepted accounting principle stock in trade have to be valued at cost of market value whichever is lower. The assessee also submitted that as per AS-1 (Disclosure of Accounting Policies) prescribed by CBDT vide notification No.SO 69 (E) dated 25.01.1996 accounting policies adopted by an assessee should be such that represents a true and fair view of the state of affairs of the business of the assessee. The assessee argued that as per AS-1 a prudent persons would provides for all known liabilities and losses even though the amount can not be determined with certainty and only represents a best estimate in the light of available information. However, the assessee’s contentions did not find favour with the AO and he disallowed the claim of Rs.1,25,73,083/- by adding the same to the income of the assessee by holding that notional MTM loss on 3 M/s. ECL Finance Ltd. NCDs has reduced its true and real income and further observed that the NCDs are not in the nature of stock in trade but investments and the CBDT circular No.775 dated 05.10.1993 whereby it is clarified that it is for the AO to determine on the facts and circumstances of each case as to whether any particular securities constitutes stock in trade or investment taking to account the guidelines issued by RBI.
In the appellate proceedings, the Ld. CIT(A) allowed the appeal of the assessee after hearing the submissions of the assessee which has been incorporated in para 4.2 of the appellate order by observing and holding as under: “4.3 I have considered the above submissions of the appellant and have also gone through the case laws cited in this regard. It is seen that this issue has been considered by ITAT, Mumbai in the cases of i) ECL Finance Limited, ii) Kotak Mahindra Investment Ltd, iii) Shri Ramesh Kumar Damani and iv) Edelweiss Capital Limited (a sister concern of the appellant) (all supra), cited by the appellant. For the assessment year 2010-11 in the case of appellants sister concern namely E Cap Equities Private Limited, I have deleted the disallowance relying on Hon'ble ITAT's decision in the case of Edelweiss Capital. Hence, respectfully following the decision of Hon'ble ITAT in above cases, I direct the AO to delete the disallowance of mark to market loss of Rs 1,25,113,083/-.”
The Ld. D.R. vehemently submitted before us that the MTM loss on NCDs is just a notional loss and assessee has reduced his true income by the MTM losses which is just a notional or contingent loss whereas the actual loss would be ascertained upon the settlement of the transactions and therefore the order of Ld. CIT(A) should be reversed and that of the AO deserved to be restored. The Ld. D.R. also referred to Instruction No.03/2010 dated 23.03.2010 wherein it has been clearly provided that there is no sale or no settlement has actually taken place and the loss on Marked to Market
4 M/s. ECL Finance Ltd. 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 Ld. A.R., on the other hand, relied on series of decisions and the order of ld CIT(A). However, he stressed on the decision of co-ordinate bench of the Tribunal in assessee’s own case in & ors. wherein an identical issue has been decided by the co-ordinate bench of the Tribunal vide order dated 22.01.2013 deciding the marked to market losses as allowable. The Ld. A.R. also submitted that in the case of group company namely Edelweiss Capital Ltd. vs. ITO in ITA No.5423/M/2007 the similar issue was decided in favour of the assessee and the order of the Tribunal has not been challenged before the High Court and has attained finality. The Ld. Counsel prayed before the Bench that in view of the said fact, the appeal of the Revenue should be dismissed.
We have heard the rival submissions of both the parties and perused the material on record. We find from the perusal of the order of co-ordinate bench of the Tribunal in assessee’s own case in that an identical issue has been decided in favour of the assessee wherein marked to market basis were held to be admissible under law. The operative part is reproduced as under: “8. We have carefully considered the rival submission in the light of material placed before us. This issue was considered by the Tribunal in the case of Edelweiss Capital Ltd. vs. ITO vide order dated 10/11/2010 in ITA No.5324/M/07. A copy of the said order is placed on our record. The issue was decided by the Tribunal in favour of assessee with the following observations.
"7. We have considered the facts and the rival contentions. In the Schedule annexed to and forming part of the Balance Sheet and Profit & Loss Account for the year under appeal (page 13 of the Paper Book), the assessee has made the following Note: - "H. Equity Futures -- Index / Stock
(a) "Initial Margin-Equity Derivative Instruments", representing initial margin paid, and "Margin Deposits", representing additional margin over and above initial margin, for entering into contracts for Equity Index / Stock Futures, which are released on final settlement / squaring-up of underlying contracts, are disclosed under Loans and Advances.
(b) Equity Index / Stock Futures are marked-to-market on a daily basis. Debit or credit balance disclosed under Loans and Advances or Current Liabilities, respectively, in the Mark-to- Market Margin - Equity Index / Stock Futures Account', represents the net amount paid or received on the basis of movement in the prices of Index / Stock Futures till the Balance Sheet date. Amount paid to brokers in addition to Mark-to-Market Margins is disclosed as "Margin Deposits' under Loans and Advances.
(c) As on the Balance Sheet date, profit/loss on open positions in Index / Stock Futures are accounted for as follows:
• Credit balance in the "Mark-to Market Margin -- Equity Index / Stock Futures Account, being anticipated profit, is ignored and no credit for the same is taken in the Profit and Loss Account.
• Debit balance in the "Mark-to-Market Margin -- Equity Index / Stock Futures Account', being anticipated loss, is adjusted in the Profit and Loss Account. d) On final settlement or squaring-up of contracts for Equity Index / Stock Futures, the profit or loss is calculated as the difference between settlement / squaring-up price and contract price. Accordingly, debit or credit balance pertaining to the settled / squared-up contract in "Mark-to- Market Margin - Equity Index / Stock Futures Account" is recognized in the Profit and Loss Account." The aforesaid Note gives a fair picture of the nature of the provision. The provision in substance has been made to cover the anticipated loss in the derivates trading. There is no dispute that the assessee holds derivatives as its stock-in-trade and there is also no dispute that it follows the principle
6 M/s. ECL Finance Ltd. "cost or market price, whichever is lower" in valuing the derivatives. When the derivatives are held as stock-in-trade then whatever rules apply to the valuation of stock-in-trade will have to be necessarily apply to their valuation also. It is a well settled position in law that 'while anticipated loss is taken into account in valuing the closing stock, anticipated profit in the shape of appreciated value of the closing stock is not brought into the account, as no prudent trader would care to show increased profit before its realization. This is the theory underlying the rule that the closing stock is to be valued at cost or market price whichever is the lower, and it is now generally accepted as an established rule of commercial practice and accountancy". This is what the Supreme Court held in the case of Chainrup Sampatram vs. Commissioner of Income Tax, West Bengal (1953) 24 ITR 481 (SC), speaking through Hon'ble Justice Patanjali Sastri, the then Chief Justice of India (page 485 -- 486 of the Report). At page 486 the Supreme Court further observed that "loss due to a fall in price below cost is allowed even if such loss has not been actually realized". Quoting from the case of Whimster & Co. vs. Commissioners of Inland Revenue (1926) 12 Tax Cases 813, the Supreme Court observed that the profits that are chargeable to tax are those realized in the year and that an exception is recognized where a trader purchased and still holds goods which are fallen in value in which case though no loss has been realized nor it has occurred, nevertheless at the close of the year he is permitted to treat these goods as of their market value. This decision of the Supreme Court governs the facts of the present case. It is to the assessee's strength that the Institute of Chartered Accountants of India in its guidelines have also approved of the rule of prudence which really means that while anticipated losses can be taken note of while valuing the closing stock, anticipated profits cannot be recognized. The anticipated loss, in the light of the judgment of the Supreme Court cited above, cannot be treated as a contingent liability.
The learned DR pointed out that the assessee has valued each scrip of the derivatives as at the end of the year. We do not see how this can make any difference to the legal principle. If the derivatives have been treated as stock-in- trade then there is nothing unusual in the assessee valuing each derivative by applying the rule cost or market whichever is lower.
We, therefore, direct the Assessing Officer to allow the provision as reflecting in substance the loss arising on account of valuation of the closing stock. The ground is allowed."
9. The only objection raised by Ld. DR is that in the Instruction No.3/2010 dated 23/3/2010 CBDT has instructed Income Tax authorities to add back such amount while computing taxable income of an assessee. Such contention of Ld. DR cannot be accepted firstly on the ground that Instructions issued by CBDT though may be binding upon Income Tax authorities but are not binding on appellate authorities. The date of assessment order in the present case is 31/12/2009 when such instructions were not even existed. Further, when Tribunal had decided the issue in the case of Edelweiss Capital Ltd. (supra) the instructions were existing but not pleaded by the department. The Tribunal has considered each and every aspect in 7 M/s. ECL Finance Ltd. details which is clear from the observations reproduced in the earlier part of this order. Taking the consistent view as taken by the Co-ordinate Bench, we see no infirmity in the granted by Ld. CIT(A). We decline to interfere in the relief granted by him and departmental appeal is dismissed.”
8. We, therefore, respectfully following the decision of the co-ordinate bench of the Tribunal, dismiss the appeal of the Revenue by affirming the order of Ld. CIT(A).
Order pronounced in the open court on 10.08.2018.