1974 (2) TMI 2 - HC - Income Tax

Speculative Transactions - Hedging Transaction - Raw Material - (1) Whether the loss of Rs. 66,417 was allowable under section 10(1), or could be set off against the company s profits of the business under proviso (a) to Explanation 2 of section 24(1) (2) Whether Rs. 52,633 claimed as business expenditure for the assessment year 1957-58 and Rs. 11,578 claimed as such for the assessment year 1958-59, under section 10(2)(xv) of the Indian Income-tax Act, 1922, have rightly been disallowed?

Issues Involved:
1. Allowability of a loss of Rs. 66,417 under section 10(1) or set-off against company's profits under proviso (a) to Explanation 2 of section 24(1) of the Indian Income-tax Act, 1922.
2. Disallowance of Rs. 52,633 and Rs. 11,578 claimed as business expenditure under section 10(2)(xv) for the assessment years 1957-58 and 1958-59, respectively.

Issue-wise Detailed Analysis:

Issue 1: Allowability of Loss of Rs. 66,417

The assessee, M/s. Delhi Flour Mills Co. Ltd., engaged in various businesses, entered into forward transactions in matra, resulting in a loss of Rs. 66,417. These transactions were speculative as they were settled by payment of differences rather than actual delivery. The assessee claimed the loss under two grounds:
1. The transactions were hedging transactions saved by proviso (a) to Explanation 2 of section 24(1).
2. The losses in speculative transactions should be set off against other business profits.

The Supreme Court in Commissioner of Income-tax v. Kantilal Nathuchand Sami clarified that losses in speculative transactions are not to be taken into account when computing total income, except to the extent they can be set off against profits from other speculative business. Given this, the assessee's second ground was not pressed.

For the first ground, the proviso (a) to Explanation 2 of section 24(1) states that contracts in respect of raw materials or merchandise entered into by a person in the course of his manufacturing or merchanting business to guard against loss through future price fluctuations shall not be deemed speculative. The assessee argued that forward transactions in matra, though not directly related to its main business commodities, should be considered hedging transactions. However, the court found that the language of the proviso is clear and requires a direct connection between the raw materials or merchandise and the goods manufactured or sold by the assessee.

The court referenced decisions from the Andhra Pradesh and Gujarat High Courts, which supported the view that the raw material in forward transactions must be directly connected to the goods manufactured by the assessee. Consequently, the forward transactions in matra did not qualify as hedging transactions under the proviso, and the loss could not be set off against the profits from the business of manufacturing atta and wheat products. The first question was answered in the negative, against the assessee and in favor of the revenue.

Issue 2: Disallowance of Rs. 52,633 and Rs. 11,578 as Business Expenditure

The assessee had reached a settlement with its employees, agreeing to pay gratuity based on years of service. In pursuance of this agreement, the assessee transferred sums to the Employees' Gratuity Fund for the assessment years 1957-58 and 1958-59. The Income-tax Officer allowed only the amounts actually paid to employees, disallowing the remaining amounts.

The crucial question was whether the liability for these amounts had accrued during the respective years. Under the mercantile system of accounting, as explained by the Supreme Court in Keshav Mills Ltd. v. Commissioner of Income-tax, liabilities accrued due, though to be discharged in the future, are deductible. The court referenced the Supreme Court decision in Metal Box Company of India Ltd. v. Their Workmen, which allowed for the deduction of estimated liabilities under gratuity schemes if they are properly ascertainable.

Applying these principles, the court found that the provision made by the assessee for gratuity represented an accrued liability, as the right to receive gratuity accrued to employees annually. The court distinguished this case from Indian Molasses Co. (Private) Ltd. v. Commissioner of Income-tax, where the liability was contingent upon uncertain events. Here, the events (death or voluntary retirement) were certain, making the liability ascertainable.

The court also referenced the Allahabad High Court decision in Madho Mahesh Sugar Mills (P.) Ltd. v. Commissioner of Income-tax, which allowed for the deduction of gratuity provisions under similar circumstances.

The court concluded that the assessee was entitled to the deduction of the full amounts for which it had made provision in the two years under reference. The second question was answered in the negative, against the revenue and in favor of the assessee.

Conclusion:
1. The loss of Rs. 66,417 from forward transactions in matra was not allowable as a set-off against the company's profits from other business activities.
2. The amounts of Rs. 52,633 and Rs. 11,578 claimed as business expenditure for gratuity provisions were allowable deductions.

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