Accounting and Taxation

Chapter 9: Accounting and Taxation of Interest Rate Derivatives

NISM Series IV — Interest Rate Derivatives | ~3% weightage | ~12 questions

Accounting — AS 30 (ICAI)

ICAI (Institute of Chartered Accountants of India) issues guidance notes on accounting for derivative contracts under Accounting Standard 30 (AS 30).

Key accounting principles:

• All derivative contracts must be recognized ON THE BALANCE SHEET (not off-balance sheet)
• Measured at FAIR VALUE (= current mark-to-market value, NOT book value, NOT zero)
• Fair value changes → taken to Profit/Loss Account EXCEPT for qualifying hedging transactions

Three hedge accounting models (same as Series I): 1. Fair value hedge — hedging changes in fair value of recognized assets/liabilities 2. Cash flow hedge — hedging variable future cash flows 3. Net investment hedge — hedging net investment in foreign operations

For hedging transactions: Fair value changes may go to equity (through Other Comprehensive Income) instead of directly to P&L.

Non-hedging (speculative/trading) derivatives: Fair value changes always go to P&L directly.

Derivatives held for trading: Reported as CURRENT ASSETS and CURRENT LIABILITIES.

Derivatives as hedge of recognized assets/liabilities: Classified as current or non-current based on the classification of the HEDGED ITEM.

Taxation

Exchange-traded derivatives = NON-SPECULATIVE BUSINESS INCOME (same as Series I currency derivatives)

Income head: Profits and Gains from Business and Profession.

Loss set-off:

• Can set off against ANY business income
• CANNOT set off against SALARY income
• Can set off against Income from Other Sources (if applicable)

Loss carry forward:

• Exchange-traded derivative losses = 8 assessment years
• Speculative losses (intraday equity) = 4 assessment years

Presumptive taxation (Section 44AD):

• Available for traders with turnover ≤ Rs 2 crore
• Digital/cheque receipts: declare profit at 6% of turnover
• Cash receipts: declare profit at 8% of turnover

FPI taxation (if position held < 12 months):

• Gains = Short-term capital gains
• Losses = Short-term capital losses

Stamp duty on exchange-traded IRDs: Levied on the BUYER only (not seller).

Trap Alert

Trap 1: "Derivatives remain off-balance-sheet" — FALSE All derivatives ON balance sheet at fair value.

Trap 2: "Fair value = book value" — FALSE Fair value = current mark-to-market (liquidation) value.

Trap 3: "Fair value always goes to P&L" — FALSE For qualifying hedging transactions, it may go to equity (OCI).

Trap 4: "IRD losses can be set off against salary" — FALSE Non-speculative business losses: can set off against business income and other sources but NOT salary.

Trap 5: "IRD losses carry forward = 4 years" — FALSE Exchange-traded IRDs = 8 years. Speculative = 4 years.

Trap 6: "Presumptive taxation 8% for digital receipts" — FALSE Digital = 6% | Cash = 8%.

Trap 7: "Stamp duty = both buyer and seller" — FALSE Stamp duty on exchange-traded IRDs = BUYER ONLY.

Must-remember rules

• ICAI issues guidance | AS 30 = accounting for derivatives
• All derivatives on balance sheet at FAIR VALUE (mark-to-market)
• Fair value changes → P&L (except qualifying hedges)
• Three hedges: fair value, cash flow, net investment
• Trading derivatives = current assets/liabilities
• Hedge of recognized asset/liability = current or non-current (matches hedged item)
• Exchange-traded IRDs = non-speculative business income
• Loss set-off: business income and other sources (NOT salary)
• Carry forward: 8 years (IRDs) | 4 years (speculative intraday equity)
• Presumptive: 6% digital | 8% cash (Section 44AD, turnover ≤ Rs 2Cr)
• FPI < 12 months = short-term capital gain/loss
• Stamp duty: BUYER only

Quick revision — 60 second scan

• ICAI | AS 30 | On balance sheet | Fair value = mark-to-market
• Hedges: fair value, cash flow, net investment
• Non-hedging → P&L | Hedging → may go to equity
• IRD losses: 8-year carry forward | Cannot offset salary
• Presumptive: 6% digital, 8% cash
• FPI <12 months = short-term CG/CL
• Stamp duty: buyer only