Loss marked to market Notional loss is not an allowed expense

Fact and issue of the case

The brief facts are that the assessee company is a limited company engaged in the business of manufacturing and trading in POY, PTY, Bulk drugs, etc. The assessee filed its return of income on 27.11.2015, declaring total income of Rs.14,61,44,220/- under the normal provisions and book profit of Rs.207,43,63,243/- u/s. 115JB of the Act. The assessee revised its return of income dated 16.05.2016, declaring total income of Rs.14,61,44,220/- under the normal provisions and book profit at Rs.207,42,63,243/- u/s. 115JB of the Act. The assessee’s case was selected for scrutiny and the A.O. made a reference u/s. 92CA(1) of the Act to the Transfer Pricing Officer (TPO for short) for computation of arms length price in relation to the international transactions of the assessee and also made an addition on the foreign exchange losses on ECB loan, amounting to Rs.2,28,63,345/-. The A.O. also made an addition of Rs.29,28,34,962/- on account of ‘loss on derivative contracts’. The assessee raised an objection before the ld. DRP, challenging the various additions made by the A.O. and after disposing of the objections, the A.O. passed the final assessment order as per the proposal of the ld. DRP. The assessee has challenged the impugned addition before us.

Ground no. 1 raised by the assessee is general in nature and ground no. 2 pertains to the disallowance of foreign exchange losses, upward adjustment of Rs.2,28,63,345/- on account of foreign exchange losses on ECB loan. It is observed that the assessee has availed ECB loan from Canara Bank for an amount of USD 40 million (INR Rs.234,54,29,000/-) during FY 2014-15 at an average exchange rate of Rs.58.8 per USD, for the purpose of refinancing the existing rupee borrowings from ICICI Bank, Axis Bank Ltd. and Aditya Birla Group. The assessee has stated that the said loan was not availed for making the payment for imported machineries or for purchase of fixed assets but was only to reduce the cost of borrowings and contended that it was in the nature of ‘revenue expenditure’. The assessee has stated that it had repaid USD 2 million at an average exchange rate of Rs.62.07 per USD and the balance USD 38 million was valued at an exchange rate as on 31.03.2015, thereby arriving at a loss of Rs.14,75,72,500/-. The assessee stated that the same has been amortized to the period of ECB loan and an amount of Rs.2,28,63,345/- has been claimed as an expenditure during the impugned year. The said loss was debited in the P & L account of the assessee.

The A.O. held that the same is to be capitalized to the cost of the asset and that the same was not allowable expenditure u/s. 37 of the Act. The A.O. relied on the decision of the Hon’ble Supreme Court in the case of Sutlej Cotton Mills Ltd. vs. CIT [1979] 116 ITR 1 (SC) when the foreign currency is used for the business or for trading purpose for transaction on revenue account, the loss on account of depreciation of its value due to the exchange rate will amount to ‘trading loss’, but if the said amount is held as ‘capital asset’ then the loss would be a ‘capital loss’. The A.O. treated the same to be a ‘capital loss’. The A.O. further held that the loss incurred on repayment of capital expenditure loans to be capital loss and the ‘marked to market loss’ claimed on the same is of notional in nature and held the same to be a ‘speculation loss’. The A.O. disallowed the loss claimed in the impugned year, amounting to Rs.14,75,72,500/-, which has been amortized to the entire period of loan, thereby disallowing Rs.2.28 crores for the impugned year.

Observation of the court

From the above observation and by respectfully following the said decision, we hold that the ‘marked to market loss’ is not a notional loss and is, therefore, allowable expenditure. We also hold that the said transaction is not a speculative transaction as per section 43(5) of the act and is merely a hedging transaction and thereby the same would fall under the exception to section 43(5) of the Act. We hereby direct the A.O. to allow the said loss while computing the income of the assessee.

In the result, the appeal filed by the assessee is allowed.