Kerala High Court Upholds Relief To Kalyan Jewellers, Rules Unrealised Mark-To-Market Gains Not Taxable

The Kerala High Court on 11 March, held that unrealised gains arising from mark-to-market valuation of forward contracts are not taxable as income unless actually realised.

The Division Bench comprising Justice Devan Ramachandran and Justice Basant Balaji dismissed the appeal filed by the Principal Commissioner of Income Tax against Kalyan Jewellers India Ltd. The judges held:

“It is doubtless that, in a 'mark-to-market' forward commodities contract, the gains and losses fluctuate until the instrument matures on the period of expiry. In one year it is likely that there would be losses, which would perhaps transmute to be profits in the next year; and it continues in that cycle until the maturity happens.”

The case arose from assessment proceedings for the relevant assessment year, where Kalyan Jewellers had entered into forward contracts in commodity derivatives and, in its books of account, recorded gains on a mark-to-market basis.

The Assessing Officer treated these notional gains as taxable income and passed an assessment order making additions on this account. The order was subsequently subjected to revision and reassessment proceedings, culminating in confirmation of the additions by the Commissioner of Income Tax (Appeals).

Aggrieved, Kalyan Jewellers approached the Income Tax Appellate Tribunal (ITAT), contending that the gains reflected were purely notional and had not actually accrued, since the forward contracts had not matured.

The Tribunal accepted its plea and deleted the additions, holding that such hypothetical income cannot be brought to tax.

Challenging this relief granted by the Tribunal, the Revenue preferred an appeal before the High Court. It contended that once Kalyan Jewellers had recognised the gains in its books, the same should be treated as income liable to tax.

The High Court held that in mark-to-market forward contracts, gains and losses continue to fluctuate until the date of expiry, and actual profit or loss crystallises only upon settlement of the contract.

The Bench noted that the Supreme Court in Commissioner of Income Tax, Delhi v. Woodward Governor India (P.) Ltd. [(2009) SCC OnLine SC 710] had clearly held that no prudent trader would recognise anticipated profits before actual realisation, and that the principle of valuing closing stock at cost or market price, whichever is lower, is rooted in the doctrine of real income.

It further noted that mere book entries reflecting notional gains do not create a taxable event. It emphasised that the concept of “real income” governs taxation, and unless income has actually accrued in a real sense, it cannot be brought to tax.

The judges rejected the Revenue's argument that disclosure in books is determinative, holding that accounting treatment cannot override substantive principles of tax law.

They said that even the counsel representing the appellant, “also agrees that the actual accrual of profit or loss - as the case may be, under the derivative, happens only at the close of the expiry of the instrument; but his argument is that, when the assessee shows it as a profit in their account for the relevant year, it becomes exigible to tax.”

Accordingly, the High Court dismissed the appeal and upheld the deletion of additions in favour of Kalyan Jewellers.

For Appellant: Jose Joseph and Navaneeth N. Nath

For Respondent: R. Jaikrishna, Kum. Narayani Harikrishnan, Akhil Shaji, C.S. Arun Shankar, Anish P., K. Suresh Chandran