M/s. ABN AMRO SECURITIES (I) P. LTD., MUMBAI V. ITO - 3(1)(1), MUMBAI

ITA 7073/MUM/2006

• Counselvise Citation: [2011] 140 COUNSELVISE.COM (IT) 54967 (ITAT-MUMBAI)
• Duration Of Justice: 4 year(s) 7 month(s) 30 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: 2003-2004
• Appeal Filed On: 27-12-2006
• Result in Favour of: Assessee
• Court: TRIBUNAL
• Assessee Lawyers: USHA NAIR
• Keywords: Business income
• Section: 143(3); 145

Judgement Text

ITA NO. 7073/MUM/2006 ASSESSMENT YEAR: 2003- 04 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. 7073/MUM/06 ASSESSMENT YEAR: 2003-04 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 DATED 18 TH AUGUST 2006, IN THE MATTER OF ASSESSMENT UNDER SECTION 143(3) OF THE INCOME TAX ACT, 1961 FOR THE ASSESSMENT YEAR 2003-04, ON THE FOLLOWING GROUND: 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 10,10,92,000 BEING LOSS ON ACCOUNT OF VA LUATION OF INTEREST RATE SWAP ON THE BASIS THAT THE SAME IS A NOTIONAL OR IMAGINARY LOSS . ITA NO. 7073/MUM/2006 ASSESSMENT YEAR: 2003- 04 PAGE 2 OF 11 2. THE ASSESSEE IS ENGAGED IN THE BUSINESS OF DEA LING IN GOVERNMENT SECURITIES, BONDS, DEBENTURES AND PROVIDING SERVICE S OF ARRANGING AND UNDERWRITING THE ISSUE OF DEBENTURES AND BONDS ETC. DURING THE COURSE OF THE ASSESSMENT PROCEEDINGS, THE ASSESSING OFFICER NOTIC ED THAT THE ASSESSEE HAS CLAIMED A DEDUCTION OF RS 10,10,92,000 BEING LOSS O N INTEREST RATE SWAP VALUATIONS. 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, ON MULTIP LE OCCASIONS, DURING THE CONTRACT PERIOD. IT WAS ALSO SUBMITTED THAT THESE C ONTRACTS GENERALLY INVOLVE EXCHANGE OF FIXED RATE OF INTEREST, WITH FLOATING R ATE OF INTEREST, AND VICE VERSA . ON EACH PAYMENT DATE, THE INTEREST IS NOTIONALL Y PAID ON THE AGREED FIXED OR FLOATING RATE BY ONE PARTY TO THE OTHER, B Y SETTLING FOR THE DIFFERENCE PAYMENTS. HAVING SO EXPLAINED THE NATURE OF INTERES T RATE SWAP, THE ASSESSEE SUBMITTED THAT THE ASSESSEE HAD THREE ONGOING INTER EST RATE SWAP CONTRACTS, FOR A NOTIONAL PRINCIPAL AMOUNT OF RS 185 CRORES, U NDER WHICH THE ASSESSEE WAS TO PAY A FIXED RATE OF INTEREST AND RECEIVE TH E FLOATING RATE OF INTEREST. IT WAS THEN SUBMITTED THAT THE DEDUCTION OF RS 10,10,9 2,000 HAS BEEN CLAIMED ON ACCOUNT OF UNREALIZED LOSS ON THE BASIS OF VALU ATION OF INTEREST RATE SWAP. THIS VALUATION, ACCORDING TO THE ASSESSEE WAS ARRIV ED AT BY WORKING OUT FUTURE EXTRAPOLATION OF THE YIELD CURVE, CONSIDERIN G PAST HISTORY OF AVAILABLE RATES AND CURRENT MARKET RATE. IT WAS ALSO SUBMITT ED THAT THIS PROVISION HAS BEEN MADE IN ACCORDANCE WITH THE GUIDELINES ISSUED BY THE RESERVE BANK OF INDIA, AND THE METHOD OF VALUATION CONSISTENTLY FOL LOWED ALL ALONG. IT WAS ALSO SUBMITTED THAT THE ASSESSEE BEING ENGAGED IN THE BU SINESS OF DEALING IN THE INTEREST BEARING SECURITIES, AND THE INTEREST RATE, I.E. YIELD, BEING CONTINGENT UPON VARIOUS ECONOMIC, POLITICAL AND INTERNATIONAL FACTORS, OVER WHICH ASSESSEE HAS NO CONTROL, THE INTEREST RATE SWAPS EN TERED INTO BY THE ASSESSEE ACT AS AN INSURANCE AGAINST LOSSES DUE TO HEAVY FLU CTUATIONS IN THE YIELD. IT WAS FURTHER SUBMITTED THAT RESERVE BANK OF INDIA GU IDELINES ARE MANDATORY ON THE ASSESSEE, AND THE INTEREST RATE SWAP VALUATI ONS HAVE BEEN DONE IN ITA NO. 7073/MUM/2006 ASSESSMENT YEAR: 2003- 04 PAGE 3 OF 11 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 INCOME, A REFERENCE WAS ALSO MADE TO HO NBLE SUPREME COURTS JUDGMENT IN THE CASES OF CHAINRUP SAMPATRAM VS CIT (24 ITR 481), ALA FIRM VS CIT (189 ITR 285) AND SANJEEV WOOLEN MILLS VS CI T (279 ITR 434). 3. THE ASSESSING OFFICER, HOWEVER, WAS NOT IMPRESSE D BY ANY OF THESE SUBMISSIONS. HE WAS OF THE VIEW THAT THIS LOSS ON V ALUATION OF INTEREST RATE SWAP IS NOTHING BUT AN UNASCERTAINED LIABILITY WHIC H CANNOT BE ALLOWED AS A DEDUCTION IN COMPUTATION OF BUSINESS INCOME. HE NO TED THAT WHATEVER LOSSES HAD ACTUALLY INCURRED IN CONNECTION WITH THESE INTE REST RATE SWAP CONTRACTS, AND DEBITED TO THE PROFIT AND LOSS ACCOUNT UPON TH EIR BECOMING PAYABLE, HAVE ALREADY BEEN ALLOWED AS A DEDUCTION. HOWEVER, WHAT HAS BEEN CLAIMED AS DEDUCTION IN THE IMPUGNED CLAIM IS THE LOSS WHICH W OULD 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 OCC UR. THE ASSESSING OFFICER, ON THE BASIS OF THIS REASONING, CONCLUDED THAT WHAT HAS BEEN CLAIMED AS DEDUCTION IS ONLY A CONTINGENT LIABILITY AND A PROV ISION MADE FOR A LIABILITY WHICH MAY ARISE IN FUTURE. IT WAS ALSO OBSERVED THA T AS THE ASSESSEE WAS FOLLOWING MERCANTILE METHOD OF ACCOUNTING, NO DEDU CTION CAN BE MADE IN RESPECT OF A LIABILITY WHICH HAS NOT DEFINITELY ARI SEN AND THAT DEDUCTION CAN ONLY BE ALLOWED IN RESPECT OF ASCERTAINED AND ENFOR CEABLE LIABILITY WHICH COULD BE ENFORCED ON OR BEFORE THE END OF THE RELEVANT PR EVIOUS 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 MA DRAS HIGH COURTS JUDGMENT IN THE CASE OF CIT VS. INDIAN OVERSEAS BAN K (151 ITR 446). AS FOR THE RESERVE BANK OF INDIAS GUIDELINES AND THE ACCOUNTING TREATMENT, THE ASSESSING OFFICER REFERRED TO HONBL E SUPREME COURTS JUDGMENT IN THE CASE OF TUTICORIN ALKALI CHEMICAL S & FERTILIZERS LTD VS CIT (227 ITR 172) IN SUPPORT OF THE PROPOSITION THAT ME RELY BECAUSE STAND OF THE ASSESSEE IS SUPPORTED BY RBI GUIDELINES AND ACCOUN TING PRACTICES, IT ENTITLES ITA NO. 7073/MUM/2006 ASSESSMENT YEAR: 2003- 04 PAGE 4 OF 11 ASSESSEE TO GET THE DEDUCTION AS INCOME TAX LAW DO ES NOT MATCH STEP BY STEP WITH THE DIVERGENT FOOTPRINTS OF THE ACCOUNTANCY PR OFESSION. AS REGARDS THE JUDICIAL PRECEDENTS CITED BY THE ASSESSEE, THE ASSE SSING OFFICER WAS OF THE VIEW THAT THESE DECISIONS ARE FULLY DISTINGUISHABLE AS THE ISSUE FOR CONSIDERATION IN THESE CASES WAS VALUATION OF STOCK . IT WAS THUS CONCLUDED THAT THE CLAIM OF DEDUCTION IN RESPECT OF LOSS ON V ALUATION OF INTEREST RATE SWAP WAS NOT ADMISSIBLE, AND IT WAS, ACCORDINGLY, D ECLINED. AGGRIEVED, ASSESSEE CARRIED THE MATTER IN APPEAL BEFORE THE CI T(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 CASE AS ALSO THE APPLICABLE LEGAL POSITION. 5. IT IS, TO BEGIN WITH, NECESSARY TO UNDERSTAND TH E NATURE OF INTEREST RATE SWAP VALUATIONS. AN INTEREST RATE SWAP CONTRACT IS TYPICALLY A CONTRACT BETWEEN TWO PARTIES WHICH DECIDE TO PAY INTEREST ON FIXED RATE, AS AGREED TO BETWEEN THE PARTIES, ON A NOTIONAL PRINCIPAL AMOUNT IN CONSIDERATION OF RECEIVING A FLOATING RATE OF INTEREST, OR VICE VERSA . IN PRACTICE, THESE OBLIGATIONS ARE SETTLED BY MAKING A NET PAYMENT, I. E. DIFFERENCE BETWEEN FIXED AND FLOATING RATE OF INTEREST. IF FIXED RATE OF INT EREST IS MORE THAN THE FLOATING RATE OF INTEREST, THE PERSON UNDER OBLIGATION TO PA Y FIXED RATE 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 PER SON UNDER OBLIGATION TO PAY THE FLOATING RATE OF INTEREST. THESE CONTRACTS ARE ENTERED INTO TO HEDGE AGAINST VARIATIONS IN FLOATING RATE OF INTEREST FRO M TIME TO TIME. THE FLOATING RATE OF INTEREST IS INDICATED BY MIBOR (MUMBAI INTE R BANK OFFER RATE), WHICH IS BENCHMARK INTEREST RATE FOR THE CALL MONEY MARKE T, AND THE RATE AT WHICH BANKS CAN BORROW FUNDS, IN A MARKETABLE SIZE, FROM OTHER BANKS. LET US SAY ASSESSEE HAS AN OBLIGATION TO PAY FLOATING RATE OF INTEREST ON BONDS OF A VALUE OF RS 100 CRORES BUT, SINCE THE ASSESSEE PERCEIVES THE MARKETS AS VOLATILE AND NOT FIT FOR OPEN RISK BEING TAKEN, THE ASSESSEE HED GES AGAINST THIS OBLIGATION ITA NO. 7073/MUM/2006 ASSESSMENT YEAR: 2003- 04 PAGE 5 OF 11 BY ENTERING INTO AN INTEREST RATE SWAP AT 4% WHICH HE FINDS REASONABLE AT THAT POINT OF TIME. THE FIXED RATE OF INTEREST IN SUCH C ASES IS A NEGOTIATED RATE, WHILE FLOATING RATE OF INTEREST IS AT THE MERCY OF THE MARKET FORCES, WHEN MARKET EXPECTATIONS OF THE FLOATING INTEREST RATE I S LOW, THE AGREED FIXED RATE OF INTEREST UNDER THE SWAP CONTRACT RATE IS ALSO LO W. HOWEVER, MANY FACTORS AFFECT THE VARIABLE RATE AND THE RATES COULD MOVE E ITHER WAY; IT IS THIS RISK OF SIGNIFICANT VARIATIONS IN THE FLOATING RATE WHICH I S SOUGHT TO BE MITIGATED BY THE ASSESSEE BY ENTERING INTO INTEREST RATE SWAPSFO R EXAMPLE, ON 30 TH JUNE, ASSESSEE ENTERS INTO AN AGREEMENT WITH PARTY A TO P AY FIXED RATE OF INTEREST @ 4% ON A NOTIONAL PRINCIPAL AMOUNT OF RS 100 CRORE S, IN CONSIDERATION OF RECEIVING FLOATING RATE OF INTEREST ON THE SAME, FO R A PERIOD OF ONE YEAR. THE SETTLEMENTS ARE TO BE DONE ON HALF YEARLY BASIS BEGI NNING WITH 31 ST DECEMBER OF THAT YEAR. THERE WILL BE NO CASH FLOWS AS ON THE DATE OF CONTRACTS, BUT, ASSUMING THAT FLOATING RATE OF INTEREST IS 4.50% ON 31 ST DECEMBER, THE ASSESSEE WILL RECEIVE .50% INTEREST ON RS 100 CRORE S FOR SIX MONTHS, AS ON THAT DATE. SIMILARLY, IF THE FLOATING RATE OF INTE REST 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 WHETHER T HE AMOUNT IS RECEIVABLE OR PAYABLE UNDER THE INTEREST RATE SWAP CONTRACT, T HE AMOUNTS ARE BOOKED AS INCOME OR EXPENDITURE IN THE PROFIT AND LOSS ACCOUN T. THERE ARE NO ISSUES WITH REGARD TO THE INCOME SO DISCLOSED OR THE EXPEN DITURE SO CLAIMED FOR 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 SETTLEM ENTS ARE TO TAKE PLACE IN FUTURE, AND, THEREFORE, THE FUTURE CASH INFLOWS AND OUTFLOWS ARE TO BE DISCOUNTED BY TIME VALUE OF MONEY AND NET PRESENT VALUE OF THE CASH INFLOWS OR OUTFLOWS ARE TO BE TAKEN INTO ACCOUNT. IT IS LI KE THIS. IF YOU HAVE TO RECEIVE ITA NO. 7073/MUM/2006 ASSESSMENT YEAR: 2003- 04 PAGE 6 OF 11 RS 100 SIX MONTHS NOW, AND THE BENCHMARK DISCOUNTIN G RATE IS 6% FOR THIS SIX MONTH PERIOD, RS 100 RECEIVED SIX MONTHS FROM N OW IS AS GOOD AS RS 94.34 TODAY, BECAUSE THIS 94.34% INVESTED FOR AN YI ELD OF 6% WILL WORK OUT TO RS 100 SIX MONTHS FROM TODAY. WHAT HAS BEEN REFERRE D TO AS DISCOUNTING CURVE IS THIS DISCOUNTING FACTOR, WHICH IS AGAIN A FI GURE DRIVEN BY MONEY MARKETS AND IS IN MARKET DOMAIN. LET US SAY, IN T HE EXAMPLE WE HAVE TAKEN ABOVE, WE WANT TO EVALUATE THE RESULTS OF THESE INT EREST RATE SWAP CONTRACTS AS ON INTERVENING 31 ST MARCH. THE COMPUTATION WILL THEN BE ON THE FOLLO WING 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 WILL HAVE T O PAY UNDER THE CONTRACT IF THE CONTRACTS ARE TO BE SETTLED AT THE FLOATING RAT ES 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 REQUIRING OUR ITA NO. 7073/MUM/2006 ASSESSMENT YEAR: 2003- 04 PAGE 7 OF 11 ADJUDICATION IS WHETHER THIS LOSS ON VALUATION OF I NTEREST RATE SWAP CONTRACTS CAN BE ALLOWED AS A DEDUCTION OR NOT. 9. IN PLAIN WORDS, THE VALUATION OF INTEREST RATE S WAP AS ON THE BALANCE SHEET DATE ONLY INDICATES COMPUTATION OF PROFIT OR LOSS ON ACCOUNT OF THESE PROFITS AS ON THAT DATE. IT IS ALSO IMPORTANT TO BE AR IN MIND THE FACT THAT WHATEVER IS CLAIMED AS A LOSS AT THIS STAGE, IS EVE NTUALLY REDUCED FROM THE OVERALL LOSS OR ADDED TO OVERALL PROFIT TAKEN INTO ACCOUNT, FOR TAX PURPOSES, IN THE SUBSEQUENT ASSESSMENT YEAR IN WHICH THE SETTLEM ENT DATE FALLS. THERE IS NO DISPUTE THAT WHATEVER IS THE LOSS ON INTEREST RA TE SWAP VALUATION AS ON THE BALANCE SHEET DATE IS TO BE SQUARED UP BY TRANSFER TO THE ACTUAL LOSS OR PROFIT ON SETTLEMENT. ITS NOT REALLY, THEREFORE, THE QUES TION AS TO WHETHER THE DEDUCTION IS TO BE ALLOWED OR NOT, BUT ONLY THE ASS ESSMENT YEAR IN WHICH DEDUCTION IS TO BE ALLOWED. VIEWED IN THE LONG TER M PERSPECTIVE, THUS, IT IS WHOLLY TAX NEUTRAL BUT FOR THE TIMING OF DEDUCTION. 9. SECTION 145 OF THE INCOME TAX ACT, AS IT STANDS NOW, INTER ALIA LAYS DOWN THAT BUSINESS INCOME HAS TO BE COMPUTED IN ACCORDANCE W ITH THE C ASH OR MERCANTILE SYSTEM OF ACCOUNTING AS REGULARLY EMPLOY ED BY THE ASSESSEE. THE ONLY RIDER TO THIS STATUTORY REQUIREMENT REGARDING METHOD OF ACCOUNTING IS THAT THE CENTRAL GOVERNMENT MAY NOTIFY, IN THE OF FICIAL GAZETTE FROM TIME TO TIME, ACCOUNTING ST ANDARDS AND THE APPLICABLE ACCOUNTING STANDARDS W ILL HAVE TO BE FOLLOWED BY THE ASSESSEE IN THE METHOD OF ACC OUNTING FOLLOWED. ONE OF THESE MANDATORY ACCOUNTING STANDARD, NOTIFIED VIDE NOTIFICATION NO. 9949 DATED 25 TH JANUARY 1996, INTER ALIA PROVIDES THAT PROVISIONS SHOULD BE MADE FOR ALL KNOWN LIABILITIES AND LOSSES EVEN THOUGH TH E AMOUNT CANNOT BE DETERMINED WITH CERTAINTY AND REPRESENTS ONLY A BES T ESTIMATE IN THE LIGHT OF AVAILABLE INFORMATION. THIS APPROACH REQUIRES ALL ANTICIPATED 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 ITA NO. 7073/MUM/2006 ASSESSMENT YEAR: 2003- 04 PAGE 8 OF 11 ACCOUNTS ARE CORRECT AND COMPLETE TO THE SATISFACTI ON OF THE ASSESSING OFFICER BUT THE METHOD EMPLOYED IS SUCH THAT, IN THE OPINIO N OF THE ASSESSING OFFICER, THE INCOME CANNOT PROPERLY BE DEDUCED THEREFROM, TH EN 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 SECTION 145 AND AS LONG AS THE MANDATORY ACCOUNTING STANDARDS ARE DULY FOLLOWED. I T IS NOT EVEN ASSESSING OFFICERS CASE THAT THE MANDATORY ACCOUNTING STANDA RDS HAVE NOT BEEN FOLLOWED. THIS ANALYSIS OF SECTION 145, READ WITH A PPLICABLE ACCOUNTING STANDARDS, APART, EVEN ON FIRST PRINCIPLES, DEDUCTI ON IN RESPECT OF ANTICIPATED LOSSES, AS A MEASURE OF PRUDENT ACCOUNTING PRINCIPL ES, CANNOT BE DECLINED. IT IS ONLY ELEMENTARY THAT THE ACCOUNTANCY PRINCIPLE O F CONSERVATISM, WHICH HAS BEEN DULY RECOGNIZED BY THE COURTS, MANDATES THAT A NTICIPATED LOSSES ARE TO BE PROVIDED FOR IN THE COMPUTATION OF INCOME BUT IT DOES NOT PERMIT ANTICIPATED PROFITS TO BE TAKEN INTO ACCOUNT TILL T HE PROFITS ACTUALLY ARISE. THAT IS THE UNDERLYING REASON THAT IN THE CASE OF U NSOLD STOCK, WHEN MARKET RATE IS HIGHER THAN THE PURCHASE PRICE, THE MARKET PRICE IS IGNORED IN COMPUTATION OF VALUE OF STOCK, AND, AS A RESULT, AN TICIPATED PROFIT ON SALE OF SUCH STOCK IS IGNORED. HOWEVER, WHEN THE MARKET PRI CE OF STOCK IS LOWER THAN THE PURCHASE PRICE, THE MARKET PRICE IS TAKEN INTO ACCOUNT, AND, ACCORDINGLY, 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 (1953) 24 IT R 481 (SC), HONBLE SUPREME COURT TOOK NOTE OF THIS POSITION AND OBSERV ED THAT 'WHILE ANTICIPATED LOSS IS TAKEN INTO ACCOUNT, ANTICIPATED PROFIT...IS NOT BROUGHT INTO ACCOUNT AS NO PRUDENT TRADER WOULD CARE TO SHOW INC REASED PROFIT BEFORE ITS ACTUAL REALISATION. THIS IS THE THEORY UNDERLYING T HE RULE THAT THE CLOSING STOCK IS TO BE VALUED AT COST OR MARKET PRICE WHICH EVER IS LOWER, AND IT IS NOW GENERALLY ACCEPTED AS AN ESTABLISHED RULE OF COMMER CIAL PRACTICE AND ACCOUNTANCY'. NO DOUBT THESE OBSERVATIONS WERE MADE IN THE CONTEXT OF ITA NO. 7073/MUM/2006 ASSESSMENT YEAR: 2003- 04 PAGE 9 OF 11 VALUATION OF STOCK BUT WHAT IS MATERIAL IS THE THEO RY UNDERLYING THE PRINCIPLE OF VALUING CLOSING STOCK AND THE FACT 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 ACCOUNT ING PRINCIPLES DULY APPROVED BY HONBLE SUPREME COURT, EVEN AN ANTICIPATED LOSS, EVEN IF IT MAY NOT HAVE CRYSTALLIZED IN THE RELEVANT PREVIOUS YEAR , IS TO BE 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 HEDGE AGAINS T THE INCREASE IN FLOATING RATE OF INTEREST WHICH WOULD MEANT HIGHER CASH OUTFL OWS FOR THE ASSESSEE, AND IT WAS FOR THIS REASON THAT THE ASSESSEE ENTERED IN TO THREE CONTRACTS FOR A NOTIONAL VALUE OF RS 185 CRORES, WHICH WERE TO REMA IN VALID TILL 4 TH JULY 2006, 15 TH MAY 2007 AND 13 TH JULY 2006 RESPECTIVELY, AND SETTLED FOR PAYING AN AGREED FIXED RATE OF INTEREST ON THE NOTIONAL VALUE OF RS 185 CRORES. AS THE ASSESSEE HAS INCURRED LOSS ON VALUATION OF THESE CO NTRACTS, IT IS OBVIOUS THAT FIXED RATE PAYABLE BY THE ASSESSEE IS HIGHER THAN T HE FLOATING RATE RECEIVABLE BY THE ASSESSEE. ON THESE FACTS, IT CANNOT BE DISPU TED THAT THE ASSESSEE DID INCUR A LOSS ON THESE CONTRACTS EVEN ON THE BALANCE SHEET DATE. THE ASSESSEES ESTIMATED LIABILITY ON ACCOUNT OF FIXED RATE OF INT EREST, AFTER DULY TAKING INTO ACCOUNT DISCOUNTING FACTOR FOR TIME VALUE OF MONEY, IS CLEARLY MORE THAT THE AMOUNT RECEIVABLE BY THE ASSESSEE FOR THE SAME AMOU NT AT THE 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 THE CALL MONEY MARKET , IS NOT IN DISPUTE EITHER. HOWEVER, SINCE THE SETTLEMENT DATE IS STILL A LITTL E AWAY AND IN CASE THE FLOATING RATE INDEED GOES UP, THE ASSESSEE MAY BE ABLE TO RE COUP SOME OF THESE LOSSES, BUT THAT IS A DOUBLE EDGED SWORD IN THE SENSE IN CA SE FLOATING RATE COMES DOWN EVEN FURTHER, THE ASSESSEES LOSSES MAY EVEN GO UP, AND IT IS NOT THE LOSS BUT ITA NO. 7073/MUM/2006 ASSESSMENT YEAR: 2003- 04 PAGE 10 OF 11 RECOVERY WHICH IS CONTINGENT UPON FACTORS BEYOND AS SESSEES CONTROL. LOSS HAVING BEEN INCURRED IS A REALITY, ITS RECOUPMENT O R AGGRAVATION IS CONTINGENT. IT IS CONTINGENT UPON FUTURE HAPPENINGS IS WHETHER OR NOT LOSS THE ASSESSEE WILL BE ABLE TO RECOUP THE LOSSES TILL SETTLEMENT D ATE, AND SUCH RECOUPMENT OR AGGRAVATION OF LOSS WILL FALL IN PERIOD BEYOND THE END OF THE RELEVANT PREVIOUS YEAR. VIEWED THUS, AND BEARING IN MIND THE FACT TH AT THE REAL ISSUE IN THIS APPEAL BEFORE US IS NOT THE DEDUCTIBILITY BUT ONLY TIMING OF 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 YEAR, THE LOSS IS DEDUCTIBLE IN THE RELEVANT PREVIOUS YEAR. AS REGARDS ASSESSING OFFICERS OBJECTION THAT ACCOU NTING PRINCIPLES NEED NOT GOVERN THE DEDUCTIBILITY, AND R ELIANCE ON JUDICIAL PRECEDENTS IN SUPPORT THEREOF, THIS OBJECTION IS NO T SUSTAINABLE IN LAW FOR THE REASON THAT THE ACCOUNTING PRINCIPLE OF PRUDENCE, W HICH HAS BEEN RELIED UPON BY THE ASSESSEE, IS NOW BINDING IN VIEW OF SECTION 145(2) READ WITH NOTIFICATION NO. 9949. AS REGARDS RELIANCE U PON HONBLE MADRAS HIGH COURTS JUDGMENT IN THE CASE OF INDIAN OVERSEAS BANK (SUPRA ), IN SUPPORT OF THE PROPOSITION THAT WHEN ANTICIPATED PROFITS ON UNMATU RED CONTRACTS ARE HELD, TO BE NON-TAXABLE, THERE IS NO GOOD REASON AS TO WH Y ANTICIPATED LOSSES ON UNMATURED CONTRACTS CAN BE TAKEN INTO ACCOUNT WHILE COMPUTING BUSINESS INCOME, WE FIND THAT THERE IS AN INHERENT FALLACY I N THIS APPROACH INASMUCH AS ANTICIPATED LOSSES AND ANTICIPATED PROFITS ARE N OT TREATED IN THE SAME MANNER IN THE COMPUTATION OF BUSINESS PROFITS. TH ESE DUAL STANDARDS 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 WOU LD NOT FOLLOW, AS A COROLLARY THERETO, THAT ANTICIPATED LOSSES CANNOT BE ALLOWED AS DEDUCTION IN COMPUTATION OF BUSINESS INCOME. IN VIEW OF THESE D ISCUSSIONS, AS ALSO IN VIEW OF SPECIAL BENCH DECISION IN THE CASE OF DCIT VS BANK OF BAHRAIN & KUWAIT (132 TTJ 505) AND A COORDINATE BENCH DECISIO N IN THE CASE OF ADIT VS J P MORGAN CHASE BANK ( 2010 TII 185 ITAT MUM), WE UPHOLD THE GRIEVANCE ITA NO. 7073/MUM/2006 ASSESSMENT YEAR: 2003- 04 PAGE 11 OF 11 OF THE ASSESSEE. THE IMPUGNED DISALLOWANCE IS ACCOR DINGLY DELETED. THIS RELIEF IS, HOWEVER, SUBJECT TO THE RIDER THAT THE A LLOWABILITY IN DEDUCTION IN THE CURRENT YEAR IS SUBJECT TO VERIFICATION OF CORR ESPONDING ADJUSTMENT IN THE YEAR IN WHICH NEXT SETTLEMENT DATE FALLS. THE ASSE SSEE GETS THE RELIEF ACCORDINGLY. 11. IN THE RESULT, THE APPEAL IS ALLOWED IN THE TER MS 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