2015 (12) TMI 1904 - AT - Income Tax

Treatment of loss arisen on account of foreign exchange derivative contracts - assessee suffered a loss on account of foreign exchange forward contract transactions and treated the same as part of business loss and set off such loss against the business income of the assessee - AO was of the opinion that this is a speculative loss and cannot be set off against business income of the assessee in view of the provisions of sec. 73 - as per CIT(A) loss arising from these forward contracts is not a speculative loss u/s 43(5) and he directed the Assessing Officer to treat the above loss as regular business loss HELD THAT - AO has to consider the foreign exchange derivative in proportion to export turnover as regular business transaction of the assessee. If the derivative transaction undertaken by the assessee is in excess of export turnover then that loss suffered in respect of that portion of excess transaction has to be considered as speculative loss only and that excess derivative transaction has no proximity with export turnover and the AO is directed to compute accordingly. AO has to see whether there is any premature cancellation of forward contract of foreign exchange and that transaction should be taken out for the purpose of considering the business loss and only the transctions which are completed to be considered for the purpose of determining the business loss from these foreign exchange forward contract. With this observation, we remand this issue to the file of the AO for fresh consideration. This issue was considered by the Mumbai Tribunal while delivering the decision in the case of Araska Diamond P. Ltd, 2014 (10) TMI 776 - ITAT MUMBAI and after following the judgments of Bengal Assam Co. Ltd 2009 (7) TMI 108 - CALCUTTA HIGH COURT and Badridas Gauridu P. Ltd 2003 (1) TMI 61 - BOMBAY HIGH COURT the Tribunal came to the conclusion that the transactions, which were prematurely cancelled, cannot be considered as business transaction and it is to be considered as speculative transaction. Appeal of the Revenue is allowed for statistical purposes.

Summary

Issues Involved:
1. Treatment of loss arising from foreign exchange derivative contracts.
2. Applicability of Section 73 of the Income-tax Act to the loss incurred.
3. Classification of transactions as speculative or non-speculative under Section 43(5) of the Income-tax Act.
4. Proportionality of foreign exchange derivative transactions to export turnover.
5. Premature cancellation of forward contracts and its impact on classification as speculative or non-speculative transactions.

Detailed Analysis:

1. Treatment of Loss Arising from Foreign Exchange Derivative Contracts:
The assessee-company, engaged in processing and exporting marine products, incurred a loss of Rs. 2,56,46,747/- from foreign exchange forward contract transactions. The assessee treated this loss as a business loss and set it off against its business income. The Assessing Officer (AO) classified this loss as speculative and disallowed the set-off against business income under Section 73 of the Income-tax Act.

2. Applicability of Section 73 of the Income-tax Act:
The Commissioner of Income-tax (Appeals) [CIT(A)] relied on various Tribunal decisions to conclude that the transactions were part of regular business activities and not speculative. The CIT(A) referenced cases such as Munjal Showa Ltd vs DCIT and Essar Steel vs DCIT, which supported the treatment of such losses as business losses, not speculative losses. The CIT(A) directed the AO to treat the loss as a regular business loss, leading to the Revenue's appeal.

3. Classification of Transactions as Speculative or Non-Speculative under Section 43(5):
The Tribunal examined whether the transactions fell under the definition of speculative transactions as per Section 43(5). It was noted that derivative transactions in shares are not speculative under Section 43(5). The Tribunal cited the Special Bench decision in CIT v. Concord Commercial Pvt. Ltd., which held that both share delivery transactions and derivative transactions should be aggregated before applying the Explanation to Section 73.

4. Proportionality of Foreign Exchange Derivative Transactions to Export Turnover:
The Tribunal emphasized that the total derivative transactions must not exceed the total export turnover of the assessee. If the derivative transactions exceed the export turnover, the excess should be considered speculative. This principle was supported by the decision in the case of Baljit Securities Pvt. Ltd., where the Calcutta High Court held that losses from speculative transactions could only be set off against profits from speculative transactions.

5. Premature Cancellation of Forward Contracts:
The Tribunal also considered the impact of premature cancellation of forward contracts. It was noted that the Mumbai Bench of ITAT in Araska Diamond P. Ltd vs ACIT held that transactions not related to specific export or import bills and those prematurely canceled should be treated as speculative. The Tribunal directed the AO to exclude prematurely canceled transactions from business loss calculations.

Conclusion:
The Tribunal concluded that the AO should consider foreign exchange derivatives in proportion to the export turnover as regular business transactions. Any excess derivative transactions beyond the export turnover should be treated as speculative losses. Additionally, prematurely canceled forward contracts should be excluded from business loss calculations. The case was remanded to the AO for fresh consideration with these guidelines.

Final Order:
The appeal of the Revenue was allowed for statistical purposes, with the order pronounced in open court on 18th December 2015, at Chennai.