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2016 (2) TMI 502 - AT - Income TaxDisallowance of loss suffered in cancellation of foreign currency forward contracts by treating the same as speculation loss - Held that - Forward contracts entered by the assessee, an exporter and not the dealer in foreign exchange, with the Banks as incidental to the export business, are business transactions and loss or gains is not of speculation nature. The loss arising on cancellation of matured forward contracts was allowable as deduction We are unable to agree with the view taken by the tax authorities on this issue. Accordingly, we set aside the order of Ld CIT(A) on this issue and direct the AO to allow the claim relating to loss arising on cancellation of foreign exchange forward contracts. - Decided in favour of assessee
Issues Involved:
1. Disallowance of loss on cancellation of foreign currency forward contracts. 2. Classification of the loss as speculative or business loss. Detailed Analysis: Issue 1: Disallowance of Loss on Cancellation of Foreign Currency Forward Contracts The assessee, engaged in the import, manufacture, and export of diamonds, and also in power generation and distribution, entered into forward contracts in foreign exchange to hedge against currency fluctuation risks. For the assessment year 2009-10, the assessee declared a loss of Rs. 7.84 crores on the cancellation of these forward contracts. The assessing officer (AO) treated this loss as speculative and disallowed it, a decision which was upheld by the Commissioner of Income Tax (Appeals) [CIT(A)]. The AO's rationale was that the forward contracts were not linked to the business of diamonds but were separate business transactions in foreign currency, settled without actual delivery, thus constituting speculative transactions as per section 43(5) of the Income Tax Act. The AO relied on the decision of the Bangalore Tribunal in ACIT Vs. K. Mohan & Co. (Exports) P Ltd, which held that profits from forward contracts settled without actual delivery are speculative. Issue 2: Classification of the Loss as Speculative or Business Loss The Tribunal reviewed the decisions and facts of similar cases, including the Bangalore Tribunal's decision in ACIT Vs. M/s Hanuman Weaving Factory, which differentiated the nature of the issue from the K. Mohan & Co. case. The Tribunal in Hanuman Weaving Factory concluded that the loss on cancellation of forward contracts was not speculative but allowable as a business deduction. Further, the Tribunal considered the Mumbai Tribunal's decision in London Star Diamond Company (I) P Ltd Vs. DCIT, which addressed whether forward contracts integral to export activities could be considered speculative. The Tribunal examined section 43(5) defining "speculative transactions" and the exceptions provided therein. The Tribunal also referred to the Bombay High Court's decision in CIT Vs. Badridas Gauridu (P) Ltd, which held that forward contracts entered to hedge against losses in export business are not speculative but business transactions. The Tribunal noted that forward contracts, when entered into by exporters to hedge against currency fluctuations, are integral to their business activities and not speculative. The Tribunal emphasized that there is no legal requirement for a 1:1 correlation between forward contracts and export invoices, as long as the total value of forward contracts does not exceed the exports and outstanding receivables. The Tribunal concluded that the forward contracts entered by the assessee, an exporter, with banks for hedging purposes are business transactions. The loss on cancellation of these contracts should be treated as business loss, not speculative loss. Conclusion: The Tribunal set aside the CIT(A)'s order and directed the AO to allow the assessee's claim of Rs. 7.84 crores as a business loss arising from the cancellation of foreign exchange forward contracts. This decision was supported by various judgments, including CIT Vs. Badridas Gauridu Pvt Ltd and CIT Vs. Sooraj Mull Nagarmull, which consistently held that such losses are business losses when the contracts are integral to the export business. Result: The appeal filed by the assessee was allowed, and the loss of Rs. 7.84 crores was directed to be treated as a business loss. Pronounced on 20th Jan, 2016.
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