2014 (5) TMI 732 - AT - Income Tax

Disallowance of loss on foreign currency fluctuation - Assessee contended that the revenue disregarded the fact that the assessee needs to enter into forward contract in order to Hedge risk as the amount involved is high and significant Held that - Following London Star Diamond Company (I) (P.) Ltd Versus Deputy Commissioner of Income-tax 2013 (11) TMI 424 - ITAT MUMBAI - the forward contracts fall in the definition of commodities - Such forward contracts which are integral part or incidental to the core business of export of diamonds or the outstanding receivables of export proceeds constitute hedging transactions and not the speculative contracts - If the definition of commodity derivative as was provided in the Finance Bill 2013 is correlated with as provided u/s 43 of the I.T. Act, it is wide enough not only to include forward contracts in derivatives relating to goods, services and rights such as warehousing and freight but also with reference to weather and similar events and activities having a bearing on the commodity sector. Foreign exchange forward contracts entered into for the purpose of hedging the loss in import-export transactions, have been duly recognized and allowed by the Reserve Bank of India - in case of import/export business, where the transactions are demonetarized in the foreign currencies and for the purpose of hedging of the anticipated loss resulting from such import-export business and not otherwise, if the assessee enters into a forward contract in foreign exchange, then such forward contracts are to be treated as integral part or incidental to the business of export/import and cannot be said to be the speculative contracts attracting the provisions of section 43(5) of the Act - The loss from hedging transactions would be treated as business loss eligible to be set off against the profits and gains of business and profession. The foreign exchange loss incurred by the assessee on account of entering into forward contracts with the banks for the purpose of hedging the loss in connection with his import/export business of diamonds cannot be held to be a speculative loss rather a business loss which can be set off against profit and gains of business subject to the condition that the assessee will have to satisfactorily prove that the maturity of the hedge did not exceed the maturity of the underlying transaction and further to explain the requirement/necessity for premature cancellation of such forward contracts or that such cancellations or re-bookings were done to minimize the anticipated future losses from transactions thus, the order of the CIT(A) is set aside and the matter is remitted back to the AO for fresh adjudication Decided in favour of Assesee.

Summary

Issues Involved:

1. Disallowance of Rs 7,49,70,430/- on account of loss on foreign currency fluctuation.
2. Wrongly charging interest under Section 234.
3. Initiating penalty under Section 271(1)(c).

Issue-wise Detailed Analysis:

1. Disallowance of Rs 7,49,70,430/- on account of loss on foreign currency fluctuation:

The assessee, engaged in the import of rough diamonds and export of polished diamonds, incurred a loss of Rs.7,49,70,430/- due to foreign currency fluctuations. The Assessing Officer (AO) treated this loss as speculative, not falling within the exclusion clauses of Section 43(5) of the Income Tax Act, thereby disallowing it as a business loss. The Commissioner of Income Tax (Appeals) [CIT(A)] upheld this decision.

The assessee argued that the forward contracts were entered to hedge against currency fluctuations, integral to their business. The Tribunal referenced the London Star Diamond Company (I) (P.) Ltd. case, where it was held that forward contracts for hedging in the diamond export business are not speculative but hedging transactions. The Tribunal concluded that such contracts are part of the business operations, thus the loss should be considered a business loss, not speculative. The Tribunal directed the AO to reassess the case, ensuring the hedging transactions were appropriately matched with the underlying business transactions.

2. Wrongly charging interest under Section 234:

The Tribunal did not specifically address the issue of wrongly charging interest under Section 234 in the detailed analysis. However, given the context of the primary issue being remanded back to the AO, the reassessment would likely include a review of any interest charged under Section 234.

3. Initiating penalty under Section 271(1)(c):

Similar to the interest issue, the Tribunal did not delve deeply into the initiation of penalty under Section 271(1)(c). The focus remained on the nature of the forward contracts and the resultant loss. However, the remand for reassessment implies that penalties, if any, would be reconsidered in light of the new findings.

Conclusion:

The Tribunal allowed the appeal for statistical purposes, setting aside the CIT(A)'s findings and remanding the case to the AO. The AO is to reassess the nature of the forward contracts, ensuring they are genuinely hedging transactions related to the business, and not speculative. The AO must also provide the assessee an opportunity to explain the necessity and timing of any contract cancellations or re-bookings. This reassessment will also cover the implications for interest under Section 234 and penalties under Section 271(1)(c).