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TMI Blog2013 (11) TMI 424X X X X Extracts X X X X X X X X Extracts X X X X ..... d CIT (A) further erred in fact and in law in not allowing this forward contract loss of Rs. 4,69,42,680/- to be set off against the Profit and Gains on account of exchange fluctuations on realization/revaluation of the said receivables, this being directly related to the same business transaction and which has been assessed to tax. C. The CIT (A) erred in fact and in law in considering this losses as speculative without taking into account the appellants contention on the issue viz; (i) These contracts were booked as permitted by RBI Regulations. (ii) The transactions were covered by the exception provided in section 43(5)(a) on the Income Tax Act, 1961." 3. Briefly stated relevant facts of the case are that the assessee is engaged in the business of trading and manufacturing of rough and polished diamonds and filed the return of income declaring the total income of Rs. 35,29,042/-. Assessment was completed u/s 143(3) of the act determining the total income of Rs. 5,04,71,720/-. Assessing Officer made addition of Rs. 4,69,42,680/-. Relevant fac ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... the assessee contended that the impugned loss is outside the scope of the "speculation transaction" and the loss being integral part of the export business constitutes 'business loss'. Consequently, the same is eligible for set off against the foreign exchange gains earned by the assessee both on account of actual realizations and revaluation of the outstanding receivables. Eventually, AO considered the above submissions of the assessee and also examined the applicability of the provisions of section 43(5) of the Act in general and clause (c) of the proviso to section 43(5) in particular and held that the impugned transactions do not satisfy in all the conditions specified in the said provisions. Relevant discussion is given in para 9 of the assessment order. AO dismissed the applicability of clause (a) of the proviso to section 43(5) stating that the assessee failed to demonstrate that the impugned transactions were incurred for hedging the risk against the raw material or merchandize. Similarly he rejected the applicability of clause (b) of section 43(5) of the Act too. AO opined that the same applies to the stocks and shares. On the applicability of clause (c) to section 43(5), ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... uation of the outstanding receivable is concerned, the AO taxed the as the business income of the assessee and accordingly, denied the set off of the loss of Rs. 4,69,42,680/- against the gains of Rs. 679.75 lacs. Aggrieved with the same, assessee filed the present appeal before the CIT (A). Before the CIT (A) 4. During the proceedings before the first appellate proceedings, assessee made written submissions and mentioned that the impugned forward contracts (FCs) are linked or incidental to the export invoices of the year and the outstanding receivables related to the exports and therefore, these are hedging transactions and constitutes business contracts. Assessee mentioned that, leaving 50% of the contracts which are settled by delivery, rest of the transactions are either terminated by the Bank on due / maturity dates due to commercial reasons because of non-realization of exports from the debtors. Further, the assessee mentioned that out of the forward contracts cancelled prior to the due dates, some of these contracts are cancelled three days prior in view of the week end holidays. Referring to the terminated and cancelled Forward contracts on the due date or later, the asse ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... anjan, Ld Counsels for the assessee appeared before us. To start with, the back-ground facts of the case and the issues raised before the Tribunal were explained. He mentioned that the CIT(A) erred in treating the business transactions as the speculation one in nature and eventually erred in not treating the loss of Rs 4,69,42,680/- as business loss of the assessee. Briefly mentioning the grievances, Ld Counsel mentioned that, as claimed in the return of income, AO should have allowed the claim of set off of the said loss against the profits of the foreign exchange earned on actual realizations and revaluation of the outstanding receivables in foreign exchange. He also relied on the exclusions provided in the proviso to section 43(5) and also the RBI guidelines. 6. Elaborating the disputes and the issues, Ld Counsel submitted that the assessee entered into the Forward Contracts (FCs) with the Banks as integral part of the export business with the aim to safeguard against the foreign exchange fluctuation of the US dollar vis avis the Indian currency and therefore, the FCs are not speculative transactions or speculation business. To substantiate the same, he mentioned that the total ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... . In the process, judgment in the case of Sooraj Muill Magarmull 129 ITR 169 (para 3) from Calcutta High court is followed. Thus, Ld Counsel is critical of the conclusions of the CIT (A) and manner of distinguishing the said binding judgment on frivolous grounds. Ld Counsel is also critical of the CIT (A)'s conclusions, who mistook the impugned FCs as currency derivatives, and mentioned that these derivatives should have been treated differently in view of the specific definition provided to derivatives in section 2(ac) of Securities Contract Regulation Act, 1956. 9. Meaning of the expression "Commodity" used in section 43(5) of the Act: Further, elucidating the provisions of section 43(5) relating to the definition of 'speculation transaction', Ld Counsel made various propositions stating that foreign exchange contract is not a commodity and therefore, there is no provision in law to treat the impugned FCs as speculation transaction. He relied on the decision of the Tribunal in the case of M/s. Gill & Co. Ltd v. JCIT vide ITA No.216/M/2002 (AY 1996-97), dated 21st February, 2003, Voltas International Ltd v. ACIT vide ITA No.2931/M/2005 (AY 1996-97) dated 18.7.2008; and Munjal Sho ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... contracts, which again allowable as business loss and not as speculation loss. In this regard, Ld Counsel relied on the judgment of the Hon'ble Supreme Court in the case of CIT v. Shantilal (P) Ltd [1983] 144 ITR 57 (SC) and the one reported in 207 ITR 198. 13. Distinguishing the decision in the case of S. Vinodkumar Diamonds Pvt. Ltd: Bringing our attention to the decision of the ITAT, Mumbai in the case of S. Vinodkumar Diamonds Pvt. Ltd v. Addl.CIT vide ITA No.506/M/2013, Ld Counsel distinguished by stating that the loss on account of cancellation of FCs was actually allowed by the AO and therefore, there is no dispute on this issue. However, the dispute in this case revolves around if the 'loss on revaluation of outstanding FCs' whose maturity date falls in the next years'. On mentioning that the said decision is not relevant for the impugned disputed here, Ld counsel filed a copy of the MA arising from said ITA No.506/M/2013 and the same is pending for adjudication before the Tribunal. 14. Factum of foreign exchange fluctuations - Need for hedging transactions: Referring to the page 15 of the paper book, Ld Counsel mentioned that during the year, the foreign exchange rate of ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... the list of such distinguishing features include (i) discharge of onus with regard to correlation of FCs with the export invoices; (ii) failure of exports; (c) Soorajmull Nagarmull case, supra which was relied by Bombay HC was decided on Income Tax 1act, 1922; (d) facts about the RBI clearances were not demonstrated by the assessee etc. Decision of the Tribunal 16. The issues for adjudication in this order include (i) if the FCs entered into with the Bank constitutes the integral or incidental to the activity of export of the diamonds by the assessee, who is not the dealer in foreign exchange. (ii) Further, we need to examine if the AO is justified in not setting off against the profits on actual realization or revaluation as speculation profits. Scope of the Speculation Transactions and Business 17. Before declaring the decisions of the Tribunal on the issues raised before us, we find it relevant to scan the relevant provisions i.e. section 43(5) of the Act, Explanation to section 28 etc. Definitions of the speculation transaction on speculation business: 18. The provisions of section 43(5) provides for definition of "speculation transactions". The said provisions read as un ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... acts entered into in the course of manufacturing and merchandizing of the business to guard against the losses through future price fluctuations in respect of contracts for actual deliver. Clause (b) deals with the contracts entered into by dealer or investor in respect of Stock Exchange and Clause (d) deals with an eligible transaction in respect of trading derivatives carried out in a recognized Stock Exchange. Clause (e) deals with eligible transactions in respect of the trading in commodity derivatives carried out in a recognized association. These five types of contracts / eligible transactions shall not be deemed as speculative transactions. Although there is decision of the Tribunal where it is held that the FCs are not commodities, considering the judgment of Hon'ble High court of Calcutta in the case of Sooraj Muill Magarmull (supra), which was followed by the judgment of jurisdictional High Court in the case of Badridas Gauridu Pvt Ltd (supra), needs to be followed by us. The principle of "judicial discipline" assumes importance and therefore, the "commodity" includes the "forward contract'. Thus, in principle, the forward contracts, being commodity, should fall in the de ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... In this regard, relevant decisions include the decision in the case of D Kishore kumar and Co supra, binding judgment of the Bombay High Court in the case of CIT v. Badridas Gauridu Pvt Ltd (supra), judgment in the case of Sooraj Muill Magarmull 129 ITR 169 (para 3) from Calcutta High Court. The judgments from the High Court of Ahmedabad in the cases of Friends and Friends Shipping Pvt. Ltd (supra) and in the case of Panchamahal Steel Ltd (supra) are also relevant. These decisions / judgments are unanimously relevant for the proposition that the FC transactions, when entered into with the banks for hedging the losses due to foreign exchange fluctuations on the export proceeds, are to be considered integral or incidental to the export activity of the assessee. Therefore, the losses or gains constitute the business loss or gains and not the speculation activities. In the preceding paragraphs of the order, in the portions assigned to the AR's arguments, we have analyzed these issues and the DR has not provided any reasons to reject the said arguments of Ld Counsel for the assessee. Therefore, in principle, we agree with the arguments of Ld Counsel for the assessee. Further, we also a ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... the fact that the assessee realized profits on cancellation of those contracts. These transactions are integral part of the export business and cannot be considered in isolation of the export business in the course of which the transactions have been entered into. As a matter of fact, this profit on cancellation of forward contracts is generally revenue neutral because the question of profit on cancellation of forward contracts can only arise in a situation when the value of foreign currency is increasing vis-a-vis domestic currency, and when the foreign exchange value is so increasing the ultimate payment made in foreign exchange by the assessee also increases. ...... Since it is an undisputed position that the imports, in connection with which the assessee had entered into forward contracts, actually took place, this profit on cancellation of forward foreign exchange contracts effectively only reduces the costs of purchases in respect of those imports, and cannot be, by any logic, construed as transactions independent of assessee's business of importing rough diamonds and exporting cut and polished diamonds. There is one more aspect of the matter, and that is the reason as to why ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... d these facts. Under section 43(5) of the Income Tax Act, "speculative transaction" has been defined to mean a transaction in which a contract for the purchase or sale of commodity is settled otherwise than by the actual delivery or transfer of such commodity. However, as stated above, the assessee was not a dealer in foreign exchange. The assessee was an exporter of cotton. In order to hedge against losses, the assessee had booked foreign exchange in the forward market with the bank. However, the export contracts entered into by the assessee for export of cotton in some cases failed. In the circumstances, the assessee was entitled to claim deduction in respect of Rs. 13.50 lakhs as a business loss. This matter is squarely covered by the judgment of the Calcutta High Court in the case of CIT v. Sooraj Mull Nagarmull [1981]129 ITR 169." Judgment of Calcutta High Court in the case of CIT v. Sooraj Mull Nagarmull [1981] 129 ITR 169 (Cal.) Held: The assessee used to carry on export and import of jute business. In the course of normal business it used to enter into foreign exchange contracts in order to cover up loss and difference in ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... the P & L account for the year after set off and the same is the subject matter of dispute between the parties as the AO did not allow such set off. 30. As explained earlier, AO treated whole of the loss of Rs 4,69,42,680/- as the speculation loss of the assessee. The profile of the total forward contracts (FCs) booked and cancellation of the FCs and the timing thereof are tabulated as under: Total Amt of FCs (US$) Amount of Cancelled FC (US$) Loss on FCs Cancelled on/ after due date (INR) Loss on FCs Cancelled 3 days prior from due date (INR) Loss on FCs Cancelled prior to more than 3 days (INR) Total of 3+4+5 (INR) 1 2 3 4 5 6 19,444,000 10,704,760 41,488,805 4,218,940 1,892,078 46,942,680 31. Thus, the above table suggests that out of the total loss, loss of Rs. 4,14,88,805/- was to the Banks on account of loss on cancellation of matured FCs i.e., cancelled on or after the due date. This loss is payable to the Bank as part of the termination of contracts after the full period of contract. It is attributable to the genuine failure of the trade debtors, who failed to comply with the credit terms and conditions. In other words, they are not the cases of prematu ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... s which would prima facie suggest that there was no direct co-relation between the exchange document and the precise contract. However, such observations cannot be seen in isolation................ .............We find that the decisions of the Bombay High Court and the Calcutta High Court noted above would cover the situation. 34. From the above analysis and summary of judgments, it is safely concluded that the impugned FCs are "commodities". However, considering the fact that these FCs are integral part or incidental to the core business of export of diamonds or the outstanding receivables of export proceeds, in principle, the impugned FCs constitute 'hedging transaction' and not the 'speculative contracts'. As such, the banks do not entertain FCs of speculative nature with the customers like the assessee, the exporter. As such, the extention of FCs, in case of non-receipt of export proceeds on the due dates, is not allowed without cancelling the existing FCs. However, the onus is on the assessee to explain satisfactorily why the assessee resorted to premature cancellation of some FCs. Further, it is not the requirement that there must be 1:1 precise co ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... xplanation of the assessee revolves around the fact that the maturity of date of some of such premature cancelled FCs fell during the week-end days and therefore, the assessee cancelled such FCs three days prior to the due date. Related loss is quantified at Rs 42,18,940/-. In our opinion, the explanation of the assessee is acceptable and the AO is directed to allow the claim and of course, after due verification of the factum of week-ends. Thus, this part of the ground of the assessee is allowed as above without going into the alternate arguments relating to "damages". (ii) The other shade of loss of premature cancellation of FCs relates to the FCs cancelled prior to longer than three days constitutes another fraction of the loss and the assessee's explanation in this regard revolves around the general explanation of reduction of losses. Relevant loss is worked out at Rs 18,92,078/-. This segment of losses relates to premature cancellations of the FCs and the explanation of the assessee is very general. As such, premature cancellations should also be allowed as business loss in view of the decisions discussed in the preceding paragraphs, so long as the re ..... X X X X Extracts X X X X X X X X Extracts X X X X
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