2018 (12) TMI 1339 - HC - Income Tax

Entitlement for deduction u/s 80IB - hedging profit derived from industrial activity - whether hedging activity of Mentha Oil has a direct nexus with the manufacturing activity? - Held that - In the present case what we find is that the assessee needed high quantity of steady supply of the raw material, which would go into manufacturing its final product. If the assessee did not enter into hedging contract, it would be exposed to wide fluctuation of costs in procuring such material. This would expose the assessee to possible losses since while undertaking contracts for production and sale of the final product, the assessee would have taken into account the procurement price of the raw material at the prevailing rate. In order to avoid such uncertainties, the assessee would enter into hedging contracts. Essentially, the entire exercise was for the purpose of making the profit out of its manufacturing activity more predictable. If the assessee had not entered into such contract and relied on the spot purchase of the product, surely the resultant loss or profit as a case may be, would be part of the assessee s manufacturing activity and thereby, in any case qualify for deduction under Section 80IB or eligible for carrying forward loss if otherwise permissible under the Act. No difference in the situation merely because such gain or loss were pursuant to hedging contract of the assessee. - Decided against revenue

Summary

Issues:
1. Eligibility of hedging profit for deduction under Section 80IB of the Income Tax Act, 1961.
2. Allowability of losses from hedging contracts against business income.

Analysis:

Issue 1: Eligibility of hedging profit for deduction under Section 80IB
The primary issue in the case was whether the profit derived from hedging contracts by the assessee, engaged in manufacturing L-Menthol, had a direct nexus with the manufacturing activity and was eligible for deduction under Section 80IB of the Income Tax Act, 1961. The assessee entered into forward contracts to hedge against price fluctuations of the raw material, Crude Menthol Oil, used in manufacturing. The Assessing Officer disallowed the deduction, stating that the profit was not derived from the manufacturing activity. However, the CIT (Appeals) and the Tribunal allowed the deduction, emphasizing the close connection between the hedging contracts and the manufacturing activity. The High Court noted that the hedging contracts were essential for stabilizing costs and making profits from manufacturing more predictable. The Court referred to precedents like the Pankaj Oil Mills case, where losses from hedging contracts were allowed as business losses. The Court held that the profit from hedging contracts was part of the manufacturing activity and thus eligible for deduction under Section 80IB.

Issue 2: Allowability of losses from hedging contracts
The second issue involved the allowability of losses from hedging contracts against the assessee's business income. In years where the hedging contracts resulted in losses, the assessee sought to set off these losses against its business income. The Assessing Officer rejected the claim, deeming the losses speculative. However, the CIT (Appeals) and the Tribunal allowed the assessee's appeals. The High Court, in line with precedents and considering the purpose of the hedging contracts to stabilize costs, upheld the decision to allow the losses as part of the business activity. The Court emphasized that the losses were not speculative but inherent to the business operation and thus eligible for set off against business income.

In conclusion, the High Court dismissed the revenue's appeals, affirming the decisions of the CIT (Appeals) and the Tribunal. The Court clarified that the profit from hedging contracts and losses incurred therein were integral to the manufacturing activity, making them eligible for deduction and set off, respectively, under the Income Tax Act.