2022 (2) TMI 527 - AT - Income Tax

Treatment to Forex loss incurred by the assessee on account of derivative transactions as speculative transactions - Whether derivative transactions entered into by the assessee with State Bank of India is not in the ordinary course of business of the assessee who is an exporter of granites and the Export bills or receivables of the assessee cannot be linked to the derivative transactions? - HELD THAT - We ourselves do not subscribe to the reasons given by the AO for the simple reason that the assessee being an export of goods to Japan Company had entered into hedging transactions with State Bank of India by entering into Forex derivatives to minimize possible loss in fluctuation in USD, because the Japanese Companies agreed to make the payments through their Chinese Intermediaries by USD. Further, during the year under consideration, the assessee achieved an export turnover payments through their Chinese Intermediaries by USD. Further, during the year under consideration, the assessee achieved an export turnover. When the assessee enters into a hedging transaction to minimize the possible loss from fluctuation in foreign currency, then profit or loss arises on account of appreciation or depreciation in the value of foreign currency held by it on conversion into another currency, such profit or loss would ordinarily be a trading profit or loss, if the foreign currency is held by the assessee on Revenue account or as a trading asset or as a part of circulating capital embarked in the business, if the underline asset is more than the amount of forward contracts entered into by the assessee. This legal principle is supported by the decision of the Hon ble Supreme Court in the case of CIT v. Woodward Governor India Pvt. Ltd. 2009 (4) TMI 4 - SUPREME COURT wherein, it was held that the loss arising in the process of conversion of foreign currency, which is part of trading asset of the assessee, is a trading loss as any other loss. In this case, the facts available on record clearly shows that the assessee being an export of goods had huge receivables from customers entered into a hedging contract with its bankers to minimize the possible fluctuation in foreign currency, which resulted in loss and the same has been treated as Revenue expenditure or business loss. The Ld.CIT(A) after considering the relevant facts has rightly held that loss incurred by the assessee on account of fluctuation in foreign currency, is in the nature of business loss, but not speculative loss, which is covered u/s.43(5) - Decided against revenue.

Summary

Issues Involved:
1. Whether the order of the CIT(A) is contrary to law, facts, and circumstances of the case.
2. Whether the forex derivative loss should be treated as non-speculative and a business loss.
3. Whether the derivative transactions entered into by the assessee with State Bank of India are in the ordinary course of business.
4. Whether the forex derivative transactions are speculative in nature and not allowable as business expenditure.
5. Whether the forex derivative transactions fall within speculative transactions as they are not settled by actual delivery of foreign exchange.
6. Whether the transactions were analyzed for specific underlying exposure or balance sheet exposure.
7. Whether the forex derivative transactions increased the risk to the assessee instead of reducing it as a hedge.
8. Applicability of the decision in Shri Vinodkumar Diamonds (P) Ltd. vs. Additional Commissioner of Income Tax.

Issue-wise Detailed Analysis:

1. Order of CIT(A) Contrary to Law, Facts, and Circumstances:
The Revenue contended that the CIT(A)’s order was contrary to law and facts. However, the CIT(A) followed judicial precedents and analyzed the facts thoroughly, concluding that the forex loss was a business loss and not speculative.

2. Forex Derivative Loss as Non-Speculative and Business Loss:
The CIT(A) allowed the forex derivative loss as a business loss, citing that the transactions were for hedging export receivables. The CIT(A) relied on the Supreme Court decision in CIT v. Woodward Governor India Pvt. Ltd., which states that profit or loss from foreign currency fluctuations in the ordinary course of business is a trading profit or loss.

3. Derivative Transactions in the Ordinary Course of Business:
The Revenue argued that the transactions were not in the ordinary course of business. However, the assessee demonstrated that the transactions were to hedge the risk of foreign currency fluctuations due to export receivables, which is a common business practice.

4. Speculative Nature of Forex Derivative Transactions:
The AO treated the forex loss as speculative. The CIT(A) disagreed, stating that the transactions were for hedging purposes and not speculative. The CIT(A) noted that the assessee had entered into these transactions to minimize the risk of currency fluctuations, which is a business activity.

5. Settlement of Forex Derivative Transactions:
The Revenue argued that the transactions were speculative as they were not settled by actual delivery of foreign exchange. The CIT(A) found that the transactions were for hedging export receivables and were settled based on currency fluctuations, making them business transactions.

6. Analysis of Specific Underlying Exposure:
The Revenue claimed that neither the bank nor the assessee analyzed specific underlying exposure. The CIT(A) noted that the transactions were based on the assessee’s export receivables, which were substantial and justified the hedging contracts.

7. Risk Increase Due to Forex Derivative Transactions:
The Revenue contended that the transactions increased the assessee’s risk. The CIT(A) found that the transactions were prudent business decisions to hedge against currency fluctuations, and the losses incurred were business losses.

8. Applicability of Shri Vinodkumar Diamonds Case:
The Revenue cited the decision in Shri Vinodkumar Diamonds (P) Ltd. The CIT(A) distinguished the case, noting that the assessee’s transactions were directly related to its export business and were not speculative.

Conclusion:
The ITAT upheld the CIT(A)’s order, concluding that the forex derivative transactions were for hedging purposes and the resulting loss was a business loss, not speculative. The appeal filed by the Revenue was dismissed. The decision emphasized that the transactions were part of the ordinary course of business and aimed at minimizing currency fluctuation risks.