Foreign Currency Derivative Losses Allowed as Business Expenditure: ITAT quashes Revisionary Income Tax Order [Read Order]

The Income Tax Appellate Tribunal (ITAT), Ahmedabad, has quashed a revisionary order passed under Section 263 of the Income Tax Act, 1961, by the Principal Commissioner of Income Tax. The Tribunal held that losses arising from foreign currency derivative transactions and exchange rate differences were not speculative in nature but allowable as business expenditure.

The appeals were filed by Vardhman Stampings Pvt. Ltd., an Ahmedabad-based company, against the order of the Principal Commissioner of Income Tax-4 (PCIT), for the Assessment Years (AY) 2014–15 and 2015–16. The dispute centered on the assessee’s claim of losses aggregating ₹1,50,12,699, which included loss on derivative contracts and loss on account of foreign exchange fluctuation.

While the Assessing Officer (AO) had accepted the claims in scrutiny assessment, the PCIT invoked revisionary powers under Section 263, holding the allowance erroneous and prejudicial to the Revenue.

The appellant represented by Manish J. Shah and Rushin Patel, contended that all transactions related to derivatives were settled through recognized exchanges, with records substantiating these as actual, not notional, losses. It was argued that the loss of ₹53.49 lakh on account of exchange rate differences was recorded in accordance with Accounting Standard-11 issued by the Institute of Chartered Accountants of India and supported by Supreme Court rulings in CIT v. Woodward Governor Pvt. Ltd. (2009) and ONGC v. CIT. (2015).

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It was further submitted that the loss of ₹82.91 lakh on foreign currency derivative transactions was a settled loss incurred on hedging raw material imports through MCX-SX, a SEBI-recognized stock exchange, thereby falling within the exception in Section 43(5)(e).

It was also emphasized that the PCIT wrongly treated the losses as “mark-to-market” notional losses and, in addition, invoked Explanation to Section 73 without giving the assessee an opportunity to respond.

The revenue authorities represented by H. Phani Raju, supported the PCIT’s view that the losses on foreign currency derivative transactions were speculative and not allowable under Section 43(5) of the Income Tax Act, 1961. It was also contended that the Explanation to Section 73 would disqualify the set-off of such losses.

The Bench comprising of Accountant Member, Annapurna Gupta and Judicial Member, T.R. Senthil Kumar held that the PCIT’s findings were based on an incorrect appreciation of facts and law. It was observed that the exchange rate difference loss was merely a restatement of creditors’ balances under AS-11 and had been consistently held allowable by the Supreme Court.

Comprehensive Guide of Law and Procedure for Filing of Income Tax Appeals, Click Here

As for the derivative loss, the Tribunal noted that it was an actual settled loss incurred through recognized exchanges and not a speculative or notional loss. The CBDT Instruction applied only to mark-to-market notional losses and not to such settled transactions. The Tribunal also found that the reliance placed by the PCIT on Explanation to Section 73 was misapplied and not applicable to the facts of the assessee’s case.

Accordingly, the appeal was allowed for both the years. Therefore, the order passed by PCIT under Section 263 was quashed.

Consequently, a similar order passed in the succeeding AY 2015-2016 also stands quashed.

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