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TMI Blog1976 (5) TMI 3X X X X Extracts X X X X X X X X Extracts X X X X ..... of the goods manufactured by him are saved and excepted by prov. (a) from the class of speculative transactions as defined in s. 43(5) of the I.T. Act, 1961, and, therefore, the loss incurred as a result of such contracts of sale was not entitled to be set off against the other business income. The assessee being aggrieved with this order of the ITO, carried the matter in appeal before the AAC, Jamnagar, who also, following the aforesaid decision of this court, confirmed the order of the ITO. The assessee, therefore, carried the matter in further appeal before the Tribunal at Ahmedabad. It was contended on behalf of the assessee before the Tribunal that the contracts of sale entered into by the assessee were, for all intents and purposes, what are known commercially as " hedging contracts " entered into with a view to guarding against the loss through future price fluctuations of the groundnut oil in respect of which it had entered into certain forward transactions, and since the assessee had sufficient stock on hand to meet its obligations of supplying oil tins under the said contracts, the loss of Rs. 27,157 suffered by it was, for all intents and purposes, a hedging loss which t ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... w materials or merchandise entered into by a person in the course of his manufacturing or merchanting business, would not be deemed to be a speculative transaction, if its purpose is to guard against the loss through future price fluctuations in respect of his contracts for actual delivery of goods manufactured by him or merchandise sold by him. There is no justification in the prov. (a) to s. 43(5) of the I.T. Act, 1961, to restrict the width and import of the words " a contract in respect of raw materials or merchandise " as to mean " a contract of purchase only " as read by the Division Bench of this court in Chimanlal Chhotalal's case [1968] 69 ITR 129 (Guj). In so far as the Division Bench gave a restrictive meaning to the said words to mean " a contract of purchase of raw materials or merchandise only " by reference to the latter part of the proviso, it read more than what is warranted therein. The interpretation placed by the Division Bench in Chimanlal Chhotalal's case [1968] 69 ITR 129 (Guj) goes against the very legislative intent evinced in prov. (a) to s. 43(5) that where bona fide forward sales are entered into with a view to guarding against the risk of fluctuations o ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... n this State to claim ex debito justitiae the benefit of the said concession which clearly goes against the decision of this court. It is in this context of the rival contentions of the parties that we have to answer the questions referred to us. It would be profitable to appreciate in proper perspective how hedge transactions are commercially understood before we determine about the true scope and width of prov. (a) to s. 43(5). As the very name suggests, hedge contracts are those contracts which hedge against prejudicial price fluctuations. Speculative transactions are not the same as agreements by way of wager. In speculative transactions the modus operandi of persons indulging in them is that when one enters into a contract of purchase, he also simultaneously enters into one or more contracts of sale against the same quantity deliverable at the same time either to the original vendor or to some one else, so as either to secure profit or to minimise loss, before the Vaida day ; and similarly when he enters into a contract of sale, he simultaneously enters into one or more contracts to purchase the same quantity before the Vaida day. The result of such dealings, when the sale a ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... by which the risk can be reduced. He, therefore, goes to the forward market and sells cotton forward contract for delivery after one month, at, say, Rs. 770 per candy. The purchase transaction in the ready market is thus counterbalanced by a sale transaction in the forward market. At the end of one month, if the ready price has fallen by Rs. 50 he would be put to a loss in the ready market, when he offsets his original purchase by a sale in that market. At the same time, however, he would also be offsetting his original sale on the forward market by a corresponding purchase in that market. Since the course of prices in the forward market generally follows the same trend as in the ready market, he would be purchasing in the forward market also at a lower price, perhaps at Rs. 720 per candy, making a profit of Rs. 50 per candy. He would thus make a profit on the forward market which would reduce or at times even more than wipe out the loss that he suffers on the ready market. In this way, he is able to reduce his risk and cut his losses by recourse to the forward market and might even in favourable circumstances end up with a profit on balance. To take another illustration, an expo ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... effective insurance against the risk of loss in the price fluctuations of the commodity, manufactured or the merchandise sold. If this is the correct meaning of the hedging transactions in the commercial world, is there any warrant to read the prov. (a) to s. 43(5) of the I. T. Act, 1961, so as to justify an inference that the legislature intended to exclude from speculative transactions, the contracts of sale of raw materials or merchandise entered into by a person in the course of his manufacturing or merchanting business to guard against the loss through adverse price fluctuations ? However, according to s. 43(5) of the I. T. Act, 1961, and even for that matter under s. 24 of the I. T. Act, 1922, 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. Expl. 2 of s. 24 of the 1961 Act enjoins that when an assessee enters into speculative transactions so as to constitute a business, such business is deemed to be a distinct and separate business from any other business of his. By s. 73(1) ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... on as to mean only contracts for purchase because, as read by the Division Bench in Chimnalal Chhotalal's case [1968] 69 ITR 129 (Guj), such contracts would be entered into by a manufacturer or merchant to guard against the risk of adverse price fluctuations of manufactured goods or merchandise sold in respect of which a trader might have entered into contracts of actual delivery thereof (hereinafter referred to as the " second set of contract " for the sake of convenience). In our opinion, there is no warrant or justification for restricting the width of the first set of contracts so as to mean the contracts of purchase only. The restrictive meaning as spelt out by the Division Bench in Chimanlal Chhotalal's case [1968] 69 ITR 129 (Guj), in the context of the second set of contracts in the said proviso is unwarranted, in our opinion, inasmuch as, apart from militating against the accepted meaning of hedging transactions in the commercial world, it runs counter to the well-known principle of interpretation of statutes since it reads more than what is prescribed in the later portion of the said proviso. It is no doubt true that risk of loss which is to be guarded against is one ar ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... o above. In the ultimate analysis, by hedging transactions a trader by a corresponding contract of sale and purchase in the forward market tries to offset the likely loss which may arise in the ready market due to adverse price fluctuations. The reasoning of the Division Bench in Chimanlal Chhotalal's case [1968] 69 ITR 129 (Guj) may require something more to be read in the first set of contracts referred to in the opening part of prov. (a) to s. 43(5). We do not think that such a reading is permissible since it would require rewriting of the proviso. Another infirmity in that reasoning, which we should respectfully point out, is that the Division Bench has taken it for granted that since the second set of the contracts is for actual delivery of goods and, therefore, for sale of manufactured goods or merchandise sold, the first set of contracts, which is in respect of raw materials or merchandise, must be for purchase only. Though both the sets of contracts are put in juxtaposition the inference which has been drawn by the Division Bench in Chimanlal Chhotalal's case [1968] 69 ITR 129 (Guj), from the contract of the second set of contracts so as to impute a restrictive meaning to t ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... use made a reference to stocks held, the other did not and that some officers were taking a restrictive view and disallowing the deduction of hedging losses in commodities other than stocks and shares, if they were not against stocks held but against purchases. 3.56. We have examined the issue at some length. We find that even the Central Board of Revenue had put too rigid and restrictive an interpretation on this provision, which is not in accord with the spirit of the assurance given by the Finance Minister. It does not, therefore, surprise us that the assessing officers have also taken an unduly narrow view in the matter and the genuine businessmen have been put to considerable hardship. We certainly appreciate, as we have done earlier, the principle underlying the proviso, but we equally disapprove of its wrong application for denying genuine hedging losses. We feel that the solution to the various problems which have been brought to our notice in relation to this subject can be found by expanding Explanation 2 to section 24(1) so as to classify and exclude such transactions which should not come under the mischief of this section. The assessing officer should first examine w ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... clude from the category of speculative transactions only a ' hedging purchase ' transaction entered into with reference to specific contracts for sale of goods but do not so exclude a ' hedging sale ' transaction made against stocks in hand or against contracts for purchase of ready goods. The latter type of transactions are also genuine hedging transactions so that any losses sustained therein will be allowed to be set off against other income. Board's decision: The intention has always been that where bona fide forward sales are entered into with a view to guarding against the risk of raw materials or merchandise in stock falling in value, the losses arising as a result of such forward sales should not be treated as speculation losses. Accordingly, Income-tax Officers should not treat such transactions as speculative transactions within the meaning of Explanation 2 to section 24(1). It is to be noted in this connection that hedging sale can be taken to be genuine only to the extent the total of such transactions does not exceed the total stocks of raw materials or merchandise in hand. If the forward sales exceed the ready stock, the loss arising from the excess transactions s ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... urchases and sales entered into by an assessee with a view to guard against his future loss in general in that line of business as covered by prov. (a) without violence to the language. The reasoning which has been adopted by the Madras High Court is, with great respect to the learned judges of the Division Bench of the said High Court hearing the matter, the same as the one adopted by the Division Bench of this court in Chimanlal Chhotalal's case [1968] 69 ITR 129 (Guj), which, as pointed out above, suffers from the infirmities which we have discussed and, therefore, does not appeal to us. Similarly, in Gomraj Fatehchand's case [1976] 102 ITR 131, the Madras High Court held that the assessee before it was not entitled to the benefit of prov. (a) since be bad failed to show that the forward contracts of purchases entered into by him were effected with a view to guarding against the loss through adverse price fluctuations. We do not think that the decision of the Madras High Court in Gomraj Fatehchand's case [1976] 102 ITR 131 is of any assistance to the case of the revenue before us. The decision of the Allahabad High Court in Raghunath Dass Pralhad Dass v. CIT [1974] TLR 570, ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... act to guard against loss in his holdings of stocks and shares which may arise due to adverse price fluctuations, we do not appreciate how Parliament would have intended otherwise in case of dealers in other commodities. Apart from this discriminatory treatment, we do not find any strict time schedule merely from the juxtaposition of the two sets of contracts in prov. (a). In the commercial world such time schedule for claiming a transaction is not recognised. A merchant may go to a ready market and purchase a commodity for selling it again later to a manufacturer in which case he might be required to hold on to his stock for the time being till he enters into another contract for sale of goods to be delivered to that manufacturer. Before he enters into such a contract of sale, if a merchant enters into hedging transaction so as to guard against the risk of loss due to adverse price fluctuations of the stocks of goods, we do not think that it can be successfully urged in commercial parlance that the latter transaction is not hedging transaction. The Direct Taxes Administration Enquiry Committee as well as the CBR have also recognised that hedging transactions are permissible and th ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ation to sustain the contention urged on behalf of the revenue that hedging transactions must succeed the contracts of sale for actual delivery of goods. Same view has been taken by the Andhra Pradesh High Court in Omkarmal Agarwal v. CIT [1968] 67 ITR 329. The decision of the Calcutta High Court in D. M. Wadhwana v. CIT [1966] 61 ITR 154 is not of much assistance in our opinion to the case of the revenue as the case turns on the facts and circumstances before it. On behalf of the revenue, it was seriously contended that forward transactions in order to be genuine hedging transactions must have been entered into by a manufacturer or merchant in the course of his business and must relate to the raw materials or merchandise, as the case may be. In other words, it was contended by the revenue that a manufacturer cannot hedge against the loss due to adverse price fluctuations of the goods to be manufactured by him by entering into forward transactions of any other merchandise and similarly a merchant cannot hedge against the loss by entering into a transaction in respect of raw materials. The learned Advocate-General, appearing on behalf of the assessee, joined issue with the rev ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ench of the Delhi High Court held that in order that a forward transaction in commodities may fall within prov. (a) to Expln. 2 to s. 24(1), it is necessary that the raw materials or merchandise in respect of which the forward transactions have been made by the assessee must have a direct connection with the goods manufactured or the merchandise sold by him, and the raw materials in respect of which the assessee has entered into forward transactions must be the same raw material which is used by him in his manufacturing business. Since this aspect of the controversy has not been referred to us for our opinion, we do not think it proper to volunteer our opinion in respect thereof. However, this must not stand in the way of the revenue to extend the benefit of the aforesaid view of the CBR to the concerned assessees as done in other parts of the country. Our conclusions are, therefore, as under : (1) Hedging contracts, in order to be out of speculative transactions, must be in respect of only raw materials so far as the manufacturer is concerned though these contracts may be both with regard to sales and purchases. (2). Hedging contracts need not succeed the contracts for sale ..... X X X X Extracts X X X X X X X X Extracts X X X X
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