The mandatory accounting standard (AS) 11, issued by the Institute of Chartered Accountants of India, provides that forward exchange or similar contracts entered into for trading or speculation should be marked-to-market (MTM) at each balance sheet date, and the resultant exchange differences should be recorded in the profit-and-loss account.
AS-30, which deals with recognition and measurement relating to financial instruments, is not mandatory at present, but ICAI encourages voluntary adoption to the extent that it is not in conflict with notified mandatory accounting standards. According to AS-30, all the derivatives not covered by AS-11 should be marked to market, and any resulting gains or losses should be recorded through the profit-and-loss account. Essentially, AS-30 is based on fair value accounting — a concept that is as complex as it is controversial, and has raised some uncertainties and pain points in the income-tax context as well.
The Supreme Court dealt with the issue of MTM forex losses in 2009, in the case of Woodward Governor India, and resolved it in favour of the taxpayer. Unrealised forex loss arising from the MTM treatment mandated by AS-11 was held as allowable expenditure for tax purposes. As a corollary, unrealised MTM forex gain, permitted to be recognised under AS-11, can be considered income susceptible to tax. Thus, AS-11 seems to create a level playing field for the taxpayer and taxman with reference to the tax consequences of the MTM principle.
Let’s take the case of taxpayers who adopt AS-30 voluntarily, and route the mark-to-market loss or gain on financial instruments such as derivatives through the profit-and-loss account. In principle, the above-mentioned Supreme Court decision may be helpful, although the tax officers seek to disallow the loss on the grounds that the case dealt only with the forex mark-to-market losses and not those on derivatives. They also rely on an instruction issued in 2010 by the Central Board of Direct Taxes, which required the assessing officers to disregard the MTM loss in the computation of taxable income. The instruction is silent on the course of action if the taxpayer has MTM gains. As such, the tax officer may not reduce such gains while computing taxable income.
On the other hand, ICAI has announced that entities that do not opt for AS-30 should recognise MTM losses in their books while ignoring MTM gains. This treatment is in accordance with the accounting concept of prudence. However, it does not go down well with tax officers who do not like to allow MTM losses in general, and more so if they get no chance to tax the MTM gains.
Draft Tax Accounting Standards (TAS), currently under the consideration of the CBDT, have sought to reduce the uncertainty arising from the above issues by prescribing that MTM loss or an expected loss (except those covered by other TAS) shall not be recognised. AS-1 on Disclosure of Accounting Policies precludes recognition of anticipated profit and requires recognition of expected losses. As this amounts to differential treatment for recognition of income and losses, the draft TAS provides that expected losses or MTM losses shall not be recognised unless permitted by any other TAS. It goes further to prescribe that MTM gains and losses recognised under AS-11 should also be disregarded as they are unrecognised in nature.
(Alok Saraf, a chartered accountant, contributed to this article.)
(The author is a Chartered Accountant)