2015 (4) TMI 1049 - AT - Income Tax

Loss incurred on account of forex derivative contracts - AO treated as speculative loss and thereby not allowing the assessee to set off the same against its business income - Held that - In the present case, the assessee is a manufacturer and exporter of garments and the assessee has entered into foreign currency derivative transactions to guard against future currency fluctuations which has a close proximity to the business of the assessee. On the other hand, if it is treated as stock /shares, such transactions will not be treated as speculative transactions if the transaction is carried out through a recognized stock exchange. The argument of the Revenue is that, if the transactions are made though banking sectors, then the same will fall within the scope of speculative transactions. This argument appears to be absurd and illogical because both Recognized Stock Exchange and Nationalized Banks are either Government regulatory body or extended arm of the Government. Further the characteristic of the currency and stock/shares are not the same and therefore, currency cannot be held as stock or shares. The loss incurred by the assessee on its derivative transactions shall be allowed to be set off from the business income of the assessee by treating the same as business loss and not loss due to speculation as held by the Revenue. - Decided in favour of assessee.

Issues Involved:
1. Treatment of loss incurred on forex derivative contracts.
2. Determination of whether the loss is speculative or business-related.

Issue-wise Detailed Analysis:

1. Treatment of Loss Incurred on Forex Derivative Contracts:

The primary issue in this case is whether the loss incurred by the assessee on account of forex derivative contracts should be treated as speculative loss or business loss. The assessee, a limited company engaged in manufacturing garments, filed its return of income for the assessment year 2008-09 admitting Nil income under normal computation and Rs. 7,90,33,870/- under Section 115JB of the Income Tax Act. During the scrutiny, the Assessing Officer (A.O.) disallowed the setting off of Rs. 5,44,50,660/- being the loss on derivatives against the business income, treating it as speculative loss under Section 43(5) of the Act.

The A.O. observed that the forex derivative contracts entered by the assessee with Axis Bank, Yes Bank, and IDBI Bank were in the nature of options and swap contracts, which were treated as speculative transactions because:
- There was no actual delivery of foreign currency.
- The contracts were non-deliverable forex derivative contracts without underlying exposure.
- The definition of commodity under Section 43(5) includes non-deliverable forex derivatives.

The Commissioner of Income Tax (Appeals) [CIT(A)] upheld the A.O.'s order, stating that the derivative transactions were speculative and not related to the assessee's export business. The CIT(A) compared the derivative transactions to gambling, asserting that they were separate speculative activities aimed at obtaining profit from currency movements.

2. Determination of Whether the Loss is Speculative or Business-related:

The assessee argued that the loss incurred due to forex derivative transactions should be treated as business loss since the transactions were conducted to hedge against foreign exchange risk arising from its export business. The assessee relied on several judicial decisions to support its claim, including CIT v. Vishindas Holaram, CIT v. Badridas Gauridu (P) Ltd, and others, which recognized forex derivative losses as business losses.

The Tribunal found the issue identical to the case of M/s. SCM Garments Pvt Ltd, where it was held that forex derivative transactions entered to hedge foreign exchange risk are not speculative. Key points considered by the Tribunal included:
- The assessee entered into forex derivative transactions to hedge foreign currency fluctuation risk.
- The loss incurred was realistic and directly attributable to the business.
- Foreign currency is neither a commodity nor stock/shares as defined under Section 43(5).
- The transactions were conducted through nationalized banks in compliance with RBI regulations.

The Tribunal concluded that the forex derivative transactions were incidental to the assessee's export business and should not be treated as speculative. The Tribunal directed the Revenue to set off the losses incurred on forex derivative contracts against the business income of the assessee, treating the same as business loss.

Conclusion:

The appeal of the assessee was allowed, and it was held that the loss incurred on forex derivative transactions should be treated as business loss and not speculative loss. The Tribunal directed the Revenue to allow the set-off of the losses against the business income of the assessee. The judgment emphasized that hedging transactions aimed at mitigating business risks should not be classified as speculative. The order was pronounced on 17th April 2015 at Chennai.

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