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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 ..... n in foreign exchange such transactions are in nature of hedging transactions, loss on which is genuinely business loss, hence the AO is directed to allow the same. - I .T.A. No. 1359/Mum/2014 - - - Dated:- 7-11-2016 - SHRI MAHAVIR SINGH, JUDICIAL MEMBER AND SHRI RAMIT KOCHAR, ACCOUNTANT MEMBER For The Revenue : Sh. Vikash Kumar Agarwal For The Assessee : Shri Harsh Kothari ORDER PER RAMIT KOCHAR, Accountant Member This appeal, filed by the Revenue, being ITA No. 1359/Mum/2014, is directed against the appellate order dated 21st March 2013 passed by learned Commissioner of Income Tax (Appeals)- 9, Mumbai (hereinafter called the CIT(A) ), for the assessment year 2010-11, the appellate proceedings before the learned CIT(A) arising from the assessment order dated 26th February, 2013 passed by the learned Assessing Officer (hereinafter called the AO ) u/s 143(3) of the Income-tax Act,1961 (Hereinafter called the Act ). 2. The grounds of appeal raised by the Revenue in appeal filed with the Income-tax Appellate Tribunal(hereinafter called the tribunal ) read as under : 1. Whether on the facts and in the circumstances of the case and in law, the Ld. ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... uch transactions should not exceed the total stock of raw material or merchandise in hand and in order to be genuine and valid hedging contract of purchase , there should be an existing forward contract of sale by actual delivery . It was observed by the AO that all the above conditions are to be fulfilled cumulatively, if derivative loss is claimed as hedging loss and allowable as business loss. It was held by the AO that the keeping in view facts and circumstances of the case , the assessees case is not covered by any of exceptions (a) to (d) of section 43(5) of the Act nor it is proved by the assessee that the transactions are in the nature of hedging transactions. Thus, it was held by the AO that the loss of ₹ 85,88,209/- incurred by the assessee is in the nature of speculation loss and not a business loss covered under the provisions of Section 43(5) of the Act or hedging loss and the same was therefore disallowed by the AO, vide assessment order dated 26-02-2013 passed by the AO u/s 143(3) of the Act. The AO also observed that in the preceding assessment year 2009-10, the AO disallowed the similar loss claimed by the assessee of ₹ 4,69,42,680/- which was confirme ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... . The learned DR submitted that the assessee is in business of import and export of diamonds. The assessee has booked forward contract in foreign exchange and has incurred loss on maturity/cancellation of forward foreign exchange contracts which loss was disallowed by the AO. The learned CIT(A) allowed the loss by following the decision of the tribunal in assessee s own case in ITA no. 6169/Mum/2012 for assessment year 2009- 10, vide orders dated 11.10.2013. The learned DR relied upon the order of the AO. While learned counsel for the assessee stated before us that the issues in all the three grounds raised by the Revenue are covered in favour of the assessee by the tribunal s decision in assessee s own case in ITA no. 6169/Mum/2012 for assessment year 2009-10 vide orders dated 11.10.2013 and prayed that Revenue appeal be dismissed. 6. We have considered the rival contentions and perused the material on record including tribunal s decisions in assesee s own case in preceding assessment year. We have observed that the assessee is in business of import and export of diamonds. The assessee has booked forward foreign exchange contracts and incurred loss of ₹ 85,88,209/- on ma ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... th the statutes, he also revalued the outstanding export receivable too. The total gain on account exchange difference on exports is ₹ 679.75 lacs on account of both actual realization and revaluation of outstanding receivables. The loss incurred on account of forward contracts to safeguard the outstanding receivables is ₹ 469.43 lacs. Accordingly, assessee set off the loss against the said gain and credited the net amount/ profit of ₹ 210.14 lacs to the profit and loss account. During the assessment proceedings, AO made various enquiries with regard to this credit entry and in response, assessee filed letters dated 29th and 30th November, 2011 which formed part of the assessment order. In these letters, the assessee provided numerous statistical data to justify its stand. In brief, total forward contracts entered into during the year works out to ₹ 135.99 Crs and the total cancellation is ₹ 126.3 Crs, the net forward contract is ₹ 9.95 Crs. The total exports in the year works out to ₹ 107.57 Crs. Total outstanding receivable in foreign exchange is much higher than any of these figures. Briefly, the stand of the assessee is that it entered ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... plicability of clause (d) of the proviso to section 43(5), AO ruled out the same considering the unfulfilment of the conditions specified therein. Thus, the AO concluded that the foreign exchange contracts constitute speculative transactions u/s 43(5) of the Act. AO also discussed the provisions of Explanation 2 to section 28 of the Act which provides for the explaining the deemed 'speculation business' and held that the profit and loss arising from such transactions have to be computed separately and treat the same as per the provisions relating to the 'speculation business'. In this context he also referred to the provisions of Explanation to section 73 relating to 'speculation loss'. Relying on the principles relating to the onus AO held that the assessee failed to demonstrate that the transactions in question relates to hedging transactions. AO analyzed the principles laid down by the AAR-New Delhi, in the case of Sopropha S.A., In re [2004] 268 ITR 37/138 Taxman 75 and held that the said principles are found unfulfilled for calling the impugned transactions as hedging transactions. On the burden of proof issues, AO relied on the judgment of the Hon' ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ring to the rest of the loss-yielded FCs, which are cancelled prior to the due date, assessee mentioned that they are cancelled to reduce the loss and it is a business decision of the assessee. Further, assessee argued that the provisions of section 43(5) are not applicable to this case as it applied only to the commodity including stocks and shares and relied on the decision of the ITAT, Delhi in the case of Munjul Showa Ltd. v. Dy.CIT. 94 TTJ 227 [2005]. As per the assessee the forward contracts do no constitutes 'commodity', which is precondition for invoking the said sub-section (5) of section 43 of the Act. Even if it is applied, the impugned FCs being hedging in nature are covered by clause (a) to the proviso to section 43(5) of the Act. The outstanding receivables are always higher than the forward contracts cumulatively. In large number of transactions, the cancellation of contracts was done only on the maturity and therefore, there are no speculative contracts. Assessee relied on the Bombay High Court judgment in the case of CIT v. Badridas Gauridu (P.) Ltd. [2003] 261 ITR 256 and Ors and mentioned that the said judgment applied to the case of the assessee. Regardi ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... d 3% of the 'Outstanding Receivable of export proceeds in foreign currency' in the beginning of the year. At no point of time, the same exceeded the said trade receivables in currency. 7. One-to-One Correlation between the FCs Vs Invoices: Further on the FCs being the integral part of the export business, Ld counsel mentioned that the FCs and the export invoices are closely correlated and such correlation need not be to the last rupee and the precise dates. In this regard, he relied on the judgments in the case of CIT v. Friends Friends Shipping (P.) Ltd. [2013] 217 Taxman 267/35 taxmann.com 553 (Guj.), and Panchasheel Ltd. (supra) and the CBDT Circular. To substantiate the same, Ld counsel filed a statement of comparison between the dates and values of the FCs qua the export invoices raised in the year. Ld Counsel submitted that 1:1 correlation between the export invoices and foreign exchange contracts is not required and broad matching should be sufficient. 8. Loss on cancellation of the FCs constitutes Business loss: Ld Counsel explained the facts of the binding coordinate bench decision in the case of D Kishore Kumar Co. v. Dy. CIT [2005] 2 SOT 769 (mum) ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... TTJ 702 (Mum.); and Munjal Showa Ltd. (supra) . However, Ld Counsel fairly mentioned that the Hon'ble Calcutta High Court in the case of Sooraj Mull Nagarmull (supra) held differently and FCs are treated as commodity . The Provisions of section 43(5) are invoked validly only if the FCs constitutes the commodity . 10. Clause (a) of section 43(5) of the Act - Meaning of the expression in respect of.. : It is the argument of the assessee that the assessee is not a dealer in the foreign exchange; but he is exporter of diamonds and the contracts are entered into with the Bank in respect of the export invoices. The FCs, being the hedging transactions, covered by the provisions of clause (a) of section 43(5) of the Act are outside the scope of the speculation business. He also explained the meaning of the expression in respect of in connection with export contracts of the assessee and relied on the judgment of the Hon'ble Supreme Court in the case of Renusagar Power Co. Ltd. v. General Electric Co. [1984] 4 SCC 679 dated 16 August, 1984 and judgment in the case reported in AIR 1997 SC 1302 (sic) assuming that these are not covered by the said clause (a) of the proviso t ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... exchange rate of the dollar varied from ₹ 39.97 to ₹ 51.21 registering the variations nearly ₹ 12/- during the year. He also demonstrated that the assessee has allowed to take the exposure on past performance up to the average of previous three Financial Years actual turnover of the year which is higher. Further, Ld Counsel mentioned that in case of non-cancellation of said contracts by the assessee, the banker will in any way terminate the same on the seventh working day after the maturity day (page 21 of the paper book). Referring to the assessee's failure to make extensions instead of cancellation, Ld Counsel mentioned that such extensions procedurally involve opening fresh FCs on the cancellation of the contracts. Thereby it does not make any difference so far as the final loss is concerned. Ld DRs Arguments: 15. Dr Deepak Pote, IRS appeared for the Revenue and made various arguments substantiating the conclusions of the AO and the CIT(A). In this regard, Ld DR filed a write up to summarize the Revenue's stand. As per the same, the assessee's business is trading and manufacturing of rough and polished diamonds. Ld DR questioned the ass ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... for definition of speculation transactions . The said provisions read as under: 43(1) to (4)** ** ** (5) speculative transaction means a transaction in which a contract for the purchase or sale of any commodity, including stocks and shares, is periodically or ultimately settled otherwise than by the actual delivery or transfer of the commodity or scrips: PROVIDED that for the purposes of this clause- (a) a contract in respect of raw materials or merchandise entered into by a person in the course of his manufacturing or merchanting business to guard against loss through future price fluctuations in respect of his contracts for actual delivery of goods manufactured by him or merchandise sold by him; or (b) a contract in respect of stocks and shares entered into by a dealer or investor therein to guard against loss in his holdings of stocks and shares through price fluctuations; or (c) a contract entered into by a member of a forward market or a stock exchange in the course of any transaction in the nature of jobbing or arbitrage to guard against loss which may arise in the ordinary course of his business as such member; [or] [(d) an ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... y the exclusion provisions of clause (a) to the proviso to section 43(5) of the Act. The clause (a) of the proviso to section 43(5) provides for exclusion of the hedging transaction' from the definition of the 'speculation transactions'. There are number of judgments in support of the assessee and relevant 'ratios' or conclusions are discussed in the succeeding paragraphs. 20. Before taking up these discussions, we shall now take up the provisions of the Explanation to section 28 of the Act, which also provide definition of Speculative Business . The said explanation reads as under: Explanation 2. - Where speculative transactions carried on by an assessee are of such a nature as to constitute a business, the business (hereinafter referred to as 'speculation business ) shall be deemed to be distinct and separate from any other business 21. Explanation to section 28 uses the expression 'speculative transactions carried on by an assessee are of such a nature as to constitute a business', and thus, considering the nature of these transactions, the impugned FCs cannot be deemed as the speculation business without going into the nature ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... wed considering the specific definition provided to derivatives in section 2(ac) of Securities Contract Regulation Act, 1956 and it is not the requirement of the law that the 1:1 correlation between the FCs and the export invoices should exist and should be established by the assessee. So long as the total value of the FCs does not exceed, the claim of the assessee is sustainable as business loss. We have also analyzed the decisions relied on by Ld DR and find they are distinguishable. Now, we shall proceed to import some conclusions of the said decisions. Relevant judgmental laws - Conclusions Held portions 23. Relevant extracts from the cited judgments are inserted in the succeeding paragraphs here as under: A. Held portion in the case of D. Kishorekumar (supra) The details of forward exchange contract clearly show that all the forward exchange contracts were in respect of each specific import order placed by the assessee. The purpose of these transactions was clearly to minimise assessee's risk on account of fall in value of rupee, but the quantum of foreign exchange covered by these forward contracts was limited to the extent of assessee's actual ex ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ys to 77 days away. The decision as to whether further hedging against the increase in foreign currency is warranted or not is essentially a commercial decision which depends on a number of factors, most important factor being the trend of currency markets at that point of time and businessman's perception about future trends of the currency market. For example, when a businessman perceives that the market value of foreign currency vis-a-vis the domestic currency will not go any higher or when the market starts the declining trend, he may see business expediency in cancellation of contract. The fact of premature cancellation, therefore, cannot alter the nature of transaction. For all these reasons, the credit shown in the P L a/c as 'profit on cancellation of forward contracts' is as integral part of the export business, as purchases or imports .. The assessee succeeds on this issue. In the result, the appeal is allowed. 24. Although, the said decision was pronounced in the context of section 80HC of the Act, the ratio of the said decision is of paramount importance. B. Bombay High Court judgment in the case of Badridas Gauridu (P.) Ltd. (Supra) 25. I ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... oubtedly, the contract for foreign exchange as such can be treated as a contract for commodity . The Conclusion of this judgment as reported reads as under: Where in the normal course of business of import and export of jute, the assessee entered into foreign exchange contract to cover up the losses and differences in exchange valuation, the transaction is not a speculative transaction. 26. The above extracts unanimously support that the FCs entered by the assessee, an exporter and not the dealer in foreign exchange, with the Banks as incidental to the export business, are business transactions and loss or gains is not of speculation nature. The only relevant decision cited by Ld DR is the one delivered in the case of S. Vinodkumar Diamonds (P.) Ltd. (supra) and in this case, AO allowed the relevant loss as business loss and relevant portion is extracted as under: 4 He further held that losses incurred by the assessee during the year on account of change in value of currencies at the time of payment was allowed while finalising the assessment, that M to M losses were of notional losses and contingent in nature. Finally, loss on a/c. of outstanding ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... the weekend days, where the books remain closed. Finally the loss of ₹ 18,92,078/- is relevant to the FCs cancelled prematurely and there is no specific explanation from the assessee in this regard. However, the standard explanation revolves around the commercial nature of decision of the assessee, which he can take after considering the facts and circumstances and the said decision is taken for prevention of further losses if any. 32. Fluctuations - Related facts:- Further, the facts relating to Dollar fluctuations are undisputed. The perusal of the chart furnished by the assessee reflecting the dollar value in rupees in the month of April and found that the fluctuations are varying from ₹ 39.8550 to ₹ 40.6550 in the month of April. Further, assessee also furnished another chart for the FY under consideration showing changing the dollar value for the year and it is the fact that the dollar value per INR varied from ₹ 39.85 to ₹ 51.21 per $ registering the variations nearly ₹ 12/- during the year. 33. Correlation of forward contracts vis- -vis export invoices: Assessee filed a chart furnishing the export invoices raised in the year un ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ture cancellation of FCs may not alter the above conclusions so long as the assessee has valid and acceptable explanation for such cancellations. It should not be the case, to start with, FC can be a 'hedging transaction' but the ending of such FC is 'speculation'. In the light of this synopsis of our views in the matter, we shall not deliberate on the impugned losses. 35. The subdivisions of the loss of ₹ 4,69,42,680/: we have already tabulated above the three subdivisions of the impugned losses based on the timing of the cancellation of the FCs. Broadly the loss is divided into two types and the adjudication of the each subdivision of loss is given as under: (a) Loss on Cancellation of Matured FCs amounting to ₹ 4,14,88,805/-relates to the FCs cancelled or terminated on or after the due date. In other words, the FCs booked as integral part of the export invoices lived its booking period in full and they were either terminated by the Bank on or after due date of maturity date of the contract as the actual realization were not received in time. These are not premature cancellations by the assessee and therefore, in our considered view, the sa ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... of the Revenue. Assessee needs to answer as to why it went for premature termination and the onus is on the assessee as per the ratio of the SC judgment in the case of Joseph John (supra). Further, during the proceedings before us, on this issue, Ld Counsel for the assessee put forwarded various new arguments describing the impugned loss as 'damages' payable to the Banks for breach of contracts or settlement of the contracts. These aspects are not emanating from the orders of the lower authorities. One needs to study the correspondence with the Banks and the RBI guidelines on the issue whether such payments to bank should be treated as damages for breach of contract. One needs to examine who the bank treats the same and relevant accounting principles. In this regard, Ld Counsel also filed written submission too. In principle, this part of the losses relating to premature cancellations of FCs amounting to ₹ 18,92,078/- should be remanded to the file of the AO for want of speaking order on this issue after considering the cited judgments like Shantilal (P.) Ltd. (supra) on this issue. AO is directed to disallow this loss in the absence of specific explanation, if any. A ..... X X X X Extracts X X X X X X X X Extracts X X X X
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