M/S. ABN AMRO SECURITIES (INDIA) PVT. LTD, MUMBAI V. THE DCIT 3(1), MUMBAI

ITA 264/MUM/2008

• Counselvise Citation: [2011] 140 COUNSELVISE.COM (IT) 54966 (ITAT-MUMBAI)
• Duration Of Justice: 3 year(s) 7 month(s) 15 day(s)
• Appeal Type: Income Tax Appeal
• Pronouncement Date: 26-08-2011
• Appeal Filed By: Assessee
• Order Result: Allowed
• Bench Allotted: A
• Next Hearing Date: 09-08-2010
• Assessment Year: 2004-2005
• Appeal Filed On: 11-01-2008
• Result in Favour of: Assessee
• Court: TRIBUNAL
• Assessee Lawyers: USHA NAIR
• Keywords: Business income
• Section: 143(3); 145

Judgement Text

ITA NO. 264/MUM/2008 ASSESSMENT YEAR: 2004- 05 PAGE 1 OF 11 IN THE INCOME TAX APPELLATE TRIBUNAL MUMBAI A BENCH, MUMBAI BEFORE SHRI PRAMOD KUMAR (ACCOUNTANT MEMBER) AND SHRI VIJAY PAL RAO (JUDICIAL MEMBER) ITA NO. 264/MUM/08 ASSESSMENT YEAR: 2004-05 ABN AMRO SECURITIES INDIA PVT LTD ...APPELLANT 81, SAKHAR BHAWAN 8 TH FLOOR NARIMAN POINT, MUMBAI 400 021 PAN : AABCA3423F VS. INCOME TAX OFFICER WARD 3(1)(1), MUMBAI 400 020 RESPONDENT APPEARANCES: P J PARDIWALA, FOR THE APPELLANT USHA NAIR, FOR THE RESPONDENT DATE OF HEARING : AUGUST 03, 2011 DATE OF PRONOUNCEMENT : AUGUST 26 ,2011 O R D E R PER PRAMOD KUMAR: 1. BY WAY OF THIS APPEAL, THE ASSESSEE APPELLANT HA S CHALLENGED CORRECTNESS OF CIT(A)S ORDER D ATED 30 TH OCTOBER 2007, IN THE MATTER OF ASSESSMENT UNDER SECTION 143(3) OF THE INCOME TAX ACT, 1961 FOR THE ASSESSMENT YEAR 2004-05, ON THE FOLLOWING GROUND: ITA NO. 264/MUM/2008 ASSESSMENT YEAR: 2004- 05 PAGE 2 OF 11 BASED ON THE FACTS OF THE CASE AND IN LAW, THE CIT( A) ERRED IN CONFIRMING THE ACTION OF THE ASSESSING OFFICER IN D ISALLOWING THE LOSS OF RS 98,84,000 BEING LOSS ON ACCOUNT OF VALUA TION OF INTEREST RATE SWAP ON THE BASIS THAT THE SAME IS A NOTIONAL OR IMAGINARY LOSS . 2. LEARNED REPRESENTATIVES SUBMITS THAT WHATEVER IS DE CIDED IN ASSESSEES APPEAL FOR THE ASSESSMENT YEAR 2003-04, WHICH WAS H EARD ALONG WITH THIS APPEAL, WILL FOLLOW MUTATIS MUTANDI HERE AS WELL, AS THE MATERIAL FACTS AND LEGAL ISSUES N THIS CASE IN PARI MATERIA WITH THE ASSESSMENT YEAR 2003-04. VIDE OUR ORDER OF EVEN DATE, WE HAVE UPH ELD ASSESSEES GRIEVANCE IN AND OBSERVED AS FOLLOWS: 2. THE ASSESSEE IS ENGAGED IN THE BUSINESS OF DEA LING IN GOVERNMENT SECURITIES, BONDS, DEBENTURES AND PROVID ING SERVICES OF ARRANGING AND UNDERWRITING THE ISSUE OF DEBENTURES AND BONDS ETC. DURING THE COURSE OF THE ASSESSMENT PROCEEDINGS, TH E ASSESSING OFFICER NOTICED THAT THE ASSESSEE HAS CLAIMED A DEDU CTION OF RS 10,10,92,000 BEING LOSS ON INTEREST RATE SWAP VALUAT IONS. IN THE COURSE OF ENSUING EXAMINATION OF THIS CLAIM BY THE ASSESSING OFFICER, IT WAS SUBMITTED BY THE ASSESSEE THAT INTEREST RATE SWAP IS A FINANCIAL CONTRACT BETWEEN TWO PARTIES EXCHANGING A STREAM OF INTEREST PAYMENTS FOR A NOTIONAL PRINCIPAL AMOUNT, O N MULTIPLE OCCASIONS, DURING THE CONTRACT PERIOD. IT WAS ALSO S UBMITTED THAT THESE CONTRACTS GENERALLY INVOLVE EXCHANGE OF FIXED RATE OF INTEREST, WITH FLOATING RATE OF INTEREST, AND VICE VERSA. ON EACH PAYMENT DATE, THE INTEREST IS NOTIONALLY PAID ON THE AGREED FIXED OR FLOATING RATE BY ONE PARTY TO THE OTHER, BY SETTLING FOR THE DIFFERE NCE PAYMENTS. HAVING SO EXPLAINED THE NATURE OF INTEREST RATE SWAP , THE ASSESSEE SUBMITTED THAT THE ASSESSEE HAD THREE ONGOING INTER EST RATE SWAP CONTRACTS, FOR A NOTIONAL PRINCIPAL AMOUNT OF RS 1 85 CRORES, UNDER WHICH THE ASSESSEE WAS TO PAY A FIXED RATE OF INTE REST AND RECEIVE THE FLOATING RATE OF INTEREST. IT WAS THEN SUBMITTED TH AT THE DEDUCTION OF RS 10,10,92,000 HAS BEEN CLAIMED ON ACCOUNT OF UNR EALIZED LOSS ON THE BASIS OF VALUATION OF INTEREST RATE SWAP. THIS VA LUATION, ACCORDING TO THE ASSESSEE WAS ARRIVED AT BY WORKING OUT FUTUR E EXTRAPOLATION OF THE YIELD CURVE, CONSIDERING PAST HISTORY OF AVAILA BLE RATES AND ITA NO. 264/MUM/2008 ASSESSMENT YEAR: 2004- 05 PAGE 3 OF 11 CURRENT MARKET RATE. IT WAS ALSO SUBMITTED THAT THI S PROVISION HAS BEEN MADE IN ACCORDANCE WITH THE GUIDELINES ISSUED BY THE RESERVE BANK OF INDIA, AND THE METHOD OF VALUATION CONSISTEN TLY FOLLOWED ALL ALONG. IT WAS ALSO SUBMITTED THAT THE ASSESSEE BEIN G ENGAGED IN THE BUSINESS OF DEALING IN THE INTEREST BEARING SECURIT IES, AND THE INTEREST RATE, I.E. YIELD, BEING CONTINGENT UPON VAR IOUS ECONOMIC, POLITICAL AND INTERNATIONAL FACTORS, OVER WHICH ASS ESSEE HAS NO CONTROL, THE INTEREST RATE SWAPS ENTERED INTO BY TH E ASSESSEE ACT AS AN INSURANCE AGAINST LOSSES DUE TO HEAVY FLUCTUATIONS IN THE YIELD. IT WAS FURTHER SUBMITTED THAT RESERVE BANK OF INDIA GUIDEL INES ARE MANDATORY ON THE ASSESSEE, AND THE INTEREST RATE SWA P VALUATIONS HAVE BEEN DONE IN ACCORDANCE WITH SUCH GUIDELINES. IN SUPPORT OF THE PROPOSITION THAT LOSS ON VALUATION OF INTEREST RATE SWAP IS TO BE ALLOWED AS A DEDUCTION IN COMPUTATION OF BUSINESS I NCOME, A REFERENCE WAS ALSO MADE TO HONBLE SUPREME COURTS JUDGMENT IN THE CASES OF CHAINRUP SAMPATRAM VS CIT (24 ITR 481), AL A FIRM VS CIT (189 ITR 285) AND SANJEEV WOOLEN MILLS VS CIT (279 ITR 434). 3. THE ASSESSING OFFICER, HOWEVER, WAS NOT IMPRESSE D BY ANY OF THESE SUBMISSIONS. HE WAS OF THE VIEW THAT THIS LOS S ON VALUATION OF INTEREST RATE SWAP IS NOTHING BUT AN UNASCERTAINED L IABILITY WHICH CANNOT BE ALLOWED AS A DEDUCTION IN COMPUTATION OF B USINESS INCOME. HE NOTED THAT WHATEVER LOSSES HAD ACTUALLY INCURRED IN CONNECTION WITH THESE INTEREST RATE SWAP CONTRACTS, AND DEBI TED TO THE PROFIT AND LOSS ACCOUNT UPON THEIR BECOMING PAYABLE, HAVE ALREADY BEEN ALLOWED AS A DEDUCTION. HOWEVER, WHAT HAS BEEN CLAIM ED AS DEDUCTION IN THE IMPUGNED CLAIM IS THE LOSS WHICH WOULD HAVE OCCURRED IF THE SWAPS ARE TO BE SQUARED UP AS ON THE BALANCE SHEET DATE. IT WAS THUS AN UNREALIZED LOSS WHICH MAY, OR MAY NOT, ACTUALLY O CCUR. THE ASSESSING OFFICER, ON THE BASIS OF THIS REASONING, CONCLUDED THAT WHAT HAS BEEN CLAIMED AS DEDUCTION IS ONLY A CONTINGENT L IABILITY AND A PROVISION MADE FOR A LIABILITY WHICH MAY ARISE IN F UTURE. IT WAS ALSO OBSERVED THAT AS THE ASSESSEE WAS FOLLOWING MERCANT ILE METHOD OF ACCOUNTING, NO DEDUCTION CAN BE MADE IN RESPECT OF A LIABILITY WHICH HAS NOT DEFINITELY ARISEN AND THAT DEDUCTION CAN ON LY BE ALLOWED IN RESPECT OF ASCERTAINED AND ENFORCEABLE LIABILITY WH ICH COULD BE ENFORCED ON OR BEFORE THE END OF THE RELEVANT PREVI OUS YEAR. IN SUPPORT OF THIS STAND, A REFERENCE WAS MADE TO HONBLE BOMBAY HIGH COURTS JUDGMENT IN THE CASE OF CIT VS. PHALTON SUGAR WORKS (162 ITR 622) AND TO HONBLE MADRAS HIGH COURTS JUDGMENT IN THE CASE OF CIT ITA NO. 264/MUM/2008 ASSESSMENT YEAR: 2004- 05 PAGE 4 OF 11 VS. INDIAN OVERSEAS BANK (151 ITR 446). AS FOR THE RESERVE BANK OF INDIAS GUIDELINES A ND THE ACCOUNTING TREATMENT, THE ASSESSING OFFICER REFERRED TO HONBLE SUPREME COURTS JUDGMEN T IN THE CASE OF TUTICORIN ALKALI CHEMICALS & FERTILIZERS LTD VS CIT (227 ITR 172) IN SUPPORT OF THE PROPOSITION THAT MERELY BECAUSE STAN D OF THE ASSESSEE IS SUPPORTED BY RBI GUIDELINES AND ACCOUNTING PRAC TICES, IT ENTITLES ASSESSEE TO GET THE DEDUCTION AS INCOME TAX LAW DOE S NOT MATCH STEP BY STEP WITH THE DIVERGENT FOOTPRINTS OF THE ACCOUNT ANCY PROFESSION. AS REGARDS THE JUDICIAL PRECEDENTS CITED BY THE ASS ESSEE, THE ASSESSING OFFICER WAS OF THE VIEW THAT THESE DECISI ONS ARE FULLY DISTINGUISHABLE AS THE ISSUE FOR CONSIDERATION IN TH ESE CASES WAS VALUATION OF STOCK. IT WAS THUS CONCLUDED THAT THE CL AIM OF DEDUCTION IN RESPECT OF LOSS ON VALUATION OF INTEREST RATE SWAP WAS NOT ADMISSIBLE, AND IT WAS, ACCORDINGLY, DECLINED. AGGRIE VED, ASSESSEE CARRIED THE MATTER IN APPEAL BEFORE THE CIT(A) BUT WITHOUT ANY SUCCESS. THE ASSESSEE IS NOT SATISFIED AND IS IN SE COND APPEAL BEFORE US. 4. WE HAVE HEARD THE RIVAL CONTENTIONS, PERUSED THE MATERIAL ON RECORD AND DULY CONSIDERED FACTUAL MATRIX OF THE CAS E AS ALSO THE APPLICABLE LEGAL POSITION. 5. IT IS, TO BEGIN WITH, NECESSARY TO UNDERSTAND THE NATURE OF INTEREST RATE SWAP VALUATIONS. AN INTEREST RATE SWAP C ONTRACT IS TYPICALLY A CONTRACT BETWEEN TWO PARTIES WHICH DECI DE TO PAY INTEREST ON FIXED RATE, AS AGREED TO BETWEEN THE PARTIES, ON A NOTIONAL PRINCIPAL AMOUNT IN CONSIDERATION OF RECEIVING A FL OATING RATE OF INTEREST, OR VICE VERSA. IN PRACTICE, THESE OBLIGATI ONS ARE SETTLED BY MAKING A NET PAYMENT, I.E. DIFFERENCE BETWEEN FIXED AND FLOATING RATE OF INTEREST. IF FIXED RATE OF INTEREST IS MORE THAN THE FLOATING RATE OF INTEREST, THE PERSON UNDER OBLIGATION TO PAY FIXED R ATE OF INTEREST ONLY PAYS THE DIFFERENCE BETWEEN FIXED RATE AND FLOATING RATE, AND WHEN IT IS THE OTHER WAY ROUND, THE NET PAYMENT IS MADE BY THE PERSON UNDER OBLIGATION TO PAY THE FLOATING RATE OF INTEREST. THE SE CONTRACTS ARE ENTERED INTO TO HEDGE AGAINST VARIATIONS IN FLOATIN G RATE OF INTEREST FROM TIME TO TIME. THE FLOATING RATE OF INTEREST IS INDICATED BY MIBOR (MUMBAI INTER BANK OFFER RATE), WHICH IS BENCHMARK INTEREST RATE FOR THE CALL MONEY MARKET, AND THE RATE AT WHICH BA NKS CAN BORROW FUNDS, IN A MARKETABLE SIZE, FROM OTHER BANKS. LET US SAY ASSESSEE HAS AN OBLIGATION TO PAY FLOATING RATE OF INTEREST ON BO NDS OF A VALUE OF RS ITA NO. 264/MUM/2008 ASSESSMENT YEAR: 2004- 05 PAGE 5 OF 11 100 CRORES BUT, SINCE THE ASSESSEE PERCEIVES THE MA RKETS AS VOLATILE AND NOT FIT FOR OPEN RISK BEING TAKEN, THE ASSESSEE HEDGES AGAINST THIS OBLIGATION BY ENTERING INTO AN INTEREST RATE SW AP AT 4% WHICH HE FINDS REASONABLE AT THAT POINT OF TIME. THE FIXED R ATE OF INTEREST IN SUCH CASES IS A NEGOTIATED RATE, WHILE FLOATING RAT E OF INTEREST IS AT THE MERCY OF THE MARKET FORCES, WHEN MARKET EXPECTATION S OF THE FLOATING INTEREST RATE IS LOW, THE AGREED FIXED RATE OF INTER EST UNDER THE SWAP CONTRACT RATE IS ALSO LOW. HOWEVER, MANY FACTORS AF FECT THE VARIABLE RATE AND THE RATES COULD MOVE EITHER WAY; IT IS THI S RISK OF SIGNIFICANT VARIATIONS IN THE FLOATING RATE WHICH IS SOUGHT TO BE MITIGATED BY THE ASSESSEE BY ENTERING INTO INTEREST RATE SWAPSFOR EX AMPLE, ON 30 TH JUNE, ASSESSEE ENTERS INTO AN AGREEMENT WITH PARTY A TO PAY FIXED RATE OF INTEREST @ 4% ON A NOTIONAL PRINCIPAL AMOUNT OF RS 100 CRORES, IN CONSIDERATION OF RECEIVING FLOATING RATE OF INTEREST ON THE SAME, FOR A PERIOD OF ONE YEAR. THE SETTLEMENTS ARE TO BE DONE ON HALF YEARLY BASIS BEGINNING WITH 31 ST DECEMBER OF THAT YEAR. THERE WILL BE NO CASH FLOWS AS ON THE DATE OF CONTRACTS, BUT, ASS UMING THAT FLOATING RATE OF INTEREST IS 4.50% ON 31 ST DECEMBER, THE ASSESSEE WILL RECEIVE .50% INTEREST ON RS 100 CRORES FOR SIX MONTHS, AS O N THAT DATE. SIMILARLY, IF THE FLOATING RATE OF INTEREST AS ON 30 TH JUNE OF THE FOLLOWING YEAR IS 3.75% THE ASSESSEE WILL PAY .25% INTEREST ON RS 100 CRORES FOR SIX MONTHS ON THAT DATE. DEPENDING ON WH ETHER THE AMOUNT IS RECEIVABLE OR PAYABLE UNDER THE INTEREST R ATE SWAP CONTRACT, THE AMOUNTS ARE BOOKED AS INCOME OR EXPEN DITURE IN THE PROFIT AND LOSS ACCOUNT. THERE ARE NO ISSUES WITH R EGARD TO THE INCOME SO DISCLOSED OR THE EXPENDITURE SO CLAIMED F OR DEDUCTION. 6. THE DISPUTE, HOWEVER, ARISES WITH RESPECT TO UNS ETTLED INTEREST RATE SWAP CONTRACTS AS AT THE END OF THE YEAR. 7. WHILE COMPUTING THE POSITION OF UNSETTLED INTERE ST RATE SWAP, IT IS ALSO IMPORTANT TO BEAR IN MIND THE FACT THAT THE SETTLEMENTS ARE TO TAKE PLACE IN FUTURE, AND, THEREFORE, THE FUTURE CA SH INFLOWS AND OUTFLOWS ARE TO BE DISCOUNTED BY TIME VALUE OF MONEY AND NET PRESENT VALUE OF THE CASH INFLOWS OR OUTFLOWS ARE T O BE TAKEN INTO ACCOUNT. IT IS LIKE THIS. IF YOU HAVE TO RECEIVE R S 100 SIX MONTHS NOW, AND THE BENCHMARK DISCOUNTING RATE IS 6% FOR THIS S IX MONTH PERIOD, RS 100 RECEIVED SIX MONTHS FROM NOW IS AS GOOD AS R S 94.34 TODAY, BECAUSE THIS 94.34% INVESTED FOR AN YIELD OF 6% WILL WORK OUT TO RS 100 SIX MONTHS FROM TODAY. WHAT HAS BEEN REFERRED TO AS ITA NO. 264/MUM/2008 ASSESSMENT YEAR: 2004- 05 PAGE 6 OF 11 DISCOUNTING CURVE IS THIS DISCOUNTING FACTOR, WHI CH IS AGAIN A FIGURE DRIVEN BY MONEY MARKETS AND IS IN MARKET DOMAIN. L ET US SAY, IN THE EXAMPLE WE HAVE TAKEN ABOVE, WE WANT TO EVALUATE THE RESULTS OF THESE INTEREST RATE SWAP CONTRACTS AS ON INTERVENING 31 ST MARCH. THE COMPUTATION WILL THEN BE ON THE FOLLOWING BASIS: PRESENT VALUE OF THE FIXED INTEREST RATE PAYABLE UN DER THE CONTRACT: INTEREST PAYABLE FOR RS 100 CRORES @ 4% 4,00,00,000 DISCOUNTED VALUE AS ON TODAY * (*TAKING THE DISCOUNTING FACTOR SAY @ 6% - DETERMINED BY USING A DISCOUNT CURVE WHICH IS PUBLICLY KNOWN NUMBER) I.E. 4,00,00,000 X 4% X 6/12 X 0 .9434 1,88,68,000 PRESENT VALUE OF FLOATING INTEREST RATE RECEIVABLE UNDER THE CONTRACT: INTEREST RECEIVABLE UNDER THE CONTRACT @ 3.75% 3,75,00,000 DISCOUNTED VALUE AS ON TODAY * (*TAKING THE DISCOUNTING FACTOR SAY @ 6% - DETERMINED BY USING A DISCOUNT CURVE WHICH IS PUBLICLY KNOWN NUMBER) I.E. 4,00,00,000 X 4% X 6/12 X 0 .9434 1,76,88,750 8. THE NET NEGATIVE VALUE OF THIS CONTRACT, AS ON 3 1 ST MARCH, IS RS 11,79,250 BECAUSE THAT IS THE AMOUNT THE ASSESSEE W ILL HAVE TO PAY UNDER THE CONTRACT IF THE CONTRACTS ARE TO BE SETTL ED AT THE FLOATING RATES PREVAILING AS ON 31 ST MARCH. IN PLAIN WORDS, THIS FIGURE REPRESENTS THE LOSS ON INTEREST RATE SWAP CONTRACTS IF THESE CONTRACTS WERE TO BE SETTLED AS ON 31 ST MARCH, OR, TO PUT IN DIFFERENTLY, MARKET VALUE OF THESE CONTRACTS AS ON THAT DAY. THE ISSUE RE QUIRING OUR ADJUDICATION IS WHETHER THIS LOSS ON VALUATION OF IN TEREST RATE SWAP CONTRACTS CAN BE ALLOWED AS A DEDUCTION OR NOT. 9. IN PLAIN WORDS, THE VALUATION OF INTEREST RATE SW AP AS ON THE ITA NO. 264/MUM/2008 ASSESSMENT YEAR: 2004- 05 PAGE 7 OF 11 BALANCE SHEET DATE ONLY INDICATES COMPUTATION OF PR OFIT OR LOSS ON ACCOUNT OF THESE PROFITS AS ON THAT DATE. IT IS ALS O IMPORTANT TO BEAR IN MIND THE FACT THAT WHATEVER IS CLAIMED AS A LOSS AT THIS STAGE, IS EVENTUALLY REDUCED FROM THE OVERALL LOSS OR ADDED TO OVERALL PROFIT TAKEN INTO ACCOUNT, FOR TAX PURPOSES, IN THE SUBSEQ UENT ASSESSMENT YEAR IN WHICH THE SETTLEMENT DATE FALLS. THERE IS N O DISPUTE THAT WHATEVER IS THE LOSS ON INTEREST RATE SWAP VALUATION AS ON THE BALANCE SHEET DATE IS TO BE SQUARED UP BY TRANSFER TO THE A CTUAL LOSS OR PROFIT ON SETTLEMENT. ITS NOT REALLY, THEREFORE, THE QUESTI ON AS TO WHETHER THE DEDUCTION IS TO BE ALLOWED OR NOT, BUT ONLY THE ASSESSMENT YEAR IN WHICH DEDUCTION IS TO BE ALLOWED. VIEWED IN THE LO NG TERM PERSPECTIVE, THUS, IT IS WHOLLY TAX NEUTRAL BUT FOR THE TIMING OF DEDUCTION. 9. SECTION 145 OF THE INCOME TAX ACT, AS IT STANDS N OW, INTER ALIA LAYS DOWN THAT BUSINESS INCOME HAS TO BE COMPUTED IN ACCORDANCE WITH THE CASH OR MERCANTILE SYSTEM OF ACCOUNTING AS REGULARLY EMPLOYED BY THE ASSESSEE. THE ONLY RIDER TO THIS S TATUTORY REQ UIREMENT REGARDING METHOD OF ACCOUNTING IS THAT T HE CENTRAL GOVERNMENT MAY NOTIFY, IN THE OFFICIAL GAZETTE FROM TIME TO TIME, ACCOUNTING STANDARDS AND THE APPLICABLE ACCOUNTING STANDARDS WILL HAVE TO BE FOLLOWED BY THE ASSESSEE IN THE METHOD O F ACCOUNTING FOLLOWED. ONE OF THESE MANDATORY ACCOUNTING STANDAR D, NOTIFIED VIDE NOTIFICATION NO. 9949 DATED 25 TH JANUARY 1996, INTER ALIA PROVIDES THAT PROVISIONS SHOULD BE MADE FOR ALL KNOWN LIABILITIE S AND LOSSES EVEN THOUGH THE AMOUNT CANNOT BE DETERMINED WITH CE RTAINTY AND REPRESENTS ONLY A BEST ESTIMATE IN THE LIGHT OF AVA ILABLE INFORMATION. THIS APPROACH REQUIRES ALL ANTICIPAT ED LOSSES TO BE TAKEN INTO ACCOUNT IN COMPUTATION OF INCOME TAXABLE UNDER THE HEAD PROFITS AND GAINS FROM BUSINESS AND PROFESSION. UNLIKE IN THE PRE AMENDED SECTION, AS IT STOOD BEFORE 1.4.1997, WHICH PROVIDED THAT IN ANY CASE WHERE THE ACCOUNTS ARE CORRECT AND COM PLETE TO THE SATISFACTION OF THE ASSESSING OFFICER BUT THE METHO D EMPLOYED IS SUCH THAT, IN THE OPINION OF THE ASSESSING OFFICER, THE INCOME CANNOT PROPERLY BE DEDUCED THEREFROM, THEN THE COMPUTATION SHALL BE MADE UPON SUCH BASIS AND IN SUCH MANNER AS THE ASSESSING OFFICER MAY DETERMINE, THERE IS NO ENABLING PROVISION NOW WHICH PERMITS THE ASSESSING OFFICER TO TINKER WITH THE PROFITS COMPUT ED IN ACCORDANCE WITH THE METHOD OF ACCOUNTING SO EMPLOYED UNDER SEC TION 145 AND AS ITA NO. 264/MUM/2008 ASSESSMENT YEAR: 2004- 05 PAGE 8 OF 11 LONG AS THE MANDATORY ACCOUNTING STANDARDS ARE DULY FOLLOWED. IT IS NOT EVEN ASSESSING OFFICERS CASE THAT THE MANDATOR Y ACCOUNTING STANDARDS HAVE NOT BEEN FOLLOWED. THIS ANALYSIS OF SECTION 145, READ WITH APPLICABLE ACCOUNTING STANDARDS, APART, EVEN O N FIRST PRINCIPLES, DEDUCTION IN RESPECT OF ANTICIPATED LOS SES, AS A MEASURE OF PRUDENT ACCOUNTING PRINCIPLES, CANNOT BE DECLINE D. IT IS ONLY ELEMENTARY THAT THE ACCOUNTANCY PRINCIPLE OF CONSER VATISM, WHICH HAS BEEN DULY RECOGNIZED BY THE COURTS, MANDATES TH AT ANTICIPATED LOSSES ARE TO BE PROVIDED FOR IN THE COMPUTATION OF INCOME BUT IT DOES NOT PERMIT ANTICIPATED PROFITS TO BE TAKEN INTO ACC OUNT TILL THE PROFITS ACTUALLY ARISE. THAT IS THE UNDERLYING REASON THAT IN THE CASE OF UNSOLD STOCK, WHEN MARKET RATE IS HIGHER THAN THE P URCHASE PRICE, THE MARKET PRICE IS IGNORED IN COMPUTATION OF VALUE OF STOCK, AND, AS A RESULT, ANTICIPATED PROFIT ON SALE OF SUCH STOCK IS IGNORED. HOWEVER, WHEN THE MARKET PRICE OF STOCK IS LOWER THAN THE PU RCHASE PRICE, THE MARKET PRICE IS TAKEN INTO ACCOUNT, AND, ACCORDINGL Y, ANTICIPATED LOSS IS TAKEN INTO ACCOUNT. THESE DUAL STANDARDS IN RECOGNIZING ANTICIPATED LOSSES AND ANTICIPATED PROFITS ARE ACCE PTED ACCOUNTING NORMS. IN THE CASE OF CHAINRUP SAMPATRAM VS. CIT (1 953) 24 ITR 481 (SC), HONBLE SUPREME COURT TOOK NOTE OF THIS POSIT ION AND OBSERVED THAT 'WHILE ANTICIPATED LOSS IS TAKEN INTO ACCOUNT, ANTICIPATED PROFIT...IS NOT BROUGHT INTO ACCOUNT AS NO PRUDENT TRADER WOULD CARE TO SHOW INCREASED PROFIT BEFORE ITS ACTUAL REALISAT ION. THIS IS THE THEORY UNDERLYING THE RULE THAT THE CLOSING STOCK I S TO BE VALUED AT COST OR MARKET PRICE WHICHEVER IS LOWER, AND IT IS NOW GENERALLY ACCEPTED AS AN ESTABLISHED RULE OF COMMERCIAL PRACT ICE AND ACCOUNTANCY'. NO DOUBT THESE OBSERVATIONS WERE MADE IN THE CONTEXT OF VALUATION OF STOCK BUT WHAT IS MATERIAL IS THE T HEORY UNDERLYING THE PRINCIPLE OF VALUING CLOSING STOCK AND THE FAC T THAT SUCH A THEORY HAS THE ACCEPTANCE OF THE HONBLE SUPREME COURT. WHICHEVER WAY ONE LOOKS AT IT, WHETHER FROM THE POINT OF VIEW OF THE IMPACT OF SECTION 145 AND THE MANDATORY ACCOUNTING STANDARDS OR FROM THE POINT OF VIEW OF PURE ACCOUNTING PRINCIPLES DULY APPROVED B Y HONBLE SUPREME COURT, EVEN AN ANTICIPATED LOSS, EVEN IF IT MAY NOT HAVE CRYSTALLIZED IN THE RELEVANT PREVIOUS YEAR, IS TO B E ALLOWED AS A DEDUCTION IN THE COMPUTATION OF BUSINESS PROFITS. 10. IT IS IMPORTANT TO BEAR IN MIND THE FACT THAT T HE INTEREST RATE SWAP WAS ENTERED INTO AS THE ASSESSEE WANTED TO HED GE AGAINST THE ITA NO. 264/MUM/2008 ASSESSMENT YEAR: 2004- 05 PAGE 9 OF 11 INCREASE IN FLOATING RATE OF INTEREST WHICH WOULD MEANT HIGHER CASH OUTFLOWS FOR THE ASSESSEE, AND IT WAS FOR THIS REAS ON THAT THE ASSESSEE ENTERED INTO THREE CONTRACTS FOR A NOTION AL VALUE OF RS 185 CRORES, WHICH WERE TO REMAIN VALID TILL 4 TH JULY 2006, 15 TH MAY 2007 AND 13 TH JULY 2006 RESPECTIVELY, AND SETTLED FOR PAYING AN A GREED FIXED RATE OF INTEREST ON THE NOTIONAL VALUE OF RS 1 85 CRORES. AS THE ASSESSEE HAS INCURRED LOSS ON VALUATION OF THESE CON TRACTS, IT IS OBVIOUS THAT FIXED RATE PAYABLE BY THE ASSESSEE IS HIGHER THAN THE FLOATING RATE RECEIVABLE BY THE ASSESSEE. ON THESE FACTS, IT CANNOT BE DISPUTED THAT THE ASSESSEE DID INCUR A LOSS ON THES E CONTRACTS EVEN ON THE BALANCE SHEET DATE. THE ASSESSEES ESTIMATED LIABILITY ON ACCOUNT OF FIXED RATE OF INTEREST, AFTER DULY TAKING INTO ACC OUNT DISCOUNTING FACTOR FOR TIME VALUE OF MONEY, IS CLEARLY MORE THAT THE AMOUNT RECEIVABLE BY THE ASSESSEE FOR THE SAME AMOUNT AT T HE AGREED FIXED RATE. THIS ASPECT HAS NOT BEEN DISPUTED BY THE AUTH ORITIES BELOW AT ALL. THERE IS NO DISPUTE ON THE DISCOUNTING FACTOR EITHER AND THAT DISCOUNTING FACTOR, BEING A MARKET DRIVEN RATE IN TH E CALL MONEY MARKET, IS NOT IN DISPUTE EITHER. HOWEVER, SINCE TH E SETTLEMENT DATE IS STILL A LITTLE AWAY AND IN CASE THE FLOATING RATE IN DEED GOES UP, THE ASSESSEE MAY BE ABLE TO RECOUP SOME OF THESE LOSSES , BUT THAT IS A DOUBLE EDGED SWORD IN THE SENSE IN CASE FLOATING RA TE COMES DOWN EVEN FURTHER, THE ASSESSEES LOSSES MAY EVEN GO UP, AND IT IS NOT THE LOSS BUT RECOVERY WHICH IS CONTINGENT UPON FACTORS BEYOND ASSESSEES CONTROL. LOSS HAVING BEEN INCURRED IS A REALITY, ITS RECOUPMENT OR AGGRAVATION IS CONTINGENT. IT IS CONTINGENT UPON F UTURE HAPPENINGS IS WHETHER OR NOT LOSS THE ASSESSEE WILL BE ABLE TO RECOUP THE LOSSES TILL SETTLEMENT DATE, AND SUCH RECOUPMENT OR AGGRAV ATION OF LOSS WILL FALL IN PERIOD BEYOND THE END OF THE RELEVANT PREVI OUS YEAR. VIEWED THUS, AND BEARING IN MIND THE FACT THAT THE REAL IS SUE IN THIS APPEAL BEFORE US IS NOT THE DEDUCTIBILITY BUT ONLY TIMING O F THE DEDUCTION, WE ARE OF THE CONSIDERED VIEW THAT THE LOSS COMPUTED V IS--VIS THE VARIATION AS ON THE END OF THE RELEVANT PREVIOUS Y EAR, THE LOSS IS DEDUCTIBLE IN THE RELEVANT PREVIOUS YEAR. AS REGA RDS ASSESSING OFFICERS OBJECTION THAT ACCOUNTING PRINCIPLES NEED NOT GOVERN THE DEDUCTIBILITY, AND RELIANCE ON JUDICIAL PRECEDENTS IN SUPPORT THEREOF, THIS OBJECTION IS NOT SUSTAINABLE IN LAW FOR THE RE ASON THAT THE ACCOUNTING PRINCIPLE OF PRUDENCE, WHICH HAS BEEN RE LIED UPON BY THE ASSESSEE, IS NOW BINDING IN VIEW OF SECTION 145(2) READ WITH NOTIFICATION NO. 9949. AS REGARDS RELIANCE UPON HONBLE MADRAS HIGH COURTS JUDGMENT IN THE CASE OF INDIAN OVERSEAS BAN K (SUPRA) , IN ITA NO. 264/MUM/2008 ASSESSMENT YEAR: 2004- 05 PAGE 10 OF 11 SUPPORT OF THE PROPOSITION THAT WHEN ANTICIPATED PR OFITS ON UNMATURED CONTRACTS ARE HELD, TO BE NON-TAXABLE, TH ERE IS NO GOOD REASON AS TO WHY ANTICIPATED LOSSES ON UNMATURED CO NTRACTS CAN BE TAKEN INTO ACCOUNT WHILE COMPUTING BUSINESS INCOME, WE FIND THAT THERE IS AN INHERENT FALLACY IN THIS APPROACH INASM UCH AS ANTICIPATED LOSSES AND ANTICIPATED PROFITS ARE NOT TREATED IN T HE SAME MANNER IN THE COMPUTATION OF BUSINESS PROFITS. THESE DUAL S TANDARDS IN RECOGNIZING ANTICIPATED LOSSES AND ANTICIPATED PROF ITS ARE ACCEPTED ACCOUNTING NORMS AND IN THE CASE OF CHAINRUP SAMPAT RAM (SUPRA), HONBLE SUPREME COURT HAS APPROVED THIS DUALITY IN APPROACH. JUST BECAUSE ANTICIPATED PROFITS ARE NOT ASSESSED TO TAX , IT WOULD NOT FOLLOW, AS A COROLLARY THERETO, THAT ANTICIPATED LO SSES CANNOT BE ALLOWED AS DEDUCTION IN COMPUTATION OF BUSINESS INC OME. IN VIEW OF THESE DISCUSSIONS, AS ALSO IN VIEW OF SPECIAL BENCH DECISION IN THE CASE OF DCIT VS BANK OF BAHRAIN & KUWAIT (132 TTJ 5 05) AND A COORDINATE BENCH DECISION IN THE CASE OF ADIT VS J P MORGAN CHASE BANK ( 2010 TII 185 ITAT MUM), WE UPHOLD THE GRIEVA NCE OF THE ASSESSEE. THE IMPUGNED DISALLOWANCE IS ACCORDINGLY DELETED. THIS RELIEF IS, HOWEVER, SUBJECT TO THE RIDER THAT THE A LLOWABILITY IN DEDUCTION IN THE CURRENT YEAR IS SUBJECT TO VERIFIC ATION OF CORRESPONDING ADJUSTMENT IN THE YEAR IN WHICH NEXT SETTLEMENT DATE FALLS. THE ASSESSEE GETS THE RELIEF ACCORDINGLY. 3. WE SEE NO REASONS TO TAKE ANY OTHER VIEW OF THE MATTER THAN THE VIEW SO TAKEN IN ASSESSEES OWN CASE FOR THE IMMEDIATELY PR ECEDING A SSESSMENT YEAR. 4. CONSISTENT WITH THE STAND TAKEN FOR THE ASSESSME NT YEAR 2003-04, WE UPHOLD THE GRIEVANCE OF THE ASSESSEE IN PRINCIPLE A ND DIRECT THE ASSESSING OFFICER TO DELETE THE IMPUGNED DISALLOWANCE OF RS 9 8,84,000 . THIS RELIEF IS, HOWEVER, SUBJECT TO THE RIDER THAT THE ALLOWABILITY IN DEDUCTION IN THE CURRENT YEAR IS SUBJECT TO VERIFICATION OF CORRESPO NDING ADJUSTMENT IN THE YEAR IN WHICH NEXT SETTLEMENT DATE FALLS. THE ASSE SSEE GETS THE RELIEF ACCORDINGLY. ITA NO. 264/MUM/2008 ASSESSMENT YEAR: 2004- 05 PAGE 11 OF 11 5. IN THE RESULT, THE APPEAL IS ALLOWED IN THE TERM S INDICATED ABOVE. PRONOUNCED IN THE OPEN COURT TODAY ON 26 TH DAY OF AUGUST, 2011. SD/XX SD/XX (VIJAY PAL RAO ) (PRAMOD KUM AR) JUDICIAL MEMBER ACCOUNTANT MEMBER MUMBAI; 26 TH DAY OF AUGUST, 2011 . COPY FORWARDED TO : 1. THE APPELLANT 2. THE RESPONDENT 3. COMMISSIONER , MUMBAI 4. DEPARTMENTAL REPRESENTATIVE, BENCH, MUMBAI 5. GUARD FILE TRUE COP Y BY ORDER ETC. ASSISTANT REGISTRAR INCOME TAX APPELLATE TRIBUNAL MUMBAI BENCHES, MUMBAI