R.V. Easwar, President. - This is an appeal by the assessee for the assessment year 2004-05. The assessee has filed summarized grounds of appeal at the time of the hearing, which have been taken into account. The assessee is a company dealing in securities and acting as investment bankers. The appeal arises out of the assessment framed under section 143(3) of the Income-tax Act, 1961, on 15-12-2006.

2. The first ground of appeal is directed against the disallowance of expenses on the ground that they were incurred to earn exempted income. The Assessing Officer has disallowed 10 per cent of the exempted income by invoking section 14A of the Act. In page 2 of the assessment order he has accepted that the interest expenditure is not being disallowed by invoking the above section because the loan funds have not been utilized for making investments which yielded exempt income. The contention of the learned representative for the assessee before us is based on the recent judgment of the Hon’ble Bombay High Court in the case of Godrej & Boyce Mfg. Co. Ltd. v. Dy. CIT [2010] 328 ITR 81¹ . A copy of the judgment dated 12-8-2010 has been filed. The Hon’ble High Court has held that Rule 8D of the Income-tax Rules which has been notified on 24-3-2008 would apply from the assessment year 2008-09 only. Since we are concerned with the assessment year 2004-05, the said Rule cannot be invoked. As regards the disallowance under section 14A, the Hon’ble High Court has laid down guidelines as to how the section has to be understood and applied. Respectfully following those guidelines we set aside the orders of the departmental authorities on this issue and restore the same to the file of the Assessing Officer with directions to him to decide the applicability of section 14A afresh in the light of the guidelines laid down in the aforesaid judgment. The assessee shall be given adequate opportunity of putting forth its case.

3. The second ground is directed against the disallowance of renovation expenses of Rs. 9,90,394 on the ground that they are capital in nature. The assessee took 5,712 sq. ft. of space on lease for a period of five years on leave and license basis from Shalaka Sangh Co-operative Housing Society Limited. A copy of the leave and license agreement is at pages 38 to 44 of the Paper Book. The lease was for a period of five years initially, to be renewed after that period at the option of the licensee. Under clause 4(c) of the agreement, it was the responsibility of the assessee to keep the interior of the said premises in good condition during the period of the license and be responsible for the ordinary routine maintenance of the fittings and fixtures in the premises. Clause 4(f ) provided that the assessee should deliver vacant and peaceful possession of the premises in good condition to the licensor on the expiry of the lease. The assessee incurred the expenditure during the relevant accounting year, which was disallowed by the Assessing Officer as capital in nature and his view was upheld by the CIT(A). The contention of the assessee before us is that the expenditure was incurred wholly and exclusively for the purpose of assessee’s business and no enduring benefit had accrued to the assessee nor was any capital asset created. It was further contended that the expenditure was incurred in the month of March 2004 as per the terms of the license agreement because the license period was coming to an end in June 2005 and that in these circumstances it cannot be said that the assessee derived any enduring advantage by incurring the expenditure. The learned Departmental Representative strongly supported the orders of the income-tax authorities.

4. We have carefully considered the rival contentions. The expenditure disallowed consists of the following :—

We further find that though the assessee could retain the premises for a period of five years from 2-6-2000, which is the date of the leave and license agreement, it handed over the premises to the licensor on 31-7-2004, after a period of four years because it had entered into an agreement with another person for taking new premises on lease in April 2004. Before shifting to the new premises the assessee under clause 4(f) of the leave and license agreement, had to ensure that the premises were delivered back to the licensor in good condition. The expenditure was incurred in March 2004, a few months before the premises were handed over. In proof of the claim that the premises were handed over even before the license period got over, the learned representative for the assessee, at our instance filed a letter dated 14-7-2004 written by Shalaka Sangh Co-operative Housing Society Limited. It is seen from this letter that the assessee handed over possession of the premises on 14-7-2004, which is acknowledged by the Housing Society. The expenditure has thus been incurred in terms of the leave and license agreement. Further, they are routine maintenance and repair expenses which the assessee would have had to incur in the normal carrying on of its business. The nature of the work shows that no additional space or capital advantage was derived by incurring the expenditure. We, therefore, hold that the expenditure is allowable as revenue expenditure. We direct accordingly and allow the second ground.

5. The third and last ground is against the disallowance of the provision for loss of Rs. 9,36,256 made by the assessee on "Mark to Market" basis in respect of trading in derivatives. The brief facts in this connection are that the aforesaid provision was made in the Profit and Loss Account being anticipated loss on Equity Index/Stock Futures Account. The breakup is Rs. 8,86,912 and Rs. 49,344 respectively. When asked to furnish the details and the basis of the claim, the assessee filed a Note stating that the provision was made in accordance with the suggestions of the Institute of Chartered Accountants of India to the effect that a provision should be made at the end of the year by a debit to the Profit and Loss Account for anticipated loss equivalent to the debit balance in the Mark to Market Margin Index/Stock Futures Account. According to the assessee, the loss should be anticipated and provided for, though anticipated profit cannot be taken credit. The assessee further pointed out that there is no difference between valuation of stock and the valuation of the derivates and that in both provision should be made for anticipated losses though anticipated profits cannot be taken note of.

6. The Assessing Officer did not accept the assessee’s submissions. He noted that the provision has been created in respect of contracts pending on 31-3-2004, which will be squared off in the next financial year and there was always the possibility that there may not be any loss when they are squared off. He viewed it as a contingent liability which may or may not arise in future. According to him there is no room for allowing a contingent liability under the mercantile system of accounting under which only a liability in present time can be allowed. He referred to certain authorities in support of his view. As regards the guidelines issued by the Institute of Chartered Accountants of India, which were claimed to have been followed by the assessee, the Assessing Officer observed that the accounting entries cannot control or decide the allowability of the claim. In this view of the matter, he disallowed the provision. The disallowance having been upheld by the CIT(A) for substantially the same reasons, the assessee is in further appeal before the Tribunal.

7. We have considered the facts and the rival contentions. In the Schedule annexed to and forming part of the Balance Sheet and Profit & Loss Account for the year under appeal (page 13 of the Paper Book), the assessee has made the following Note :—

"H. Equity Futures - Index/Stock

u "Initial Margin - Equity Derivative Instruments", representing initial margin paid, and "Margin Deposits", representing additional margin over and above initial margin, for entering into contracts for Equity Index/Stock Futures, which are released on final settlement/squaring-up of underlying contracts, are disclosed under Loans and Advances.

u Equity Index/Stock Futures are marked-to-market on a daily basis. Debit or credit balance disclosed under Loans and Advances or Current Liabilities, respectively, in the "Mark-to-Market Margin - Equity Index/Stock Futures Account", represents the net amount paid or received on the basis of movement in the prices of Index/Stock Futures till the Balance Sheet date. Amount paid to brokers in addition to Mark-to-Market Margins is disclosed as "Margin Deposits" under Loans and Advances.

u As on the Balance Sheet date, profit/loss on open positions in Index/Stock Futures are accounted for as follows :

l Credit balance in the "Mark-to-Market Margin - Equity Index/Stock Futures Account", being anticipated profit, is ignored and no credit for the same is taken in the Profit and Loss Account.

l Debit balance in the "Mark-to-Market Margin - Equity Index/Stock Futures Account", being anticipated loss, is adjusted in the Profit and Loss Account.

u On final settlement or squaring-up of contracts for Equity Index/Stock Futures, the profit or loss is calculated as the difference between settlement/squaring-up price and contract price. Accordingly, debit or credit balance pertaining to the settled/squared-up contract in "Mark-to-Market Margin - Equity Index/Stock Futures Account" is recognized in the Profit and Loss Account."

The aforesaid Note gives a fair picture of the nature of the provision. The provision in substance has been made to cover the anticipated loss in the derivates trading. There is no dispute that the assessee holds derivatives as its stock-in-trade and there is also no dispute that it follows the principle "cost or market price, whichever is lower" in valuing the derivatives. When the derivatives are held as stock-in-trade then whatever rules apply to the valuation of stock-in-trade will have to be necessarily apply to their valuation also. It is a well settled position in law that "while anticipated loss is taken into account in valuing the closing stock, anticipated profit in the shape of appreciated value of the closing stock is not brought into the account, as no prudent trader would care to show increased profit before its realization. This is the theory underlying the rule that the closing stock is to be valued at cost or market price whichever is the lower, and it is now generally accepted as an established rule of commercial practice and accountancy". This is what the Supreme Court held in the case of Chainrup Sampatram v. Commissioner Of Income Tax, West Bengal [1953] 24 ITR 481, speaking through Hon’ble Justice Patanjali Sastri, the then Chief Justice of India (pages 485 - 486 of the Report). At page 486 the Supreme Court further observed that "loss due to a fall in price below cost is allowed even if such loss has not been actually realized". Quoting from the case of Whimster & Co. v. Commissioners of Inland Revenue [1926] 12 TC 813, the Supreme Court observed that the profits that are chargeable to tax are those realized in the year and that an exception is recognized where a trader purchased and still holds goods which are fallen in value in which case though no loss has been realized nor it has occurred, nevertheless at the close of the year he is permitted to treat these goods as of their market value. This decision of the Supreme Court governs the facts of the present case. It is to the assessee’s strength that the Institute of Chartered Accountants of India in its guidelines have also approved of the rule of prudence which really means that while anticipated losses can be taken note of while valuing the closing stock, anticipated profits cannot be recognized. The anticipated loss, in the light of the judgment of the Supreme Court cited above, cannot be treated as a contingent liability.

8. The learned DR pointed out that the assessee has valued each scrip of the derivatives as at the end of the year. We do not see how this can make any difference to the legal principle. If the derivatives have been treated as stock-in-trade then there is nothing unusual in the assessee valuing each derivative by applying the rule cost or market whichever is lower.

9. We, therefore, direct the Assessing Officer to allow the provision as reflecting in substance the loss arising on account of valuation of the closing stock. The ground is allowed.

10. In the result, the appeal of the assessee is partly allowed.