India Disallows Forex Losses

by Mary Swire, Tax-News.com, Hong Kong

08 April 2010

The Indian Central Board of Direct Taxes (CBDT) has issued guidelines which suggests that losses against taxable income on account of forex derivatives should be disallowed.

The guidelines state that a “Marked to Market” loss is a notional loss as no sale/conclusion/settlement of contract has taken place and the asset continues to be owned by the company. It may be accounted for as a balance sheet item without any corresponding adjustment in the Profit and Loss Account, or as a loss in the Profit and Loss Account which may result in the reduction of book profit.

In cases where no sale or settlement has actually taken place and the loss on a Marked to Market basis has resulted in reduction of book profits, such a notional loss "would be contingent in nature and cannot be allowed to be set off against the taxable income." It should, therefore, be added back for the purpose of computing taxable income according to the CBDT.

In cases where a loss on a forex-derivative transaction arises on actual settlement/conclusion of contract and is not a notional or Marked to Market book entry, the CBDT suggests that such a loss could be a speculative transaction as contemplated in Section 43(5) of the Income tax Act.

The CBDT maintains that Assessing Officers need to examine the statements of accounts and the notes to accounts with a view to discovering any losses on account of forex derivatives, and examine whether such transactions are ‘eligible transactions’ in terms of Sec.43(5)(d) and as such, also not offsettable.

The foreign exchange market saw wild fluctuations in 2008-09 which resulted in substantial losses to many companies from forex derivatives; serious tax liabilities could accumulate even retrospectively, since CBDT circulars are binding on Assessing Officers.

However these circulars are only influential in law and not intended to act as actual determinations of Income Tax Act terms. Experts suggest, however, that the circular contradicts fundamental accounting and legal principles, making it likely that it could be contested successfully in the courts.

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