“Marked to market” (MTM) is an accounting and trading practice that updates an asset’s value to its current market price, rather than its original purchase (historical) price. This provides a realistic, real-time valuation of investments like stocks, mutual funds, and futures contracts, allowing for accurate tracking of unrealized profits and losses and better risk management. For futures traders, MTM requires daily settlement of gains and losses, often resulting in margin calls if losses exceed required levels.
Further, ‘Marked-to-Market’ is a
methodology of revaluing a financial instrument based on its market price on
the closing day of the accounting period. A financial instrument is valued at a
market rate to report its actual value on the date of reporting.
As per ICDS-VIII (Securities), listed
securities held as stock-in-trade shall be valued at the lower of the actual
cost initially recognised or the net realisable value at the end of the
previous year. If any loss arises due to such restatement, it shall be allowed
as a deduction under Section 36(1)(xviii) of the Income Tax Act. However, if
any gain arises due to such valuation, it shall be taxable as business income
under Section 28.
The option to restate the value at the year-end shall not be available in respect of securities that are not listed or are listed but not quoted on a recognised stock exchange. Such securities shall be recognised in the books at the actual cost at which it has been recognised initially. If any notional gain or loss is recognised by the assessee in the books, it shall be disallowed under Section 40A(13).
Section 36(1)(xviii) of the Income Tax Act, 1961 and ICDS
The Finance
Act, 2018, inserted clause (xviii) into Section 36, which stipulates that MTM
losses and other expected losses are only deductible if they are computed in
accordance with the notified ICDS.
ICDS are a
set of accounting standards that must be followed to compute taxable income
under the head "Profits and gains of business or profession."
What is the CBDT instruction No 3 of 2010, dated 23.03.2010 ?
The said
Instruction explained ‘Marked to Market’ as a concept where financial
instruments are valued at market rate to report their actual value on the date
of reporting. Such ‘Marked to Market’ losses represent notional losses and are
required to be added back to compute taxable income.
CBDT Instruction No. 3/2010, dated 23.03.2010,
provides guidelines to Assessing Officers on the tax implications of losses
arising from foreign exchange (forex) derivatives. A direct download link for
the PDF is not available from official sources, but the full text can be found
on several legal and tax websites.
SUMMARY OF
THE INSTRUCTION
Marked-to-market (MTM) losses: The instruction clarifies that MTM losses on forex
derivatives are considered notional losses since no actual settlement or sale
of the contract has occurred. Such losses are not permissible deductions and
must be added back to the assessee's taxable income.
Treatment of actual losses: For losses that arise from the actual settlement or
conclusion of a forex-derivative contract, the Assessing Officer must determine
if it is a speculative transaction. A speculative loss can only be set off
against a speculative gain.
Scrutiny of financial statements: Assessing Officers are advised to closely examine
financial statements and notes to accounts for any reference to forex
derivative losses. These losses may be concealed under heads like
"financial charges" or "foreign exchange loss".
Distinction from hedging: The instruction primarily addresses derivative
contracts and does not apply to regular hedging transactions used to safeguard
against currency fluctuations. Indian tribunals have since confirmed that MTM
losses on legitimate hedging contracts are allowable as business losses.
Marked-to-market loss on valuation of Carbon Emission Reduction (CER), not contingent loss; Rejects Revenue's capital loss plea
Kolkata ITAT
allows Assessee’s appeal, directs Revenue to allow loss arising out of the
writing off the Carbon Emission Reduction (CER) to Assessee; For Assessment
year 2013-14, Assessee debited Rs. 3.04 Cr in the P&L account being
Certified Emission Reduction (CER), which was disallowed by Revenue
observing that: (i) the expense was not incurred and it was a contingent loss,
(ii) the expense was a mere provision as CER units were not Assessee’s
stock-in-trade to value at lower of cost or market value, which was upheld by
the CIT(A); ITAT concurs with Assessee’s contention that marked-to-market loss
is not a contingent loss and that the Assessee is entitled to set off the same
against the business profits; Relies upon co-ordinate bench ruling in DCIT
v. McLeod Russel India Ltd.
(ITA No. 114-115/Kol/2016 dated 03.05.2019) (ITAT Kolkata),
wherein relying on Supreme Court ruling in CIT v. Woodward Governor of India Ltd. (2009) 312 ITR 254 (SC), it
was held that loss arising on account of valuation of asset arising from
exchange rate variation is real loss and it is not a contingent loss, also
relies on Bombay High Court ruling in CIT
v. D Chetan & Co., wherein it was held that forward contract in foreign
exchange when incidental to carrying on business of cotton exporter and done to
cover up losses on account of differences in foreign exchange valuations, would
not be speculative activity but a business activity; ITAT opines that, “the
action of the lower authorities in treating the Mark-to-Market loss on account
of foreign exchange rate fluctuation as contingent in nature cannot be held to
be justified”; Notes that the Assessee had already offered gains for
taxation in the year 2012-13, hence, following the same method of valuation,
the assessee is entitled to claim the loss on account of decrease in the price
of the CER as per exchange rate; States that when Revenue in the earlier year,
had taxed the Assessee on account of gain in valuation of CER on account of
exchange rate fluctuation, under the same circumstance, the loss arrived in
subsequent year due to exchange rate fluctuation cannot be denied; Rejects
Revenue’s contention that the said loss is of capital nature, observes that
Revenue itself rejected Assessee’s claim, in earlier year, to treat the profits
as capital receipts, remarks that “The Revenue cannot change its stand
now especially when it is already taxed the assessee on the said receipts
in the year 2012-13.” [In
favour of assessee] - [Orient
Cement Ltd. v. DCIT [TS-257-ITAT-2022(Kol)] - Date of Judgement
: 16.03.2022
(ITAT Kolkata)]
Unrealized loss on foreign exchange transactions was a
contingent liability because it was not ascertainable as to at what exchange rate transactions of foreign exchange
would be realized, thus, such loss was in nature of mark to market basis which could be allowed only at time of actual
realization of such loss
Foreign
exchange loss - The assessee claimed loss on foreign exchange transactions. In
the assessment order, the Assessing Officer had treated the loss as mark to
market loss on forward contracts. Before the Commissioner (Appeals), the
assessee vehemently contended that the Assessing Officer had wrongly considered
the loss in question as loss on forward contract of foreign exchange whereas
the loss under consideration was on the trading transactions of imports. It was
also contended by the assessee that a major portion of loss was realized loss,
whereas the Assessing Officer had treated the entire loss as unrealized, i.e.,
on mark to market basis. The Assessing Officer was directed to re-verify the
contention of the assessee regarding the exact nature of the loss in question.
The
Assessing Officer Vide remand report had partly accepted the contention of the
assessee that the loss in question was not in respect of forward contracts and
it was in respect of current assets/outstanding amounts. The Assessing Officer
had however, stated that out of the total loss of total amount only a sum of
particular amount which was realized loss was allowable whereas the remaining
amount was notional loss because it was a contingent liability as the same was
not crystallized during the year under consideration.
The
commissioner (Appeals) held that foreign exchange loss on trading transactions
had to be allowed as business loss. Therefore, the Assessing Officer was
directed to allow the loss on realized transactions of foreign exchange as
business loss. As regards the quantification of the realized loss, the
Assessing Officer was once again directed to recalculate the total amounts of
realized loss by verifying the contention of the assessee. As regards the claim
of unrealized loss, it was a contingent liability because it was not ascertainable
as to at what exchange rate the transactions of foreign exchange would be
realized, thus, such loss was in the nature of mark to market basis which
deserved to be disallowed and could only be allowed at the time of actual
realization of such loss. On appeal, the Tribunal also upheld the findings of
the Commissioner (Appeals). On miscellaneous application :
Held : In
the facts of the present case, the Commissioner (Appeals) after considering the
rival submissions had held that in the light of the decision of Supreme Court
in the case of CIT v. Woodward Governer
India (P) Ltd. (2009) 312 ITR 354 : 179 Taxman 326 (SC), the foreign
exchange loss on trading transactions have to be allowed as business loss.
Therefore, the Commissioner (Appeals) directed the Assessing Officer to allow
the loss on realized transaction of foreign exchange as business loss and with
regard to quantification of the realized loss, the Assessing Officer was
further directed to recalculate the total amount of realized loss. As regards
the claim of unrealized loss, the Commissioner (Appeals) agreed with the
contention of the Assessing Officer that it is contingent liability because it
is not ascertainable as to at what exchange rate the transactions of foreign
exchange will be realized, therefore considering the nature of such loss of
mark to market basis same was to be disallowed and same can only be allowed at
the time of actual realization of such loss. The bench after considering the
order of revenue authorities had dismissed the appeal of the assessee and
uphold the order of the Commissioner (Appeals), therefore, there was no mistake
in interpreting the judgment of Supreme Court. In view of the above discussion
as no glaring, obvious or patent mistake has been pointed out by the assessee
which was apparent from the record, therefore the miscellaneous application
filed by the assessee deserves to be dismissed. [In favour of revenue] (Related
Assessment year : 2009-10) – [Vaibhavi
Trading (P.) Ltd. v. DCIT (2018) 89 taxmann.com 132 (ITAT Mumbai)]
Disapproves CBDT Instruction terming
MTM loss as notional, cites Delhi High Court ICDS ruling
Nand
Nandan Agrawal, a trader in non-ferrous metal scrap, undertook trading in
currency derivatives and suffered loss during Assessment years 2013-14 and 2014-15.
He was advised that transaction in 'currency derivatives' was liable to be held
as ‘speculative’ within meaning of Section 43(5). Therefore, in the return of
income, he did not claim set-off of the same with other income under the
business head, or under any other head of income. During the assessment
proceedings, the assessee made the claim before the Assessing Officer that the
loss suffered by him on transaction of currency derivatives was entitled not to
be treated as a ‘speculative loss’ and that it was entitled to be adjusted
against income from regular business. The Assessing Officer denied the assessee’s
claim. The CIT(A) held that no loss had occurred to the assessee as the
transactions in currency derivatives were ‘marked to market’ and the loss
sustained was a ‘notional loss’. Aggrieved, the assessee appealed before ITAT.
ITAT
holds that losses arising to assessee-individual on account of trading
in currency derivatives, neither speculative nor notional, allows
set-off against other business income for Assessment years 2013-14 and
2014-15; Firstly, observes that derivative transactions entered by assessee
meet all the conditions laid down under clause (d) of Section 43(5) and thus,
qualify as transactions not deemed to be 'speculative transactions'; Holds that
CIT(A) erred in treating the entire loss as notional loss without looking at
the position held by assessee at the close of the financial year, notes
that only one series out of the 7 series of contracts remained
unexpired as on the end of Financial year 2012-13 while all stood settled
at the end of Financial year 2013-14; Further holds that CBDT instruction
No 3/2010 which terms marked to market loss as notional, is not in accordance
with law, observes that though the reasoning of the Board to term the loss on
account of ‘mark to market’ transactions, as contained in Instruction no.
3/2010, was disapproved by the Courts, it resurfaced in the ICDS”; Cites
Delhi High Court ruling in Chamber
of Tax Consultants striking down ICDS I (to the extent it does not
recognize expected losses and marked-to-market losses), High Court had
also held that non-acceptance of the concept of prudence in ICDS I is per
se contrary to the provisions of the Act and therefore, cannot be countenanced.
[In favour of assesse] (Related Assessment years : 2013-14 & 2014-15) - [Nand Nandan Agrawal v. DCIT, Mathura [TS-34-ITAT-2018(AGR)] – Date of Judgement : 18.01.2018 (ITAT Agra)]
All forward
contracts entered into by assessee were settled by way of actual delivery
through dollars received on export receivables, loss claimed by assessee on
account of mark to market losses on account of fluctuation in foreign currency in
respect of hedging forward contract was not allowable
Where assessee, to avoid any unforeseen losses on
account of downfall in foreign exchange rate, entered into forward contracts
and sealed amount of foreign exchange rate, which would be receivable to it,
assessee immuned itself from any fluctuation in foreign exchange rate. In such
circumstances, when it was certain that no additional liability would arise to
assessee on maturity of contract, possibility of such liability on balance
sheet date also could not arise. Thus, where all forward contracts were settled
by way of actual delivery through dollars received on export receivables and
there was no extra outgo for settlement of forward contract other than already
determined in contract, loss claimed by assessee on account of mark to market
losses on account of fluctuation in foreign currency in respect of hedging
forward contract was not allowable. [In favour of revenue] (Related Assessment
year : 2009-10) - [Bechtel India (P) Ltd. v. ACIT (2017) 165 ITD 282 : 82 taxmann.com 301 (ITAT Delhi)]
