Delhi High Court Allows Income Tax Deduction On Loss On Forward Cover Purchase Contracts For Foreign Exchange

The Delhi High Court has held that reinstatement of year-end losses on forward cover purchase contracts is allowable in spite of the fact that the forward contracts have not been closed.

The division bench of Justice Vibhu Bakharu and Justice Purushaindra Kumar Kaurav, while upholding the findings of the tribunal, held that the loss on account of forward contracts cannot be considered speculative.

The issue raised was whether the loss on forward cover purchase contracts for foreign exchange is allowable as a deduction from the income chargeable to tax for the relevant assessment year, notwithstanding that the forward contracts have not closed.

The respondent/assessee is in the business of providing engineering consultancy and related services like engineering design, construction, and commissioning of plants and installations.

The assessee had filed its income tax return for the previous year, declaring taxable income. The return was initially processed under Section 143(1), but was subsequently picked up for scrutiny. The assessee claimed a sum as a loss against a forward contract entered into to hedge the risk against foreign exchange fluctuations to cover exports and imports.

The assessee had entered into a contract with Saudi Basic Industries Corporation, Kingdom of Saudi Arabia, based on the letter of intent. The total contract value was 114 million USD, and the contract was required to be completed within a period of twenty-seven months. The forward contracts were entered into to protect against foreign exchange fluctuations.

The Assessing Officer held that the loss on forward contracts was a speculative loss and was liable to be disallowed in terms of Central Board of Direct Taxes (CBDT) Instruction No. 3/2010.

In terms of CBDT Instruction No.3/2010, the AOs were instructed to examine the "marked to market" losses. The Instruction explained "marked to market" as a concept where financial instruments are valued at the market rate to report their actual value on the date of reporting. The "marked-to-market" losses represent notional losses and were required to be added back for the purposes of computing taxable income. CBTD also directed the AOs to investigate whether such transactions were speculative, as losses on forex-derivative transactions occur on actual transactions.

The assessee appealed the assessment order in respect of disallowance on account of losses claimed on forward contracts.

The CIT(A) found that the AO had erred in disallowing the loss on account of forward cover against foreign exchange fluctuations on the basis that it was a speculative loss.

The Tribunal concurred with the decision of the CIT(A) that the loss on forward contracts could not be treated as a loss that was disallowable in terms of CBDT Instruction No.3 dated March 23, 2010. The Tribunal held that the circular was not applicable as the transaction could not be considered a speculative one.

The department submitted that the loss on forward contracts was booked on a "marked-to-market" basis and therefore was merely a notional loss in the relevant assessment year. And it was not permissible for the assessee to book such a notional loss.

The assessee stated that it was reinstating its debtors and creditors in connection with the execution of contracts entered into with foreign entities on the basis of the value of the foreign exchange. Thus, clearly, the loss on account of forward contracts would also require recognition.

The court held that the forward contracts were hedging transactions. The assessee has reinstated its debits and credits from the underlying transactions on the value of the foreign exchange on the due date. The corresponding losses and gains under the forward contracts were thus also required to be accounted for to arrive at the real profits. It would be anomalous if, on the one hand, debtors and creditors, with respect to current assets, were stated at the current value of foreign exchange and the corresponding loss on the hedging transaction was not accounted for. In essence, the assessee has stated his income by taking into account the foreign exchange value as it stood on the due date. It is well established that CBDT Instructions and Circulars that are contrary to the law are not enforceable.

Case Title: PCIT Versus Simon India Ltd.

Citation: 2022 LiveLaw (Del) 1152

Date: 02.12.2022

Counsel For Petitioner: Sr. Standing Counsel Zoheb Hossain, Vipul Agarwal, Parth Semwal

Counsel For Respondent: Advocate Piyush Kaushik

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