NBFC Entitled to Section 37(1) Deduction for Mark-to-Market Losses on NIFTY-Linked Debentures Under Mercantile System
1. The Core Dispute: Realized Loss vs. Contingent Liability
The assessee, an NBFC, issued specialized debt instruments known as Benchmark Linked Debentures (BLDs). These were principal-protected, meaning the original investment was safe, but the “coupon” (interest) was contingent upon the NIFTY index reaching a specific trigger (120% of the start level) at maturity.
Assessee’s Stand: Following the mercantile system of accounting and ICAI standards, the company valued these liabilities at the end of each year using a Mark-to-Market (MTM) basis. They recognized an unrealized loss of ₹1.85 crores as the market moved toward the trigger, treating it as an accrued liability.
Revenue’s Stand: The Assessing Officer (AO) disallowed the claim, labeling it a contingent liability. The AO argued that because the final payment depended on the NIFTY’s position on a future date, the loss was merely “notional” and had not actually been incurred.
2. Legal Analysis: Accrual of Liability in Structured Debt
The court examined the nature of structured debentures and the requirements of Section 37(1) regarding “expenditure incurred.”
I. Reality of the Contractual Obligation
The court noted that the assessee had already entered into legally binding contracts the moment the BLDs were issued. The fair-valuation movement was a reflection of the increasing probability of payment based on objective market data (NIFTY levels).
The Ruling: While the quantum of the final payment was uncertain, the obligation to pay (subject to market conditions) was real and subsisting on the balance sheet date.
II. Mercantile System and ICAI Compliance
Under Section 145, if a taxpayer follows the mercantile system, they must recognize liabilities as they accrue.
Prudence Principle: The assessee recognized losses when fair value increased but did not book gains (where value fell below face value) due to the principal protection clause. The court found this consistent with the accounting principle of conservatism/prudence.
3. Final Verdict: Deduction Allowed
The High Court held that fair-valuation losses on financial instruments, when calculated using scientifically accepted models, are not “contingent.”
Verdict: The mark-to-market loss on BLDs is a recognized business expense under Section 37(1).
Outcome: The disallowance of ₹1.85 crores was deleted, and the assessee was granted the deduction.
Key Takeaways for NBFCs and Corporates
MTM Losses are Deductible: If you use fair-value accounting (Ind AS or ICAI-compliant) for your financial liabilities, MTM losses are generally allowable as long as the underlying contract is binding.
Avoid “Contingent” Labeling: To defend such claims, ensure your valuation is based on an objective index (like NIFTY, Gold, or G-Sec yields) rather than subjective estimates.
Consistency is Key: The Revenue often challenges these if you only book losses and never gains. However, in “Principal Protected” instruments, the lack of gains is a structural feature, which this case successfully used as a defense.
IN THE ITAT MUMBAI BENCH ‘B’
Nomura Capital (India) (P.) Ltd.
v.
Deputy Commissioner of Income-tax*
Amit Shukla, Judicial Member
and Girish Agrawal, Accountant Member
and Girish Agrawal, Accountant Member
IT Appeal No. 2851 (MUM) of 2025
[Assessment year 2012-13]
[Assessment year 2012-13]
FEBRUARY 5, 2026
Madhur Agarwal, Adv. for the Appellant. Leyaqat Ali Aafaqui, Sr. DR for the Respondent.
ORDER
Girish Agrawal, Accountant Member.- This appeal filed by the assessee is against the order of National Faceless Appeal Centre (NFAC), Delhi, vide order no. ITBA/NFAC/S/250/2024-25/1073857593(1), dated 28.02.2025, passed against the assessment order by Assistant Commissioner of Income-tax, Circle – 7(2)(2), Mumbai, u/s. 143(3) of the Income-tax Act (hereinafter referred to as the “Act”), dated 29.02.2016 for Assessment Year 2012-13.
2. Grounds taken by assessee are reproduced as under:
Ground No. 1: Disallowance of losses arising on fair valuation of Benchmark Linked Debentures (BLD’) amounting to INR 1,84,97,467.
The Ld. NFAC erred in law in upholding the order of the Ld. AO and rejecting the claim of INR 1,84,97,467 arising on fair valuation of BLDs as on 31 March 2012.
While rejecting the Appellant’s claim, the Id. NFAC inter alia erred on following counts:
1.1. Considering the unrealized losses of INR 1,84,97,467 arising on fair valuation of BL.Ds as contingent liability.
1.2. Not following the decision of the Honorable Supreme Court of India in the case of Woodward Governor India Pvt. Ltd 312 ITR 254 and stating in the order that the Appellant is not following the condition laid down by the Hon’ble Supreme Court of India in the case Woodward Governor India Pvt Ltd without appreciating the detailed submission made by the Appellant explaining how the Appellant satisfies the tests prescribed by Hon’ble Supreme Court
1.3. Not following the decision of Mumbai ITAT decision in case of J.P. Morgan Securities India (P.) Ltd. v. Additional Commissioner of Income-tax, Range- (2), Mumbai which are squarely applicable to the facts of the Appellant.
1.4. Without prejudice, if the claim of INR 1,84,97,467 arising on fair valuation of BLDs as on 31 March 2012 is not allowed in the current year, the same should be allowed in the year of payment.
2.1 The only issue involved in the present appeal is in respect of disallowance of unrealized loss of Rs.1,84,97,467/- arising on account of fair valuation of Bench-mark Linked Debentures (BLD) by treating it as contingent liability by the ld. Assessing Officer.
3. Brief facts of the case are that assessee is a non-banking finance company (NBFC) primarily engaged in financing and lending activity. It filed its return of income on 24.11.2012, reporting total income at Rs.30,44,62,700/-. Facts relating to the impugned disallowance are that assessee had issued principal protected, secured, redeemable, nonconvertible bench mark linked debentures. Return on these debentures are linked to performance of specified indices namely NIFTY Index over the period of debentures. Assessee values these debentures at the end of each year on the mark to market basis by adopting widely accepted scientific model and in compliance with the accounting standard issued by the Indian Chartered Accountants of India (ICAI). Assessee has obligation to pay the principal amount to the debenture holders on the maturity date irrespective of NIFTY index prevailing on the date of maturity, since these debentures are principal protected. Assessee is also required to pay return on these debentures to the debenture holders in addition to the principal amount which is linked to NIFTY index level prevailing on the date of maturity.
3.1. While arriving at the fair value at the end of each year on the mark to market basis, if the fair value of the debentures fall below the face value then, difference between the fair value and the face value is not recognized as gains, since these debentures are principal protected and assessee is under an obligation to pay the principal amount to the debenture holder on maturity. Contrary to this, when the fair value is in excess to the face value of these debentures which is linked to NIFTY index on the date of valuation, assessee is under an obligation to pay this excess to the debenture holder for which the trigger event is set at 120% of the start level. According to the assesse, it follows accounting policy for claiming loss on fair valuation with consistency and in accordance with provisions of section 145 of the Act as well as generally accepted accounting principles.
3.2. As per Section 145 of the Act, every assessee has the option to either follow cash’ or ‘mercantile’ basis of accounting. Accordingly, assessee has chosen to follow ‘mercantile’ basis of accounting. Under mercantile basis of accounting, income and expenses are recognized on accrual basis irrespective of their timing of receipt and payment. Correspondingly, expenditure is recognized in the Profit and Loss A/c as soon as it is incurred, and timing of disbursement is irrelevant.
3.3. In the present case, the liability for fair valuation losses is a crystallized liability as the event giving rise to such liability (i.e. entering into BLD contracts) has already occurred before the Balance Sheet date. Once the liability crystallizes, the next step is its quantification. In this regard, assessee referred to the judicial precedent in the case of Bharat Earth Movers v. CIT ITR 428 (SC), wherein Hon’ble Supreme Court held that exact quantification of liability is not necessary for claiming deduction and it would suffice if it could be estimated with reasonable certainty. Hon’ble Court held as follows:
“The law is settled; if a business liability has definitely arisen in the accounting year, the deduction should be allowed although the liability may have to be quantified and discharged at a future date. What should be certain is the incurring of the liability. It should also be capable of being estimated with reasonable certainty though the actual quantification may not be possible. If these requirements are satisfied the liability is not a contingent one. The liability is in praesenti though it will be discharged at a future date. It does not make any difference if the future date on which the liability shall have to be discharged is not certain.”
3.4. According to the assessee, thus contended that it could be said that the liability existed on the Balance Sheet date and the same could be reasonably estimated. Further, the net amount is recognized by the assessee on the basis of movement in the prices of underlying instruments till the Balance Sheet date and the same is reflected under the Other Long Term Liabilities duly reported in Schedule 6 Notes to the Financial Statements.
3.5. It may be relevant to note that under Section 145(2) of the Act, the Central Government is empowered to notify Accounting Standards to be followed by any class of assessees or in respect of any class of income. The Central Government had not notified any specific accounting treatment in relation to fair valuation of BLDs during or prior to the captioned assessment year. Thus, in the absence of any specific treatment being prescribed, the ordinary accounting principles have to be followed. Reliance in this regard is placed on the decision of Hon’b;e Supreme Court in the case of CIT v. Woodward Governor India (P.) Ltd. ITR 254 (SC) wherein it has been held that:
“Under section 145(2), the Central Government is empowered to notify from time-to-time the Accounting Standards to be followed by any class of the assessees or in respect of any class of income. Accordingly, under section 209 of the Companies Act, mercantile system of accounting has been made mandatory for companies. In other words, Accounting Standard, which is continuously adopted by an assessee, can be superseded or modified by legislative intervention. However, but for such intervention or in cases falling under section 145(3), the method of accounting undertaken by the assessee continuously is supreme.”
3.6. Against the above stated contentions of the assessee, stance of the Revenue is that amount of unrealized loss of fair valuation of BLDs claimed by the assessee constitutes contingent liability, not allowable as a deduction u/s.37(1). It is a liability contingent and not crystallized as it is payable only if the trigger condition i.e., index level at or above 120% of the start level on the final valuation date, if met. According to the Revenue, this condition introduces uncertainty as the liability depends on a future event rendering it contingent. Further, Revenue observed that accounting practice of recognizing losses and not gains due to the principal protected nature of BLDs undermines the claim made by the assessee, it being selective in recognizing only the losses and not the gains which violates the principle of consistency.
4. We have heard both the parties and perused the material on record. The moot point before us is in regard to treating the fair valuation loss arrived at by the assessee in respect of valuation on the balance sheet date of the debentures to be treated as contingent or allowable loss. Admittedly, it is a fact on record that the debentures so issued by the assesse are principal protected meaning thereby, in any event on the date of redemption, the debenture holder would get its face value without any loss thereupon. However, returns on these debentures to the debenture holder are linked to market driven phenomena which in the present case is NIFTY index. There is no dispute that the assessee has to pay some amount over and above the principal debenture, if the NIFTY index level at the time of redemption is more than the NIFTY index level prevailed at the time of issue of these debentures for which a trigger event is set at 120% of the start level. In case where the NIFTY index level breaches the trigger event on the date of redemption, assessee is required to pay the excess which is over and above the principal amount of the debentures and is referred to as “coupon” in terms of the issue contained in offering information forming part of Memorandum of Private Placement for issue of debentures on a private placement basis, placed in the paper book. There is no dispute that this coupon amount payable by the assessee to the debenture holder is in fact in the nature of interest compensation which is linked to the performance of the NIFTY index. In this context, it is worth noting that it is an accepted and prudent accounting practice to provide for all known liabilities and losses as on the date of balance sheet. Accounting standards also mandate companies to provide for known liabilities and losses. In the year under consideration, assessee has computed loss which arose on account of fair valuation of these debentures linked to NIFTY index as on the balance sheet date. Thus, on the date of the balance sheet for the year under consideration, there was a liability known to the assessee in respect of these debentures. This liability would qualify as expenditure u/s. 37(1) as the term ‘expenditure’ used u/s. 37(1) covers within its ambit ‘losses incurred by the assessee”. In this regard findings of the Hon’ble Supreme Court in the case of CIT v. Woodward Governor India Pvt. Ltd. (supra) are worth noting:
“The word ‘expenditure is not defined in the Act. The word ‘expenditure’ is, therefore, required to be understood in the context in which it is used. Section 37 enjoins that any expenditure not being expenditure of the nature described in sections 30 to 35 laid out or expended wholly and exclusively for the purpose of the business, should be allowed in computing the income chargeable under the head profits and gains of business In sections 30 to 36, the expression expenses incurred as well as ‘allowances and depreciation’ have also been used For example, depreciation and allowances are dealt with in section 32. Therefore, the Parliament has used the expression ‘any expenditure’ in section 37 to cover both.
Therefore, the expression ‘expenditure’ as used in section 37 may, in the circumstances of a particular case, cover an amount which is really a loss, even though said amount has not gone out from the pocket of the
4.1. Hon’ble Special Bench of ITAT, Mumbai in the case of Dy. CIT (International Taxation) v. Bank of Bahrain & Kuwait [2010] 41 SOT 290 (Mumbai) had an occasion to determine whether the MTM losses arising on forward foreign exchange contracts could be said to be crystallized losses or contingent / notional losses for the purposes of the provisions of the Act. To determine this, Hon’ble Bench referred to certain settled accounting propositions which have received judicial recognition. The accounting propositions referred to were as follows:
| (i) | The income is to be accounted for only when right to receive the same has accrued in favour of a person thereby creating realizable debt in his favour. A legally enforceable right should have accrued in favour of assessee, |
| (ii) | All the anticipated losses though not ascertainable with precise accuracy, which have accrued on the date of balance sheet, have to be accounted for as per prudent accounting policy, |
| (iii) | Stock-in-trade is valued at the end of the previous year in accordance with the principle of matching in order to find out true profits / losses accruing to the assessee, |
| (iv) | The method of accounting consistently followed by the assessee should not be discarded casually without giving strong reasons for the same. Merely because the Assessing Officer feels that other method of accounting would be better, the assessee’s method of accounting cannot be rejected. |
4.2. After referring to the aforesaid accounting propositions it held as follows:
“It is settled principle that deduction is allowable under the Income-tax Act in respect of those liabilities which crystalize during the previous year. Therefore, the concept of crystallization of liability under Income-tax Act assumes significance vis-a-vis commercial principles in vogue. As per the commercial principles of policy of prudence, all anticipated liabilities have to be accounted for but as per Income-tax Act, only that liability will be allowed which has actually accrued. As a matter of fact, Courts have time and again given due weightage to commercial principles in deciding such issues. However, those anticipated liabilities are not allowable which are contingent in nature but, if an anticipated liability is coupled with present obligation and only quantification can vary depending upon the terms of contract, then a liability is said to have crystalized on the balance sheet date. It is in conformity with the principles of prudence also. A contingent liability depends purely on the happening or not happening of an event whereas if an event has already taken place, which, in the present case, is of entering into the contract and undertaking of obligation to meet the liability, and only consequential effect of the same is to be determined, then, it cannot be said that it is in the nature of contingent liability.”
4.3. Further, the Hon’ble Bench after considering the decision of the Supreme Court in the case of Bharat Earth Movers (supra) held as under:
“..it is evident that the anticipated losses on account of existing obligation as on 31st March, determinable with reasonable accuracy, being in the nature of expenditure / accrued liability, have to be taken into account while preparing financial statements.”
4.4. It is clear from the aforesaid decisions that a contingent liability is the one whose occurrence is dependent upon the happening or nonhappening of an event. However, where an event has already taken place such as entering into a contract and only consequential effect is to be determined, the same cannot be called a contingent liability. In the present case, assessee has already entered into legally binding BLDs contracts and the losses have arisen on fair valuation of BLDs. Given this, losses arising on fair valuation of BLDs incurred by the assessee cannot be said to be notional/contingent losses. It is only the quantum of losses/profits which is uncertain and would depend upon the level of NIFTY index prevailing on the maturity date.
5. During the year, assessee has claimed an amount of Rs.1,84,97,467/- as an allowable expense towards “provision for unrealized loss on non-convertible debentures”. In this regard, assessee has explained its case by submitting a tabular summary, describing that it would reverse the unrealized losses recognized in the profit and loss account of the earlier year, in case there is a fall in the indices in the subsequent years. The most clinching fact which ld. Assessing Officer has not considered is that these debentures are principal protected and hence there cannot be any gains arising to the assessee, if the fair value of these debentures fall below the face value, as assessee in terms of issue of these debentures is contractually obliged to pay atleast the principal amount. Thus, ld. Assessing Officer has misconstrued the entire methodology adopted by the assessee for computing the interest liability on the issue of debentures by it.
5.1. For the trigger condition, the authorities below have construed it as an uncertain event which is beyond the control of the assesse. It is important to note that this is a trigger condition which has been set at 120% of the start level meaning thereby, the fair valuation loss shall be recognized by the assessee when the NIFTY index breaches the 120% of the start level and not the start level itself (100%). This in fact puts the case of the assessee even in a better position as the losses have to be recognized only on the breaching of the level at 120% and not at the start level itself, on the date of valuation of the debentures. Also, there cannot be a situation where the assessee would earn gain since these debentures are principal protected, as already noted above.
5.2. Similar issue had come up before the Coordinate Bench of ITAT, Mumbai in the case of J.P. Morgan Securities India (P.) Ltd. v. Addl. CIT ITD 519 (Mumbai). Relevant findings of the Coordinate Bench contained in para 10 to 13 are extracted below for ready reference:
“10. We have heard the rival contentions on this issue and perused the record. There is no dispute with regard to the fact that the assessee has to pay some amount over and above the principal amount of debentures, if the nifty index level at the time of redemption is more than the nifty index level that prevailed at the time of allotment of debentures. If the nifty index level at the time of redemption is lower than the nifty index level that prevailed at the time of allotment of debentures, then the assessee is not required to pay any amount over and above the principal amount of debentures. There should not be any dispute that the amount payable by the assessee to the debenture holders is, in effect, in the nature of interest compensation only. The fixed rate of interest is the common method generally adopted and also known to everyone. However, the assessee has chosen to issue debentures, which would earn interest depending upon the performance of nifty index. It can be seen that the methodology adopted by the assessee is only a different method of computing the interest liability of the assessee.
11. It is also a known fact that the nifty index level shall not increase at a constant rate, but it will fluctuate depending upon the market conditions. So whenever the nifty index level crosses the index level that prevailed at the time of allotment of debentures, the liability of the assessee would also simultaneously increase. Conversely, if the index level goes down, the liability of the assessee would also go down.
12. The Hon’ble Supreme Court has considered the issue relating to the effect of changes in foreign exchange rates in the case of Woodward Governor India (P.) Ltd. (supra). In the case of foreign currency, also, the conversion rates keep fluctuating and hence the liability of the assessee in respect of foreign currency loan would also keep changing. The Hon’ble Supreme Court examined the Accounting standard -11 issued by ICAI, where in it is provided that any difference, loss or gain, arising on conversion of the said liability at the closing rate should be recognized in the P&L account for the reporting period. The Hon’ble Supreme Court held that the loss suffered by an assessee as on the date of balance sheet in respect of a revenue liability, on account of exchange difference, is an item of expenditure deductible u/s 37(1) of the Act.
13. In the instant case also, there is no dispute with regard to the fact that there exists a liability to pay coupon rate at the time of redemption of debentures. As stated earlier the liability would, however, depend upon the performance of nifty index level. So whenever the nifty index level crosses the index level that prevailed at the time of allotinent of debentures, the liability of the assessee would also simultaneously increase. It is an accepted and prudent accounting practice to provide for all known liabilities and losses as on the date of Balance Sheet. The accounting standards also mandate the companies to provide for known liabilities and losses, During the years under consideration, the claim of the assessee is that the nifty index level has gone up vis-a-vis the level existed at the time of allotment of debentures, meaning thereby the liability of the assessee was known as on the date of Balance Sheet. Accordingly, we are of the view that the said liability would fall in the category of ‘expenditure’, since it is in the nature of interest liability only. Accordingly, we are of the view that the ratio of the decision rendered by the Hon’ble Supreme Court in the case of Woodward Governor India (P.) Ltd. (supra) shall apply to the facts of the present case also.”
6. In the conspectus of the entire discussion made above, including the factual matrix, provisions of law and the judicial precedents, we hold that the fair valuation loss claimed by the assessee in respect of the debentures on the balance sheet date falls within the category of expenditure allowable u/s.37(1). Accordingly, disallowance made by the ld. Assessing Officer in this regard is deleted. In the result, grounds raised by the assessee are allowed.
7. In the result, appeal of the assessee is allowed.