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TMI Blog2017 (1) TMI 615X X X X Extracts X X X X X X X X Extracts X X X X ..... aw, the Ld. CIT(A) has erred in allowing the assessee's appeal regarding loss on Forward Contracts in foreign exchange when the assessee does not deal in foreign exchange and is a diamond merchant.? 2. Whether on the facts and in the circumstances of the case and in law, the Ld. CIT(A) has erred in not following decision of Co-ordinate Bench of ITAT in the case of M/s. Vinodkumar Diamonds Pvt. Ltd. in ITA no. 506/Mum/2013 even when the identical issue was decided by ITA in favour of Revenue in that case? 3. Whether on the facts and in the circumstances of the case and in law, the Ld. CIT(A) has erred in allowing loss on cancellation of Forward Contracts in foreign exchange even when the assessee was unable to establish one to one relation between its export invoices and the foreign currency transactions?" 3.The brief facts of the case is that the assessee is engaged in the business of export and import of diamonds. It was observed by the AO from the Profit and Loss account that the assessee has debited a amount of Rs. 85,88,209/- on account of exchange difference. The assessee on being asked submitted that the loss of Rs. 85,88,209/- was incurred by the assessee on cancellation ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... d CIT(A). 4. Aggrieved by the assessment order dated 26-02-2013 passed by the AO u/s 143(3) of the Act, the assessee filed appeal with the learned CIT(A), which appeal was allowed by the learned CIT(A) by following the decision of the tribunal in assessee's own case in immediately preceding assessment year 2009-10 in ITA No. 6169/Mum/2012 vide orders dated 11.10.2013, wherein the learned CIT(A) held as under: "5.2 On examination of the facts of the appellant under the year under consideration in the light of the aforementioned decision of Hon'ble ITAT in appellant's case of preceding year i.e. 2009-10 , it is noted that during the year under consideration the appellant has earned a loss of Rs. 1,69,98,416/- on the transactions which were cancelled on or after the due date of maturity. In view of the decision of Hon'ble ITAT in the case of the appellant for immediately preceding year such losses are genuine business losses which cannot be treated as speculative losses. It is also a fact that the appellant has also cancelled some of its foreign exchange forward contracts before the due date, but such transactions has resulted in net profit of Rs. 85,27,033/- ( profit on such transa ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... n exchange contracts. We have observed that the tribunal has adjudicated these issues' raised by the Revenue in detail in ITA no 6169/Mum/2012 in assessee's own case for the assessment year 2009-10 by holding as under: "This appeal filed by the assessee on 9.10.2012 is against the order of the CIT (A)-9, Mumbai dated 10.7.2012 for the assessment year 2009- 2010. 2. In this appeal, assessee filed the grounds of appeal, which was subsequently revised vide letter dated 5.10.2012. The said revised grounds filed by the assessee read as under: "1.A. The Ld CIT (A) erred in fact and law in confirming the disallowance of Forward Exchange Loss of Rs. 4,69,42,680/- claimed by the appellant in the course of business incurred due to fluctuation in foreign exchange for which the appellant had booked forward contracts with the bank against their export receivables treating the same as speculation transaction & not hedging transactions as claimed by the appellant. B. The Ld 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 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ofits. It is the stated reasoning of the assessee, being an exporter, he has outstanding receivables whose value in US dollar is always subjected to market fluctuations internationally. Therefore, he needs to hedge the receivable against the exchange loss if any. Accordingly, he entered into the forward contracts with the Banks as per the RBI guidelines. Thus, the gains as well as the loss constitute business gains and loss and entitled for set off before the net gains is credited to the P and L Account. In this regard and before the AO, the assessee relied on the exemptions provided in clause (c) of the proviso to section 43(5) of the Act which provides for the definition of "speculation transaction". Clauses (a) to (e) of the said section provides for exemption of certain facts from the definition of "speculation transaction‟. Thus, 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 revalu ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... se of Delhi Flour Mills Co. Ltd. v. CIT [1974] 95 ITR 151 (Delhi), AO opined that the foreign exchange transactions cannot have any nexus with the export of diamonds. In this regard, AO is of the opinion that the person selling cotton cannot enter into forward contract, say for gold. He also discussed the judgment of Bombay High Court in the case of CIT v. Arjan Khimji & Co. [1980] 121 ITR 421/[1979] 1 Taxman 550. Thus, AO concluded by stating that the foreign exchange/currency derivative transactions are not covered by the exclusions provided in the proviso to section 43(5) of the Act. Further, he held that assessee failed to the establish that the transactions in question have the nature of hedging transactions and he treated the loss of Rs. 4,69,42,680/- as the speculation loss and made the addition. So far as the profit earned on actual realization of export proceeds and the profits on revaluation 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). ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ills couple of conditions and the impugned transactions must be treated as hedging transactions. Further, assessee relied on RBI Circular dated 13.12.2006 and the CBDT Circular No.23D dated 12.9.1960 and mentioned that RBI has no problem with the impugned contracts as they are undergone to guard the risk of underlying receivables and the claim of the assessee needs to be accepted. Assessee also relied on the Dollar rate fluctuations from April 2008 to March 2009, which registering per dollar appreciation from Rs. 39.9668 to Rs. 51.2062 during the year. Eventually. CIT (A) considered and rejected above arguments of the assessee. Eventually, assessee's appeal was dismissed upholding the conclusions of the AO. Aggrieved with the decision of CIT (A), assessee filed the present appeal before the Tribunal vide ground imported above. Before the Tribunal Ld AR's Arguments 5. Mr Soli Dasture and Mr. Nikhil Ranjan, 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 eve ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... business transactions constitutes its integral part and loss or gains is allowable as business loss or gains as the case may be. Referring to the said decision in the case of D Kishorekumar & Co.(supra) Ld Counsel mentioned that the 'the fact of premature cancellation cannot alter the nature of the transaction'. In this case, the issue was if the gains from the FCs constitutes 'business profits' and eligible for deduction u/s 80HHC without invoking the Clause (baa) of the its Explanation. Hon'ble Tribunal held that the FCs constitutes 'integral part' and the gains are treated as 'profits of the business' and in favour of the assessee. Referring to the binding judgment of the Bombay High Court in the case of v. Badridas Gauridu (P.) (supra), Ld Counsel mentioned that the losses earned by assessee, exporter of cotton & not dealer in foreign exchange, relating to the FCs entered into with the Banks, constitutes business loss and allowable for set off against the business profits. In the process, judgment in the case of CIT v. Sooraj Mull Nagarmull [1981] 129 ITR 169/5 Taxman 289 (Cal.) (para 3) from Calcutta High court is followed. Thus, Ld Counsel ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... usiness, the transaction must be of that nature of speculation and in that case, the deemed business shall be deemed as distinct and separate from any other business carried on by the assessee. If the transactions are not linked to the export business of the assessee, the speculation transactions must not be treated as speculation business. Therefore, incidentality or integral nature of the FCs becomes relevant. Elaborating the same, Ld counsel mentioned that the provisions of section 73(1) will swing into operational only in case of speculation business and not speculation transactions. 12. Damages on settlement of FCs- allowable deduction: Ld Counsel submitted that the impugned losses are incidental to the FCs, which are integral part of the export proceeds, should be treated as contracts. The loss on breach of contract if any constitutes damages. Therefore, the payment to bank constitutes a payment of damages for such breach of 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 57/14 Taxman 1 and the one reporte ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... laimed by the assessee from the clauses to the proviso to section 43(5) of the Act. He also mentioned that the assessee failed to demonstrate the said claims and therefore, failed to discharge the onus as held by the Supreme Court in the case of Joseph John (supra). He also submitted certain data to show that the total FCs on certain dates is more than the exports receivable and also questioned the assessee's failure to demonstrate the paisa to paisa and date wise correlation between the FCs and the Export Invoices. Relying on some statements filed by the assessee, Ld DR pointed out that the period of forward contracts is not 4-6 months in all cases and pointed out certain contracts cancelled after a day or a few days, which is one of the facets of speculation activity. He strongly relied on the order of the AO and the CIT (A). Further, relying on the order of the CIT (A), Ld DR distinguished the judgment of the jurisdictional High Court in the case of Badridas Gauridu (P.) Ltd. (supra) and 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, sup ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... es carried out in a recognised association, shall not be deemed to be a speculative transaction .................." 19. The above provision provides that a transaction in which a contract in respect of trading of "any commodity' including stocks and shares is settled otherwise than by the actual delivery or transfer of commodity/scrips. Here the meaning of expression "any commodity" is a matter of debate. This definition provides for exclusion of certain specified contracts discussed in clause (a) to (e) of the proviso to section 43(5) of the Act. Clause (a) of the proviso deals with the hedging contracts 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 / e ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... certain speculation transactions shall constitute as speculation business and such speculation business shall be deemed to be distinguished and separate from any other business. Further, the provision of section 73 relating to "loss in speculation business" is another relevant provision in this regard. Thus, the Explanation 2 to section 73 also deals with deemed speculation business where there is some trading activity of shares by the assessee being other business activity. Now, we shall take up relevant judgments on the subject raised before us. 22. Relevant judgmental laws: In this regard, relevant decisions include the decision in the case of D Kishore Kumar & Co. (supra), binding judgment of the Bombay High Court in the case of Badridas Gauridu (P.) Ltd. (supra), judgment in the case of Sooraj Mull Nagarmull (supra) from Calcutta High Court. The judgments from the High Court of Ahmedabad in the cases of Friends and Friends Shipping (P.) Ltd. (supra) and in the case of Panchamahal Steel Ltd. v. U.A. Joshi, ITO [1997] 93 Taxman 1/225 ITR 458 (SC) are also relevant. These decisions / judgments are unanimously relevant for the proposition that the FC transactions, when entered i ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... t be concluded that the transactions are such a 'nature' as to constitute a business by itself. These transactions are genuine business transaction to hedge against increased cost of purchases of rough diamond imports. It is a commonly accepted part of the financial management practices today that the risk element, due rise in value of foreign currency in respect of the import transactions entered, is minimised by entering into forward contracts for purchase of that currency. This is particularly necessary in a market in which the value of domestic currency is falling, which is evident from 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 t ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... deduction in respect of loss suffered by it as a business loss"- Held yes. 25.1 Relevant finding is discussed in para 3 of the judgment and the same reads as follows:- "3. 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 booked only as incidental to the assessee's regular course of business. The Tribunal has recorded a categorical finding to this effect in its order. The Assessing Officer has not considered 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 respe ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... the return are tabulated as under: Gains (in Rs.) Profit on payment of realisation of export receivables 4,31,44,019 Loss on cancellation of FCs Profits on revaluation of o/s debtors as on 31.3.2009 2.48,13,534 6,79,57,553 29. Thus, the assessee credited Rs. 2,10,14,873/- to 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 Amount 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) 1 2 3 4 19,444,000 10,704,760 41,488,805 4,218,940 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 terminatio ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 2,680/-. Relevant portion from the judgment of the Gujarat High Court in the case of Friends & Friends Shipping (P.) Ltd. (supra) is as follows: "It is true that the CIT (A) has made some observations 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 extension of FCs, in case of non-receipt of export proceeds on the due dates, is not allowed without cancelling the existing FCs. ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... the due date of maturity of the contract. It is a settled issue that the assessee has to discharge the onus on why he had to resort to premature cancellation. In this case, the explanation 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 ge ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... he due date of maturity. In view of the decision of Hon'ble ITAT in the case of the appellant for immediately preceding year such losses are genuine business losses which cannot be treated as speculative losses. It is also a fact that the appellant has also cancelled some of its foreign exchange forward contracts before the due date, but such transactions has resulted in net profit of Rs. 85,27,033/- ( profit on such transactions as Rs. 1,17,66,612/- - loss on such transactions at Rs. 32,39,579/- ) . For the sake of discussion, even if such transactions are held to be speculative in nature simply because the appellant has cancelled these transactions before the maturity date, still it does not have any adverse effect on revenue because net result of such transactions is profit and not the loss. Therefore, after considering the totality and circumstances of the instant case as well as the principle laid down by the Hon'ble ITAT in appellant's own case in A.Y.2009-10, it is noted that the net loss of Rs. 84,71,383/- (Rs.1,69,98,416 - 85,27,033) of the appellant is in respect of the transactions of only those forward contracts which was incurred on settlement on or after due date of t ..... X X X X Extracts X X X X X X X X Extracts X X X X
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