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TMI Blog2015 (9) TMI 497X X X X Extracts X X X X X X X X Extracts X X X X ..... ajestic Exports (2015 (7) TMI 936 - ITAT CHENNAI ) and recompute the business loss in line with the order of the Tribunal, after calling for details from the assessee and giving opportunity of being heard - Decided partly in favour of revenue for statistical purposes. - I.T.A.No.518/Mds/2014 - - - Dated:- 26-8-2015 - SHRI CHANDRA POOJARI AND SHRI CHALLA NAGENDRA PRASAD, JJ. For The Appellant : Dr. U.Anjaneyalu, CIT For The Respondent : Mr. B.Ramakrishnan, C.A. ORDER Per Challa Nagendra Prasad, JM: This appeal is filed by the Revenue against the order of the Commissioner of Income Tax (Appeals-V), Chennai dated 22.11.2013 for the assessment year 2009-10. The only issue in the appeal of the Revenue is that Commissioner of Income Tax (Appeals) erred in holding that forward contracts in respect of forex transactions entered into by the assessee with the banks will not fall under the definition of speculative transaction and holding that assessee is entitled to claim such loss as business loss. 2. Counsel for the assessee submits that the issue in appeal has been decided by the co-ordinate Bench in various cases holding that loss incurred on account of forw ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 32,979/- on account of forex loss hedging is a loss incurred in speculation business and the same shall not be allowed to be set off against business income. The loss of Rs. 46,82,32,979/- on account of forex loss hedging having been held to be incurred in a speculation business, shall be allowed to be carried forward and set off as per provisions of section 73. 5. On appeal, Commissioner of Income Tax (Appeals) considering the submissions of the assessee and contentions of the Assessing Officer and following the decision of Calcutta High Court in the case of CIT Vs. Soorajmull Nagarmull (129 ITR 169), Bombay High Court in the case of CIT Vs. Badridas Gauridu P.Ltd. (261 ITR 256) and the decision of co-ordinate Bench in the case of Cotton Blossoms in ITA No.2032/Mds/2012 dated 21.2.2013 held that various contracts entered into by the assessee will not fall under the definition of speculative transaction and assessee is entitled to claim deduction as the loss as business loss. We find that recently the co-ordinate Bench has decided similar issue in the case of M/s. Majestic Exports in ITA No.1336 3072/Mds/2014 dated 24.7.2015 wherein similar view has been taken by the co-ordi ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... oods. Besides, no person other than authorized dealers and money changers are allowed in India to trade in foreign currency, much less speculate. Section 8 of the Foreign Exchange Regulations Act, 1973, provides that except with prior general or special permission of the RBI, no person other than an authorized dealer shall purchase, acquire, borrow or sell foreign currency. Further he submitted that in the normal course of business of import and export, the assessee entered into foreign exchange contract to cover up the losses and differences in exchange valuation, the transaction is not a speculative transaction. Further, the ld. Authorised Representative for assessee further contented that the assessee is not a dealer in foreign exchange. For the purpose of hedging the loss due to fluctuation in foreign exchange while implementing the export contracts, the assessee had entered into forward contract with the banks. In some cases, the export could not be executed and the assessee had to pay certain expenses. These expenses the assessee claimed by way of expenditure towards business and the transaction can be stated to be in speculation as to cover under sub-section (5) of Section ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... CIT v. Soorajmull Nagarmull [1981] 129 ITR 169. 5.3 The ld. Authorised Representative for assessee relied on the order of the Co-Ordinate Bench, Mumbai in the case of D. Kishore Kumar Co vs. DCIT, 2 SOT 769 wherein it was held that assessee engaged in importing rough diamonds and exporting cut and polished ones, profits from cancellation of forward contracts in foreign exchange entered into with a view to minimize risk were integral part of assessee s exports profits eligible for deduction u/s.80HHC and Expln.(baa) had no application . 5.4 The ld. Authorised Representative for assessee relied on the order of the Co-Ordinate Bench, Mumbai in the case of DCIT vs. Intergold (I) Ltd, 124 TTJ 337, wherein it was held that Profits on cancellation forward exchange contract were assessee s profits of business, but as such profits were not derived from export activity and were received from banks in India not in convertible foreign exchange in terms of sub-s(2), of s. 80HHC,90 percent of the same has to be reduced from profits of business as per Expln.(baa) of s.80HHC . 5.5 The ld. Authorised Representative for assessee relied on the judgment of Jurisdictiona ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... xpiration (iii) strike price of the option (iv) volatality of the underlying asset (how much it moves up or down during a given period) (v) risk free rate of return (usually the interest rate paid by Govt ot banks on guaranteed investments). After Black-Scholes model, several models were developed, the noted among them being the Garman-Kohlhagen model designed to arrive at the price of FX options. Therefore derivatives transactions ceased to be purely speculative deals, long time ago. The pricing of the deals, follows a scientific pattern on the basis of Financial Mathematics. Just as Actuaries scientifically determine the value of insurance risks and the premium payable, Financial Mathematicians (or Portfolio Managers) evaluate the price of these derivatives. Hence they cannot be termed as wagers Two of the earliest circulars so issued by the Reserve Bank of India, were A. D (M. A. Series) Circular Nos. 21 and 26 dated 23.12.1994. They were issued in exercise of the power conferred under Section 73(3) of the Foreign Exchange (Regulation) Act, 1973, permitting authorised dealers (of foreign exchange) to offer forward cover to resident customers in any currency of their choice ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... Bench, Mumbai in the case of IVF Advisors Private Limited vs. ACIT in ITA No.4798/Mum/2012, dated 13.02.2015 wherein it was held that 7.4 Considering the relevant provisions of the relevant Acts, discussed herein above in the light of Hon ble Madras High Court and the answers given to frequently asked questions by the SEBI and the incorporation of exchange traded currency derivative from August, 2008, there remain no iota of doubt that the transaction of the assessee cannot be treated as speculative transaction. We have also gone through the copies of the contract notes incorporated in the paper book filed before us. A perusal of the contract note shows that the assessee has either entered into call option or put option and on the settlement day the transaction has been settled by delivery, either the assessee has paid US dollar on the settlement day or has taken delivery of US dollar. 7.5 To sum up, the derivatives include foreign currency and call option/ put option, are transactions of derivative markets and cannot be termed as speculative in nature. Considering the totality of the facts and in the light of the judicial discussion herein above, we have no hesitation i ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... bank in order to hedge its foreign exchange risk. In the case of the assessee, what has happened is that due to adverse foreign exchange movement, the bank has debited the loss to the assessee s account. Thus, the loss debited by the bank in the assessee s account has crystallized and is a realistic loss suffered by the assessee. In these circumstances, the issue under consideration before us is that, whether loss on account forex derivates are to be considered as a business loss in parlance with Section 28 of the Act. Further, in the case of the assessee before us, the following facts emerge and the legal issues involved are discussed and summarized herein below:- (i) The assessee has entered into forex derivative transactions only in order to contain the foreign currency fluctuation risk. (ii) Thus, the loss on account forex derivative transactions are directly attributable to the normal business of the assessee. (iii) The loss incurred by the assessee is realistic and not notional. (iv) Only money changers and banks are allowed to trade in foreign currency and the assessee is neither a money changer nor a bank. (v) The assessee has only utilized t ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ) Since the assessee has entered into foreign currency derivative contract adequate enough to cover the overall exposures of foreign currency, the contention of the Revenue that the proportion of the loss in derivatives is eight times more than the loss from currency fluctuation does not have any merits. (xii) The forex derivative transactions transacted by the assessee are through nationalized banks in compliance with the RBI regulations. These regulations permit the assessee to enter into such derivative transactions only by fulfilling certain conditions in the course of the business of the assessee. These regulations do not permit the assessee to enter into forex derivative contract as a separate business. (xiii) Section 73(1) of the Act restricts the set off of speculation loss against the other business income in only those cases were speculative transactions carried on by the assessee are of such nature so as to constitute a business by itself. It is pertinent to mention here that RBI does not permit any bank under its umbrella to entertain its client in any separate business of forex derivative transactions. Permission is granted only for the clients of the bank to ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... the Revenue to set off of the losses incurred by the assessee on account of forex derivatives contracts against the business income of the assessee . 5.8 Further, he also relied on the order of the Co-ordinate Bench in the case of M/s. S.P. Apparels Ltd vs. DCIT. in ITA No.1327/Mds/2014, dated 17.04.2015 in support of his contentions. 5.9 To sum up the contention the ld. Authorised Representative submitted is as follows:- (i) Foreign Exchange is not a commodity and therefore it was outside the purview of Section 43 (5). (ii) Derivative contracts entered into by the assessee have a direct underlying currency exposure on account of export proceeds receivable by the assessee. (iii) The decision to go for cross currency option contract was a decision purely to hedge the currency exposure of the assessee and he prays that both the appeals may be allowed. 6. On the other hand, the Departmental Representative submitted that one has to examine whether the derivative transaction for foreign currency will be included in the definition of commodity or not. According to ld. Departmental Representative a perusal of Section 43(5) would indicate that it reads as ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... overed under section 43(5) of the Act and ,the loss incurred in those transactions was liable to be treated as speculative loss and not business loss. 6.2 A perusal of the above judgements and averments contained therein, it was evident that the derivative transactions are included in the meaning of commodities and in these cases the transactions were held as speculative transactions before Section 43(5)(d) was brought in by Finance Act 2005, wherein transactions in shares alone were treated as non- speculative. The dictionary meaning of commodity is any product that can be used for commerce or an article of commerce which is traded on an authorized commodity exchange was known as commodity . By this definition foreign exchange such as US Dollar and Japanese Yen or derivatives arising from these currencies have to be treated as articles of commerce which was traded on a commodity exchange. Therefore, forex derivatives are clearly commodities as understood in business parlance. Further till the liberalization of Indian economy undertaken in 1991 foreign exchange was treated as scarce commodity and was not available for trade or purchase by individuals. It was only in mid 2000 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... y derivative transactions whether to be treated as business loss or speculation loss can be concluded as speculation loss based on the following points a) The derivative transactions entered into by the assessee with State Bank of India is not in the ordinary course of business of the . assessee who is an exporter of garments. Export bills or receivables of the assessee cannot be linked to the derivative transactions. b) By entering into a currency derivative transaction the assessee is clearly taking a speculative bet on the movement of Japanese Yen with US Dollars during a fixed period. These transactions are clearly a speculative bet on the currency which are in the nature of a wager contract. c) The forex derivative transactions are not settled by actual delivery of foreign exchange but only the difference between the agreed price on the maturity date that is credited or debited to the account of the assessee. d) The assessee claims that his transactions are as per RBI guidelines and FEMA regulations a conclusive view cannot be taken in this matter at present. It is pertinent to note that Orissa High Court judgement in the case of Pravanjan Patra Vs. Republi ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... rd by the assessee and has passed a detailed assessment order and the Commissioner of Income Tax (Appeals) confirmed the view of the Assessing Officer. He placed reliance on the order of the Tribunal in the case of Shri Vinodkumar Diamonds, (P) Ltd. vs. Additional Commissioner of Income Tax (2013) 35 Taxmann 337, the Tribunal wherein it was held as under Section 43(5) of the Income-tax Act, 1961 - Speculative transactions [Hedging transactions] - Assessment year 2008-09 - Assessee company exporter of diamond entered into forward contracts in respect of foreign exchange and incurred loss on cancellation of such contracts - It claimed that these transactions were hedging contracts to cover risk of fluctuation in foreign currency rates and not speculative transaction as held by revenue - Whether, where a contract for purchase or sale of commodity is periodically or ultimately settled otherwise than by actual delivery, same would fall within speculative transaction - Held, yes - Whether for hedging transactions it is necessary that commodity in respect of which forward transactions have been made by assessee must have a direct connection with goods manufactured or sold by assessee ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... as engaged in the business of manufacturing and export of hosiery garments. During the course of export, the assessee entered into derivative contract. The assessee incurred loss in this transaction. The assessee claimed it as business loss. According to the Assessing Officer this loss was not business loss and it is a speculative loss and this transaction is speculative in nature as such the loss incurred on this transaction cannot be set off against business income of the assessee. According to the ld. Authorised Representative for assessee, the derivative transaction cannot fall under sec.73. Explanation to sec.73 creates a deeming fiction by which among the assessee, who is a company, as indicated in the said Explanation dealing with the transaction of share and suffer loss, such loss should be treated to be speculative transaction within the meaning of sec.73 of the Act, notwithstanding the fact that the definition of speculative transaction mentioned in sec.43(5) of the Act, the transaction is not of that nature as there has been actual delivery of the scrips of share. As per the definition of sec.43(5), trading of shares which is done by taking delivery does not come under ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e, prior to 1st April, 2006 any transaction in which a contract for the purchase or sale of any commodity including stocks and shares was periodically or ultimately settled otherwise than by the actual delivery or transfer of the commodity or scrip was a speculative transaction. Sub-section 1 of Section 73 provides as follows: (1) Any loss, computed in respect of a speculation business carried on by the assessee, shall not be set off except against profits and gains, if any, of another speculation business. The resultant effect was that any loss arising out of speculative transaction could only have been set off against profits arising out of speculative transaction. In the present case, the assessee, as already indicated, has been dealing in shares where delivery was in fact taken and also in shares where delivery was not ultimately taken. In other words, the assessee has been dealing in actual selling and buying of shares as also dealing in shares only for the purpose of settling the transaction otherwise than by actual delivery. The question arise whether the losses arising out of the dealings and transaction in which the assessee did not ultimately take delivery of ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ever, we make it clear that total transaction considered for determining this business loss from derivative transactions cannot be more than the total export turnover of the assessee for the assessment year under consideration and if the derivative transaction is in excess of export turnover, then that loss suffered in respect of that portion of excess transactions to be considered as speculative loss only as that excess derivative transaction has no proximity with export turnover and the Assessing Officer is directed to compute accordingly. This ground is allowed as indicated above. 6. As could be seen from the above, the Tribunal held that forex transactions entered into by the assessee are not derivative transactions. However, it was held that transactions considered for determining the business loss from derivative transactions cannot be more than the total export turnover of the assessee for the assessment year under consideration and if derivative transactions are in excess of export turnover then the loss suffered in respect of portion of that excess transactions are to be considered as speculative loss only since the excess derivative transaction has no proximity with ..... X X X X Extracts X X X X X X X X Extracts X X X X
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