2024 (4) TMI 590 - AT - Income Tax

Determine the nature of losses on forward foreign exchange contracts and foreign exchange derivative contracts - CIT(A) deleting the disallowances of losses made by the AO on Forward Foreign Exchange Contract and Foreign Exchange Derivative Contract by treating them as business loss and allowed them to set off and carry forward against the business income - AR as submitted that the transactions would not be covered u/s 43(5) but the losses were allowable to the assessee as business expenditure u/s 37(1) - HELD THAT - The assessee in the present case is not a dealer in foreign exchange and therefore it could not be said that such transactions were part and parcel of business transactions unless interse nexus thereof was established by the assessee. In the decision of Mumbai Tribunal in Vinodkumar Diamonds Pvt. Ltd. 2013 (11) TMI 408 - ITAT MUMBAI it was held by the bench that in order that for forward transactions in commodities may fall within proviso (a) to section 43(5) of the Act it would be necessary that the raw materials or merchandise in respect of which the forward transactions have been made by the assessee must have a direct connection with the goods manufactured or the merchandise sold by him. As per Board s Circular in order to be genuine and valid hedging contracts of sales the total of such transactions should not exceed the total stocks of the raw materials or the merchandise on hand which would include existing stocks as well as the stocks acquired under the firm contracts of purchase as held by Mumbai Tribunal in the case of Araska Diamond (P.) Ltd 2014 (10) TMI 776 - ITAT MUMBAI - This decision considered the decision of MP Sugar Mills (P.) Ltd. 1983 (8) TMI 42 - ALLAHABAD HIGH COURT which held that it will depend upon the facts of each case whether a particular transaction by way of forward sale which is mutually settled otherwise than by actual delivery of the said goods has been entered into with a view to safeguard against loss through price fluctuation in respect of the contract for actual delivery of the goods manufactured. Therefore the loss was held to be not allowable either u/s 43(5) or under proviso thereof. Thus the adjudication of Ld. CIT(A) is set aside and the issue is restored back to the file of CIT(A) for de novo adjudication with a direction to the assessee to substantiate its case and by filing requisite details / explanations. Revenue appeal stand allowed for statistical purposes.

Summary

Issues Involved:
1. Deletion of disallowances of losses on Forward Foreign Exchange Contract and Foreign Exchange Derivative Contract.
2. Classification of transactions as speculative or business loss u/s 43(5) of the Income-Tax Act.
3. Consideration of transactions carried through a bank as covered by proviso (d) to Section 43(5).

Summary:
Issue 1: Deletion of Disallowances of Losses
The revenue challenged the CIT(A)'s decision to delete the disallowances of losses on Forward Foreign Exchange Contract and Foreign Exchange Derivative Contract by treating them as business loss, allowing them to be set off and carried forward against business income. The Ld. AO had initially disallowed these losses, considering them speculative in nature due to lack of actual delivery.

Issue 2: Classification of Transactions
The Ld. AO classified the transactions as speculative u/s 43(5), stating that the losses were notional and not supported by proper evidence. The assessee argued that these were hedging transactions to mitigate foreign currency risk and should be considered business expenditure u/s 37(1). The CIT(A) accepted the assessee's claim, stating that the contracts were normal business activities to hedge against currency fluctuation risks.

Issue 3: Transactions Through a Bank
The Ld. AO contended that transactions carried through a bank and not through a recognized stock exchange do not satisfy the conditions laid by the Explanation to proviso (d) to Section 43(5). The CIT(A) held that the forward contracts were part of the business activity and thus not speculative.

Findings and Adjudication:
1. Assessment Proceedings: The assessee, engaged in manufacturing and export of safety matches, claimed a foreign exchange contract cancellation loss of Rs. 945.43 Lacs. The Ld. AO disallowed the loss, treating it as speculative and notional.

2. Appellate Proceedings: The assessee argued that the forward contracts were hedging transactions advised by their bank to protect against currency fluctuations. The CIT(A) found that the losses were business losses incurred due to cancellation of export orders and allowed the claim.

3. AO's Remand Report: The Ld. AO noted that the assessee failed to provide adequate details to substantiate the losses and their relation to specific transactions. The AO maintained that the transactions were speculative as they were settled without actual delivery.

4. CIT(A)'s Decision: The CIT(A) observed that the forward contracts were booked to hedge against currency risks in the export business and were not speculative. The loss was considered a business expenditure.

5. Tribunal's Conclusion: The Tribunal held that specific provisions of Sec.43(5) should prevail over general provisions. The assessee failed to establish a direct nexus between the forward contracts and the goods manufactured or sold. The Tribunal set aside the CIT(A)'s adjudication and remanded the issue back for de novo adjudication, directing the assessee to provide requisite details.

Final Order:
The appeal was allowed for statistical purposes, and the case was remanded back to the CIT(A) for fresh adjudication with all issues kept open. The order was pronounced on 22nd March, 2024.