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TMI Blog1978 (7) TMI 35X X X X Extracts X X X X X X X X Extracts X X X X ..... count styled as " new Kapas and Rui and hedging account ". On the Diwali of S.Y. 2015 the latter account contained credit to the extent of Rs. 1,11,687.50 and debits to the extent of Rs. 33,637.50, which resulted in a difference of Rs. 78,050. In the balance-sheet this difference was shown as a liability. The ITO in respect of the latter account of Rs. 78,050 which was shown on the balance-sheet as a liability considered the same as profit relating to the assessment year in question, as the books of account of the assessee were maintained on mercantile system. In an appeal preferred by the assessee, the AAC confirmed the view taken by the ITO so far as this question was concerned. According to him, the items in this account pertain to amounts of income received as a result of contracts settled in the accounting year and were not mere notional figures. He took the view that they had to be considered only in the year of account. He felt that that finding of his was confirmed by the manner in which this account was maintained by the assessee in the next year as the accounts showed clearly an opening profit brought down of Rs. 78,050. As this profit was received in the year of acco ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ng at the account under the heading " Shri Kappas and Cotton Loose Hedge A/c. " for the S.Y. 2016, it was found that the total gains in respect of hedging contracts in question had been arrived at Rs. 2,64,141.50 and the total loss in ready cotton had been arrived at Rs. 4,14,525 ; the net result was a loss of Rs. 1,48,840. This conclusion was arrived at by the Tribunal on the footing that both ready and hedging contracts entered into should not be considered separately, but should be pooled together and the combined result alone should be considered for assessment, as followed by the assessee. The Tribunal felt that the method by which the loss of Rs. 1,48,140 was arrived at by the assessee was in order. In other words, the method of taking the profits into consideration only after the transactions are finally completed was considered by the Tribunal as a proper method of accounting. The Tribunal accepted the contention of the assessee that the sum of Rs. 78,050 was rightly not declared by the assessee as its profits in the assessment year in question. It is from this order of the Tribunal that the above question has been referred to us for our determination. Mr. Joshi, on beh ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... itted that, as the object of entering into a hedging contract is to protect oneself against the known risk, the Tribunal was right in taking the view that the result of the hedging contract and ready delivery contracts ought not to be considered independently, but the same must be taken cumulatively. In other words, the total result of both the future delivery contracts as well as the hedge contracts ought to be taken into consideration and the net result alone should be considered for assessment. He emphasised that, as in the present case, the delivery in the future delivery contract was to be given in the month of March after the Diwali of S.Y. 2015, it was not permissible to the revenue to split up the result of hedging contract as on Diwali of S.Y. 2015, but it ought to have considered the net result on the basis of the system of accounting maintained by the assessee right up to the month of March, when delivery under the contract was to be given and the combined result of the hedging transactions right up to that date as well as ready delivery contracts ought to have been treated as one integrated transaction and the profit or loss arising therefrom should have been considered ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... submission was that both the taxing authorities were in error in subjecting the assessee to tax in respect of profit made in respect of hedging contracts for the Diwali of S.Y. 2015 and in not permitting the assessee to have a cumulative effect of hedging contracts till the date when delivery was effected to the mills under the various contracts of future delivery. There are two main methods of accounting, the cash system and the mercantile system, and it is not disputed that the assessee is maintaining his accounts on the mercantile system. In the accounts maintained on cash basis, a record is kept of actual receipts and actual payments. Entries are made only when money is actually collected or disbursed. If the profits of a business are accounted for in this way, the tax is payable on the difference of receipts and disbursements for the period in question. While,in the mercantile system of accounts, the net profit or loss is calculated after taking into account all the income and all the expenditure relating to the period, whether such income has been actually received or not and whether such expenditure has been actually incurred or not. In other words, the profit computed und ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... dge account " and the entries therein are from the month of Magsar of S.Y. 2015 to the month of Chaitar of the same Samvat Year, while the other account is headed " Shree Nava Kapas and Rui Hedge account " of S.Y. 2015 and the entries therein are from the month of Shravan right up to the month of Asoj. So far as the first account is concerned, the net credit entry is treated as income of the year, but so far as the second account is concerned, even though there was a net credit balance of Rs. 75,050 on the Diwali of S.Y. 2015, the assessee has treated this amount as a liability in the balance-sheet for that Samvat Year. A short question that we have to consider in the present case whether even though there was a net credit of Rs. 78,050 at the end of the Samvat Year, the assessee was justified in taking the same as a liability in the balance-sheet. Having regard to the entries in the books of account, it cannot be disputed that the sum of Rs. 78,050 was the aggregate profit in the second account and the amount was actually received by the assessee as a result of the contract completely settled during the assessment year. They are not notional figures. As the assessee was maintain ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ual delivery irrespective of the date on which the contract was entered into. While in respect of a hedging contract, profit or loss arising therefrom can be ascertained or will become crystallised every fortnight or at every fixed interval of the term when the clearance takes place. Actually, from the statements produced by the assessee it could be noticed that twice in a month in respect of a hedging contract, either he has earned profit or suffered a loss. Contracts for delivery are entered into with different parties and hedging contracts are also entered into with different parties. In our opinion, the Tribunal fell into error when it held that hedging contracts and future delivery contracts should be treated as integrated transactions and the cumulative effect of such transactions ought to be determined when actual delivery under the future delivery contract is effected. There is no obligation upon a merchant to continue his hedging contract till the date of the actual delivery. It depends upon his sweet will and volition whether he should continue the transaction and in respect of what quantities of bales of cotton. A large number of authorities were cited by Mr. Dastoor w ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... f 6,000 bales. This statement at a glance would show that various transactions which are effected between the period of the two clearances are in no way connected with any particular outstanding future delivery contract, but they are entered into by the assessee in such a manner as would result in a profitable bargain. This statement shows that in this clearance alone he has entered into various purchases and sales contracts as he considered them necessary. In respect of hedging contracts between the two clearance dates, as a result of such transactions he had made either profit or loss depending upon the nature of the transactions he had entered into and there is nothing to indicate in this statement that these various transactions which were entered into can be regarded as having been specifically connected with any specific future delivery contract, even though in the various hedging contracts entered into by him after the month of August in S. Y. 2015, in some of them he had made profits while in others he has incurred losses. There is no indication in this statement to show any connection with future delivery contracts where delivery was to be effected later on. Thus, it is ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... x liability is concerned, the income of the assessee for a particular accounting year has to be determined and if he has made a profit in that year, then he would be assessed to income-tax in accordance with the provisions of the I.T. Act, and if he has suffered a loss, he would be entitled to carry forward the loss as may be permissible under the Act. It was urged by Mr. Dastoor that the Tribunal has accepted the particular method of accounting which was followed by the assessee and has come to the conclusion that the assessee was justified in not declaring the sum of Rs. 78,050 as profit of the assessment year in question. This conclusion of the Tribunal is a surmise based upon wrong premise, because this conclusion is arrived at after observing where a contract runs for more than a year, in the case of an assessee following the mercantile system of account, the profit or loss is determined only when the contract is finally performed. These observations of the Tribunal proceed upon the transactions relating to various hedging contracts that have been entered into by the assessee. Actually during the two clearance periods several contracts of purchases and sales had been effecte ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... Ltd. [1976] 104 ITR 581 and Arvind Mills Ltd. v. CIT [1978] 112 ITR 64. None of these cases were even remotely concerned with the questions with which we have to deal with here. In Calcutta Co. Ltd.'s case [1959] 37 ITR 1 (SC), the court was concerned with the estimate of an accrued liability to be discharged at a future date in the case of an assessee who had actually sold his land and was maintaining his accounts liability (sic), and the Supreme Court held that the estimated expenditure which would be incurred in discharging the same could be deducted from the profits and gains of the business, and the amount to be expended could be debited in accounts maintained in the mercantile system of accounting before it was actually disbursed. In Tensile Steel Ltd.'s case [1976] 104 ITR 581, the Gujarat High Court was concerned with inclusion of the amount of interest payable in respect of deferred payment rates for calculation of depreciation and development rebate, and in Arvind Mills Ltd.'s case [1978] 112 ITR 64 (Guj), the court was concerned with the calculation of development rebate by reason of additional liability in respect of repayment of loans borrowed by the assessee for acq ..... X X X X Extracts X X X X X X X X Extracts X X X X
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