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TMI Blog2015 (7) TMI 936X X X X Extracts X X X X X X X X Extracts X X X X ..... eaning, so far as sec.43(5) of the Act is concerned. Again, in view of the fact that both delivery transactions and derivative transactions are non-speculative as far as sec.43(5) is concerned, it follows that both will have the same treatment as far as application of Explanation to sec.73 is concerned. Therefore, aggregation of the share trading profit and loss from derivative transactions should be done before the Explanation to sec.73 is applied. Both trading of shares and derivative transactions are not coming under the purview of Section 43(5) of the Act which provides definition of “speculative transaction” exclusively for purposes of section 28 to 41 of the Act. Again, the fact that both delivery based transaction in shares and derivative transactions are non-speculative as far as section 43(5) is concerned goes to confirm that both will have same treatment as regards application of the Explanation to Section 73 is concerned, which creates a deeming fiction. From the above decision of the Calcutta High Court in the case of Baljit Securities Pvt. Ltd. cited [2014 (6) TMI 475 - CALCUTTA HIGH COURT] the issue stands covered in favour of the assessee. However, we make it c ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ries and receives Dollars or Euros. Payments from foreign buyers in foreign currencies are received through the State Bank of India. During the year under consideration the assessee entered into many forex derivative contracts including six structured contracts. These are stated to be called as Exotic Cross Currency Option contracts. In respect of one of the structured contracts with State Bank of India on various dates, the assessee incurred huge losses to the extent of ₹ 4,30,44,915/- and the assessee claimed the said loss as business loss. As per the assessee trading in futures and options is no longer speculative transactions as per proviso (d) to Sec.43(5) inserted by the Finance Act, 2005 w.e.f. 01.04.2006. However, the Assessing Officer observed that loss incurred out of trading in futures and derivatives contract could not be considered as business loss and it is to be considered as speculative transactions and distinct from assessee s business and it is a speculative business of the assessee. Accordingly, the Assessing Officer treated the speculation loss not allowable to set off against business income of the assessee. Against this, the assessee carried the matter i ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 012, dated 21st February, 2013 wherein it was held that The assessee is an exporter of hosiery garments. There is no dispute that the assessee is not a dealer in foreign exchange. The assessee s forex transactions only in the course of its business and not as a separate business as observed by the Assessing Officer because the assessee is not a dealer in foreign exchange . 5.1 The ld. Authorised Representative for assessee relied on the order of the Co-Ordinate Bench, Delhi in the case of Munjal Showa Ltd vs. DCIT, 94 TTJ 227, dated 26th June, 2003 wherein it was held that Profit on cancellation of forward contract in foreign currency entered into for safeguarding against loss by fluctuation in foreign currency for purchase of plant and machinery with loan obtained in foreign currency is capital receipt and not speculative profit. 5.2 The ld. Authorised Representative for assessee relied on the judgment in the case of CIT vs. Badridas Gauridu (P) Ltd 261 ITR 256, (Mumbai) wherein it was held that The assessee was not a dealer in foreign exchange. The assessee was a cotton exporter. The assessee was an export house. Therefore, foreign exchange contracts were ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... he above sequence of events would show that the transaction in question, from its very nature, cannot be termed as a wager. We have seen in paragraph-55 above that three tests are to be satisfied if a contract is to be termed as a wager. The first test is that there must be two persons holding opposite views touching a future uncertain event. The second test is that one of those parties is to win and the other is to lose upon the determination of the event. The third test is that both the parties have no actual interest in the occurrence or nonoccurrence of the event, but have an interest only on the stake. The first test is satisfied in this case as there are 2 parties. But, the second test may not be satisfied in this case since the plaintiff may not always stand to lose. If the plaintiff loses in the underlying contract on account of currency fluctuation, it may get compensated by the hedging and vice versa. Therefore both parties cannot be taken to be winners or losers in absolute terms. Even if we take for the sake of argument that the first two tests are satisfied in this case, the third test is certainly not satisfied in the case on hand. Both the parties definitely have an ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... se circulars acknowledged the fact that the customers may at times, wish to hedge against a third currency instead of the rupee. Therefore these circulars permitted the authorised dealers to provide forward sale or purchase facilities, in the currency of receivables or payables against a third currency, provided the latter currency is also a permitted currency and is actively traded in the market, if the customer wished to hedge against a third currency instead of the rupee. Customers will ordinarily require forward cover facilities for the foreign currency in which their receivables or payables are denominated, against the Indian rupee. If for any reason, customers wish to hedge them against a third currency instead of the rupee, authorised dealers may provide forward sale or purchase facilities as appropriate, in the currency of the receivables or payables against the third currency provided the latter currency is also a permitted currency and is actively traded in the markets. Partial hedging may also be permitted whereby the customer hedges the currency of receivables or payables against the third currency first and completes the hedge against the rupee subsequently. Part ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... inate Bench, Madras in the case of M/s. SCM Garments (P) Ltd vs. DCIT, in ITA No.1645/Mds/2013 and ITA No.2275/Mds/2014, dated 27.02.2015 wherein it was held that We have heard the rival submissions and carefully perused the material on record and case laws relied by both the parties. In this case before us, one of the major business activities of the assessee is export of business garments as it appears from the financial statements submitted by the assessee. Therefore, it is obvious that the assessee would be having huge sundry debtors resulting from export of garments which are receivable in the foreign currency. These sundry debtors are exposed to currency fluctuation risk. One of the methods to protect loss against foreign currency fluctuation is by way of hedging . Hedging transactions are entered in order to protect against the loss due to compensatory price movement. It protects an asset or liability against fluctuation in foreign exchange rate. One of the tools for hedging the forex risk is by way of foreign currency derivatives. Section 45 of the Reserve Bank India Act, 1949 defines derivative as a financial instrument whose value depends on the value of the underl ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... he ITAT, Kolkata Bench in the case of Shri Capital services Ltd Vs. ACIT in 121 ITD 498(Kol.)(SB) has held that foreign currency is neither commodity nor shares as defined U/s. 43(5) of the Act. (vii) The Instructions issued by CBDT Instruction No.03/2010 dated 23.03.2010 has recognized the loss out of forex derivatives on actual settlement/conclusion of contracts as allowable business loss, however they have directed the Revenue to examine whether the transactions would fall U/s. 43(5)(d) of the Act, and if so to treat the same as non-speculative transaction. By the above directions, it appears that though the CBDT has recognized the loss arising out of forex derivatives on actual settlement of the contracts, directed the Revenue to treat the same as speculative transaction when they are transacted through nationalized banks and as not speculative, when these transactions are transacted through recognized stock exchange. (viii) It is pertinent to note here that the bankers act as an advisory agent to the assessee in order to protect them from foreign exchange exposure by using their expertise and these services cannot be obtained by the assessee in the stock exchange w ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... n the case M/s.Rajashree sugars and chemicals Ltd Vs. Axis Bank Ltd., in O.A Nos.251 252 of 2008 in C.S.No.240 of 2008 O.A. Nos.526 527 of 2008 in C.S No.240 of 2008A. Nos.1926, 1927, 2446 and 2447 of 2008 in S.S No.240 of 2008 vide order dated 14.10.2008 reported in 8 MLJ 261 has held that derivative transactions ceased to be speculative transactions or wages because pricing of the deal follows a scientific pattern on the basis of financial mathematics. Just as actuaries scientifically determined the value of insurance risk and the premium payable, Financial Mathematician/Portfolio Managers evaluate the price of these derivatives. Thus to sum up in the present case before us, the assessee is an exporter of garments who has entered into forex derivative transactions through its bankers with a view to effectively hedge its foreign currency risk. Therefore, these forex derivative transactions have a close proximity or rather incidental to the export business of the assessee, which cannot be considered as speculative. Moreover in the case of the assessee foreign currency contracts cannot be treated as wagering contracts for the reasons discussed herein above. Section-43(5) o ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... r Sec.43(5)(d) excludes trading in derivatives carried out through a recognized stock exchange from the ambit of speculative transaction. This clearly excludes derivatives trading through stock exchanges and conversely there cannot be any exclusion without an earlier inclusion. Unless it was the intention of the legislature that trading derivatives are included in commodity, they would not have specifically excluded trading through stock exchange under Section 43(5)(d) of the Act. Therefore, it was evident that derivatives will form part of 'commodity' mentioned u/s.43(5). He placed reliance on the order of the Special Bench of the Calcutta Tribunal in the case of Sri Capital Services vs. ACIT(2009) (121)TD (Cal) wherein it was clarified that derivatives are commodities for the purpose of Sec.43(5)(d). The relevant head notes of the judgement is reproduced as under: Section 43(5) of the Income tax Act 1961 - Speculative transactions - Assessment year 2004-05 -whether clause (d) of proviso to section 43(5) is prospective in nature and will be effective from date on which Legislature made it effective i.e.1.4.2006 - Held Yes - Whether term derivatives' in which und ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... trading in foreign currency derivatives.Therefore it is evident that when the Income Tax Act framed in 1962 the Parliament in its wisdom could not have foreseen large scale forex and forex derivatives transactions could be undertaken by the assessee. This is the reason why trading in forex derivatives was not separately incorporated into the Income Tax Act. 6.3 The Ld. Departmental Representative further contented that a perusal of the contract note and scenario analysis and risk would clearly indicate that these contracts have nothing to do with overall forex earnings of the assessee either in US Dollars or Japanese Yen. The assessee's account is debited or credited on settlement date given in the contract based on the currency movements upto maturity date. In this derivative contracts assessee can neither deliver US dollars nor Japanese Yen from the export earnings. The assessee can derive a profit or loss based on the currency movement ie. Japanese Yen Vs. US Dollars. Therefore, the claim of the assessee that these are hedging based on the export earnings cannot be accepted. The argument of the assessee that these contracts were entered into based on development research ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ot within the four corners of law. e) An analysis of the complex derivative transactions entered into by the assessee does not correlate to their trade exposure. In these derivatives the assessee had undertaken the risk of buying dollars and selling Japanese Yen, when the company was never a buyer of Dollars nor did they ever have any Japanese Yen assets. These derivative transactions were complex leveraged structures which were sold by the bankers to the assessee. Based on the currency movement at the maturity date or at the knock out time the assessee suffered huge losses which were disproportionate to their normal business. f) The fact that the Reserve Bank of India has passed penalty orders on many bankers including SBI. g) The Contract Notes mentioned certain scenario analysis and risk statement. However, a perusal of the same would indicate that these scenarios and risks have not been properly analysed by the assessee but have been merely incorporated in the Contract Note. Similarly the declaration of the exposure given in the second page of the Contract Note The size and tenor of the above transaction is not in excess of the underlying exposure in Balance ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e held as hedging transactions - Held, yes Whether, therefore, forward contract transactions in foreign exchange, against which there was no actual delivery by assessee were speculative and not hedging transactions and, thus, loss on same was not allowable - Held, yes in favour of revenue. 6.5 The Ld. Departmental Representative submitted that a perusal of the above judgement clearly indicates that foreign currency was treated as a commodity and transactions including cancellation of foreign currency forward contracts which was settled otherwise than the actual delivery will be treated as speculative transaction. The derivative transaction entered into by the assesses are without hedge, underlying and there cannot be any delivery against derivative transactions. The principle laid down in the above judgement will squarely apply in the case of the assessee. The claim of the assessee's derivative transactions are having an underlying hedge against export bills of the assessee, is akin to saying that an exporter visiting Hong Kong and having a loss from his gambling in a Casino in Macau are to be treated as a business loss. The exporter may have receivables in Hong Kong dolla ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... n as defined in the said section. Therefore, both profit/loss from all the share delivery transactions and derivative transactions are having the same meaning, so far as sec.43(5) of the Act is concerned. Again, in view of the fact that both delivery transactions and derivative transactions are non-speculative as far as sec.43(5) is concerned, it follows that both will have the same treatment as far as application of Explanation to sec.73 is concerned. Therefore, aggregation of the share trading profit and loss from derivative transactions should be done before the Explanation to sec.73 is applied. The above view has been taken by Special Bench of this Tribunal, Mumbai Bench, in the case of CIT v. Concord Commercial Pvt. Ltd. (2005) 95 ITD 117 (Mum)(SB). In this case, the Special Bench held that : Before considering whether the assessee s case is hit by the deeming provision of Explanation to Sec. 73 of the Act, the aggregate of the business profit / loss has to be worked out based on the non-speculative profits; either it is from share delivery or from share derivative. 8. From the above, it is concluded that both trading of shares and derivative transactions are not co ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... selling of shares. An answer to this question is to be found in the explanation appended to Section 73 which reads as follows: Explanation: where any part of the business of a company other than a company whose gross total income consists mainly of income which is chargeable under the heads interest on securities , or a company the principal business of which is the bu9siness of banking or the granting of loans and advances) consists in the purchase and sale of shares of other companies, such company shall, for the purposes of this section, be deemed to be carrying on a speculation business to the extent to which the business consists of the purchase. In order to resolve the issue before us, the section has to be read in the manner as follows: Explanation : Where any part of the business of a company ( . . . .. .. .. .. .. .. .. . .. .. . ) consist in the purchase and sale of shares of other companies, such company shall, for the purposes of this section, be deemed to be carrying on a speculation business to the extent to which the business consis ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... w that apart from share from Majestic Exports her individual income was only ₹ 2,94,818/- The assessee not able to explain any accumulation of income in any bank of K. Angthal. In the absence of any evidence, it was perused that there was no source for introduction of capital and the same was confirmed in the hands of the firms as undisclosed income by the Assessing Officer, which was confirmed by the Commissioner of Income Tax (Appeals). Against this, the assessee is in appeal before us. 12. We have heard both the parties and perused the material on record. If any capital is introduced by the partner, the assessee shall prove the identity of the partner, genuineness of the transaction and credit worthiness of the partner. In the present case, if the partner confirmed the introduction of the capital from their account then the burden cast upon the assessee is discharged as held by the Andhra Pradesh and Telangana High Court in the case of CIT vs. M. Venkateswara Rao, 57 taxmann.com 373. Accordingly, in the interest of justice, we remit the issue back to the file of the Assessing Officer with a direction to the assessee to place necessary evidence confirming the capital con ..... X X X X Extracts X X X X X X X X Extracts X X X X
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