MILL CONSULTANTS & INVESTMENT P.LTD,MUMBAI vs. DCIT CIR 4(3), MUMBAI

The facts in brief are that the assessee-company, in the business of share broking, trading and investment in shares and securities, was, during the course of 2 Mili Consultants & Investment Pvt. Ltd. vs. Dy. CIT assessment proceedings found by the Assessing Officer (A.O.) to have booked losses to the extent of Rs.11,53,521/- on open derivative contracts, i.e., by marking them to market as at the year-end (31.3.2008). The assessee, in justification, based it’s case on the principle of real income, relying on the decisions in the case of Godhra Electricity Co. Ltd. vs. CIT [1997] 225 ITR 746 (SC); CIT vs. Birla Gwalior (P) Ltd. [1973] 89 ITR 266 (SC); R. B. Jodha Mal Kuthiala vs. CIT [1971] 82 ITR 570; Poona Electric Supply Co. Ltd. vs. CIT [1965] 57 ITR 521 (SC); CIT vs. Shoorji Vallabhdas and Co. [1962] 46 ITR 144 (SC); and H. M. Kashiparekh and Co. Ltd. vs. CIT [1960] 39 ITR 706 (Bom). Reliance was also placed on the Accounting Standard (AS-I) notified by the Board u/s. 145(2) of the Act, which requires adoption of the accounting policies as would represent a true and fair view of the state of affairs of the reporting enterprise as at the valuation date. ‘Prudence’, along with ‘substance over form’ and ‘materiality’ are the principal considerations that ought to govern the selection of the accounting policies. ‘Prudence’ requires that provision should be made for all known liabilities and losses, even though the amount thereof may not be determinable with certainty and represent only a best estimate in light of the available information. In Oil & Natural Gas Corpn. Ltd. vs. Dy. CIT [2002] 83 ITD 151 (Del) (SB), the Tribunal per its larger bench had held that forex losses, i.e., arising out of foreign exchange fluctuation in respect of trading transactions, made with reference to the balance-sheet date, is not a contingent liability or a contingent loss but fait aaccompli and, accordingly, admissible as a deduction. In view of the A.O., the derivative contracts are not acquired at a cost and, further, do not constitute stock-in-trade, so as to attract the principle of valuation át cost or market value, whichever is less. The liability had not crystallized as on the balance-sheet date, and would be so only on the settlement of the contract at a future date. True, the principle of real income is applicable, but then disallowing such notional loss, as being claimed, is only toward the assessment of real income. The same cannot be allowed to be influenced by such notional losses. Further, even 3 Mili Consultants & Investment Pvt. Ltd. vs. Dy. CIT assuming that the derivative contract is itself a ‘stock-in-trade’, it’s cost being nil, there was no scope for valuing it below the same. Such a loss is not allowable, and is accordingly not allowed even in the case of foreign exchange derivatives. The loss was, accordingly, disallowed. In appeal, the ld. CIT(A) was of the view that open unsettled derivative contracts held by the assessee as at the close of the year formed part of the current assets, i.e., held on revenue account, or as a trading asset. The same is, in terms of the decisions by the Apex Court in CIT vs. Woodward Governor India (P) Ltd. [2009] 312 ITR 254 (SC) and Sutlej Cotton Mills Ltd. vs. CIT [1979] 116 ITR 1 (SC), liable to allowed. In Woodward Governor India (P) Ltd. (supra), wherein the liability under reference was a foreign exchange denominated liability, the Hon’ble Court had held that where forming part of the circulating capital, it as in that case, is to be stated by converting the same at the rate obtaining as at the year-end; whether restating the liability – which was in respect of import of raw material, by applying such closing rate of exchange lead to stating it at a lower or higher amount, i.e., resulted in a gain or loss. A listing of all such contracts (as on 31.3.2008) revealed that the assessee had unobsorbed profit of Rs.15,29,983/- on such open contracts on the basis of their market value/s as at the year-end, i.e., marking them to market, and which (profit) had been ignored by the A.O. The method of valuation has to be fair and reasonable, and not motivated or guided with a view to reduce the incidence of tax. He, accordingly, after show causing the assessee for enhancement, while deleting the impugned disallowance (for Rs.11.54 lacs), effected an addition for Rs.15.30 lacs, i.e., made an enhancement to the assessed income by the difference of Rs.3.76 lacs (Rs.15.30 lacs – Rs.11.54 lacs). Aggrieved, the assessee is in second appeal.

We have heard the parties, and perused the material on record. To begin with, we note, even as observed by the Bench during hearing, that the ld. CIT(A) has allowed the assessee’s claim for loss (for Rs.11.54 lacs) and, therefore, 4 Mili Consultants & Investment Pvt. Ltd. vs. Dy. CIT the assessee’s Ground No. 1 challenging the confirmation of it’s disallowance and, again, Ground # 3 toward not observing consistency, would not survive. The only question before us; the Revenue being not in appeal, is if the corresponding gain of Rs.15.30 lacs is assessable for the current year, having been brought to tax by the ld. CIT(A), and which is the substance of the assessee’s Ground # 2 before us challenging the enhancement of Rs.3.76 lacs. The same has been effected by the ld. CIT(A) ostensibly following the decision in Woodward Governor India (P) Ltd. (supra) (refer para 5.1.2 and 5.1.3 of the impugned order). We have toward the same read both the cited decisions by the Apex Court as well as that in Oil & Natural Gas Corporation Ltd. vs. CIT dated 15.3.2010 (in Civil Appeal No. 7223 of 2008/copy on record), to find that the view taken by the ld. CIT(A) is not consistent with those decisions, at least in-so-far as the accrual of income is concerned; the principle of ‘prudence’ impacting it differently. The gist of the decision in the case of ONGC (supra), rendered after considering its’ earlier decision in Woodward Governor India (P) Ltd. (supra), is vide para 10 of the Judgment, which reads as under: ‘10. Having carefully perused the decision of this Court in Woodward's case (supra), we are of the opinion that both the issues stand concluded by the said decision. Dealing with the said issues extensively, speaking for the Bench, S.H. Kapadia, J. summarised the following factors which should be taken into account in order to find out if an expenditure on account of fluctuation in the foreign currency rates, when the Assessee is following mercantile system of accounting, is deductible: (i) whether the system of accounting followed by the assessee is the mercantile system, which brings in the debits of the amount of expenditure for which a legal liability has been incurred even before it is actually disbursed and credits, what is due, immediately it becomes due even before it is actually received; (ii) whether the same system is followed by the assessee from the very beginning and if there was a change in the system, whether the change was bona fide; (iii) whether the assessee has given the same treatment to losses claimed to have accrued and to the gains that may accrue to it; 5 Mili Consultants & Investment Pvt. Ltd. vs. Dy. CIT

(iv) whether the assessee has been consistent and definite in making entries in the account books in respect of losses and gains; (v) whether the method adopted by the assessee for making entries in the books both in respect of losses and gains is as per nationally accepted accounting standards; (vi) whether the system adopted by the assessee is fair and reasonable or is adopted only with a view to reducing the incidence of taxation. Applying these factors on the facts of that case, it was held that the "loss" suffered by the Assessee, maintaining accounts regularly on mercantile system and following accounting standards prescribed by the Institute of Chartered Accountants of India (ICAI), on account of fluctuation in the rate of foreign exchange as on the date of balance- sheet was an item of expenditure under Section 37(1) of the Act, notwithstanding that the liability had not been discharged in the year in which the fluctuation in the rate of foreign exchange occurred.’ The question of booking ‘gain’, i.e., on an appreciation of the contract value/s, as would be apparent, does not arise. Providing for a liability with reference to the market value, which is adopted as a surrogate measure for realizable value, net of cost, if any, toward realization, i.e., at net realizable value, where held on revenue account, is on the basis of the accounting principle of prudence which suggests booking of all known losses and liabilities. Providing for the same is on the premise that the enterprise following accrual method of accounting, the loss had accrued even though the liability may not have crystallized or its amount may not be quantifiable with exactness and, therefore, represents only an estimate thereof, based on the best available information. Such estimates are called accounting estimates, which inform and permeate the preparation and presentation of final accounts, the background facts with regard to which are generally communicated through the notes to the accounts. As afore-said, the controversy before us is limited to whether the unrealized gain, i.e., as may stand to arise on the basis of the market values (of the underlying 6 Mili Consultants & Investment Pvt. Ltd. vs. Dy. CIT shares) as at the close of the year on open contracts, prior to the settlement date, could be taken into account for the purpose of closing accounts and recognizing income for the relevant year. The price/s obtaining on the settlement date/s, subsequent to the valuation (balance-sheet) date, may well be different and not in agreement with that as at the year-end, anterior thereto. In fact, even if anticipated, the gain is proscribed for being booked, militate as it clearly does against the accounting principle of prudence, advocating the provision for all known liabilities while at the same time not recognizing any anticipated income. The said principle, prescribed per AS-I issued by the Board, since notified u/s. 145(2) of the Act, therefore acquires the force of law. Reference in this context may also be made to AS-9 (Recognition of income) issued by Institute of Chartered Accountants of India, which again assumes legal status in view of section 209 of the Companies Act, 1956. The statement of a trade liability, at current value, is on an entirely different footing. Finally, before parting, we may add that the loss on the basis of ‘mark to market’ open derivative contracts, standing thus to be allowed in the facts and circumstances of the case, the A.O. shall be at liberty to withdraw the said loss on the settlement date/s, which the Revenue was otherwise bound to allow to the assessee, i.e., to that extent (Rs.11.54 lacs). Like-wise the ‘gain’ on the balance (brought forward) contracts would stand to be taxed in its' entirety on settlement. We state so in order to avoid any prejudice or double benefit to either side. We decide accordingly.