Loss on account of valuation of interest rate swap as on the balance sheet date is deductible.

Loss on account of valuation of interest rate swap as on the balance sheet date is deductible.

Interest rate swap is a financial contract between two parties exchanging a stream of interest payments for a notional principal amount, on multiple occasions, during the contract period. These contracts generally involve exchange of fixed rate of interest, with floating rate of interest, and vice versa. On each payment date, the interest is notionally paid on the agreed fixed or floating rate by one party to the other, by settling for the difference payments. The assessee had three ongoing interest rate swap contracts, for a notional principal amount of Rs.185 crore, under which the assessee was to pay a fixed rate of interest and receive the floating rate of interest. The assessee claimed a deduction of Rs.10,10,92,000 on account of unrealised loss on the basis of valuation of interest rate swap. This valuation, was arrived at by working out future extrapolation of the yield curve, considering past history of available rates and current market rate. This provision was made in accordance with the guidelines issued by the RBI, and the method of valuation consistently followed all along. The AO disallowed this loss considering it as unascertained liability and it was confirmed by the CIT(A).

Held:

It is important to bear in mind the fact that whatever is claimed as a loss at this stage, is eventually reduced from the overall loss or added to overall profit taken into account, for tax purposes, in the subsequent year in which the settlement date falls. It is not really, therefore, the question as to whether the deduction is to be allowed or not, but only the assessment year in which deduction is to be allowed. Viewed in the long-term perspective, thus, it is wholly tax neutral, but for the timing of deduction. One of the mandatory Accounting Standards, notified vide Notification No. 9949, dated 25th Jan., 1996, provides that “provisions should be made for all known liabilities and losses even though the amount cannot be determined with certainty and represents only a best estimate in the light of available information”. There is no enabling provision which permits the AO to tinker with the profits computed in accordance with the method of accounting so employed u/s.145 and as long as the mandatory accounting standards are duly followed. It is not even the AO’s case that the mandatory accounting standards have not been followed.

Loss having been incurred is a reality, its recoupment or aggravation is contingent. It is contingent upon future happenings i.e., whether or not loss the assessee will be able to recoup the losses till settlement date, and such recoupment or aggravation of loss will fall in period beyond the end of the relevant previous year. Viewed thus, and bearing in mind the fact that the real issue in this appeal is not the deductibility but only the timing of the deduction, the loss computed vis-à-vis the variation as on the end of the relevant previous year, the loss is deductible in the relevant previous year.