DCIT, CIRCLE- 21(1), NEW DELHI vs. RELIGARE COMTRADE LTD., NEW DELHI

The facts relating to the issue are that the assessee company is engaged in the business of trading in gold, silver, bullion, precious and semi-precious metals. During the impugned year, the assessee had claimed deduction of Rs.27.84 crores on account of arbitrage and hedging. The AO treated the same as speculative loss, rejecting the assessee’s contention that it was primarily a hedging transaction to guard against loss through future price fluctuation in respect of his contracts for actual delivery of goods as per the exclusion to the definition of speculative transaction in proviso (a) to section 43(5) of the Act. The ld.CIT(A), however, found merit in the contention of the assessee and held that the loss incurred was on account of hedging and was excluded, therefore, from the definition of speculative transaction in terms of Section 43(5)(a) of the Act. The entire controversy, therefore, before us rests on the interpretation of section 43(5)(a) and before proceeding further, we are reproducing the relevant section along with the proviso as under:-

As is evident from a bare perusal of section 43(5) of the Act, transactions for purchase or sale of commodities which are settled otherwise than by the actual delivery are treated as speculative transaction. Proviso (a) deals with an exception to this definition stating that where such transactions, settled otherwise than by actual delivery, are in respect of raw materials or merchandise dealt with by a person in the course of his business and are for the purpose of guarding against loss through future price fluctuation in respect of his contract for actual delivery of goods manufactured or sold by him, they shall not be treated as speculative transactions. Briefly put, hedging transactions for raw material or goods sold, entered into for safeguarding against business losses are not treated as speculative transactions as per the proviso (a) to section 43(5) of the Act.

In the case before us, the assessee had claimed to have entered into a transaction of trading in derivatives of gold on the Multi-commodity Exchange (MCX), which item the assessee dealt with in the course of its business. The claim of the assessee being that in the business of bullion trading, that it was indulging in, the price of gold experienced a lot of volatility and, therefore, any downward movement of gold price subsequent to purchase of gold would result in significant amount of loss to the assessee and, therefore, to protect itself from MCX for hedging purposes, which was excluded from the definition of speculative transaction as per proviso (a) to section 43(5) of the Act .

The case of the AO for rejecting assesses claim is that the exception in 43(5)(a) of the Act excludes only hedging transactions entered into with the purpose of safeguarding loss through future price fluctuation in respect of contract of actual sale (emphasis provided by us). That, if the purpose of hedging is to safeguard loss on account of price volatility in contracts of purchases, the said transactions are not covered in the exception provided in clause (a) of the proviso. The AO’s case is that the assessee, admittedly, is doing his hedging transactions both for sale and purchase and since no bifurcation is provided, therefore, he disallowed the entire amount of Rs.27.84 crores of loss in the derivative transactions undertaken by the assessee. The other reason with the AO for denying the assessee the benefit of the exclusion from speculative transaction was that it applies only to manufacturers and the assessee being a trader, the same is not applicable to it.

The Ld.CIT(A) found no merit on either basis of the AO for rejecting assesses claim of the derivative transactions being excluded from being treated as speculative in nature.

We shall first take up the basis of the AO/Ld.DR for denying the assessee the benefit of the exclusionary clause to section 43(5), i.e., the same applies only to manufacturers and not to traders.

A bare perusal of proviso (a) would show that it covers contracts settled otherwise than by actual delivery, both in respect of raw material and merchandise which are entered into by a person in the course of his manufacturing or merchandising business to safeguard against loss through price fluctuation in respect of his contracts for actual delivery of goods manufactured by him or merchandise sold by him.

The repeated use of the word ‘merchandise’ along with “ raw material”, “merchandising business” along with “manufacturing business” and “merchandise sold” along with “sale of goods manufactured” by him ,clearly reveals the intent of the legislature to include traders also in the exclusionary clause.

During the course of hearing before us, the ld. counsel for the assessee pointed out that this aspect of the application of the exclusionary clause to both traders and manufacturers has been settled by the Hon’ble apex court in the case of SK.AR.K.AR. Somasundaram Chettiar & Co. vs. CIT, 194 ITR 1 (SC), wherein at page 5 the Hon’ble apex court categorically held clause (a) of the proviso to apply to both manufacturers and merchants as under:

Our attention was also drawn to the decision of the Hon’ble Bombay High Court in the case of CIT vs. Ramchandra Shivnarain, 201 ITR 862 (Bom.). categorically holding traders also to be covered under the exclusionary clause at para 4 of the order is as under:-

The ld. counsel for the assessee pointed out that the ld. CIT(A), therefore, correctly interpreted the section to hold that proviso (a) covers both manufacturer and trader.

In the light of the same, we completely agree with the ld.CIT(A) that the finding of the AO that hedging transactions undertaken by the assessee in its capacity as trader of bullion would not be covered by proviso (a) to section 43(5) of the Act is contrary to settled law and based on an incorrect interpretation of the proviso(a) to section 43(5) of the Act.

Taking up the next aspect relating to the interpretation of section 43(5) proviso (a) of the Act, based on which the AO held the transactions undertaken by the assessee to be speculative in nature, it has been pointed out to us that the case of the AO was that proviso (a) does not save hedging of purchase transactions from the exclusionary clause to the definition of speculative transaction.

Ld. Counsel for the assessee contended that courts as also CBDT have categorically ruled out genuine hedging transactions, both of purchase and sale , from being treated as speculative.

Our attention was drawn to the decision of the Full Bench of the Hon’ble Gujarat High Court in the case of Pankaj Oil Mills vs CIT 115 ITR 824 , pointing out that it categorically held that the scope of exclusion in proviso (a) of section 43(5) would include hedging both of purchase and sale transactions and is not restricted in its scope in any manner. He also drew our attention to the conclusion in the said order 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 and actual delivery of goods manufactured, but the latter may be subsequently entered into, provided they are within the reasonable time not exceeding generally the assessment year. (3) In order to be genuine and valid hedging contracts of sales, the total of such transactions should not exceed the total stocks of the raw materials or the merchandise on hand which would include existing stocks as well as the stocks acquired under the firm contracts of purchases.”

Ld. counsel for the assessee thereafter pointed out that the CBDT had clarified that hedging transactions entered into with a view to guard against the risk of raw material or mercantile in stock falling in value should not be treated as speculation. Our attention was drawn to Circular No.23 (XXXIX-4) D dated 12.09.1960 placed at page No.131 of the paper book which is as under:

Thereafter ld. counsel for the assessee drew our attention to the facts of the derivative transactions undertaken by the assessee as demonstrated to the authorities below. He pointed out the modus operandi followed by the assessee while entering into derivative transactions, stating that after purchasing gold/bullion and contemplating fluctuation or volatility in its price subsequently 9 the assessee would enter into the sale transaction of derivative to be settled at a future date, to mitigate any losses on the actual sale of bullion. Similarly, the assessee entered into transaction of purchase of derivatives also to mitigate losses against sale contracts entered into by it which was to be executed at future date. In this regard, our attention was drawn to relevant documents corroborating these facts from the paper book filed before us at P.B 133-140 being:

He contended that the total of derivative transactions undertaken by the assessee never exceeded its purchase or sale. It was pointed out that such facts were brought to the notice of the CIT(A) also which stands reproduced at page 6 & 7 of his order as under:

Ld.Counsel for the assessee contended that clearly the assessee had demonstrated the derivative transactions to be genuine hedging transactions, based on equal value of underlying assets and not exceeding it, and considering the judicial decisions as also the CBDT Circular, the impugned transactions were rightly treated as non-speculative by the Ld.CIT(A). Our attention was drawn to para 6 (iii) - (vi) of the Ld.CIT(A)’s order as under:

Having heard both the parties, we find no infirmity in the order of the Ld.CIT(A). The judicial decisions cited by the Ld.Counsel for the assessee read alongwith the CBDT Circular No.23D of 12-09-1960, clearly bring out the position of law that hedging of purchases is also included in the exception carved to speculative transactions in proviso (a) to section 43(5) of the Act. The Revenue does not dispute the fact that the derivative transactions entered into by the assessee were genuine hedging transactions. Ld.CIT(A) has recorded the fact of the hedging transactions undertaken by the assessee not exceeding its total stock of raw material or merchandise, which has remained uncontroverted before us. The interpretation by the AO of the proviso (a) to section 43(5) of the Act as not excluding hedging of purchase transactions from being treated as speculative, we agree with the ld.CIT(A), is incorrect.

We do not, therefore, find any infirmity in the order of the ld.CIT(A) deleting the disallowance of losses incurred by the assessee in derivative transaction amounting to Rs.27.84 crores.

We have also noted that the grounds raised by the Revenue before us raise a completely different issue. As per the grounds raised, the case of the Revenue is that trading in derivatives of commodities in the MCX platform has been excluded from the definition of speculative transaction only w.e.f.

There is no merit in this argument of the Revenue. The assessee in any case has sought exclusion under proviso (a) to section 43(5) of the Act and has been held to be entitled so by the ld.CIT(A) whose order has been confirmed by us also. The assessee has held its transactions to be in the nature of hedging transactions to safeguard against any loss from the sale of its goods in terms of proviso (a) to section 43(5). The clause (e) to which the Revenue has drawn our attention to stating that the assessee is entitled to be excluded by virtue of this proviso alone having traded on the MCX platform applies only to traders dealing in derivatives on the MCX platform. While proviso (a) excludes hedging transactions from the purview of speculative transaction, proviso (e) deals with a completely different set of and nature of transactions. Proviso (e) excludes all derivative transactions carried out on the MCX platform of trading of commodities transaction tax by all traders to be not speculative in nature. Therefore, the scope of both the provisos are completely different. In the present case, it is not the claim of the assessee that it was dealing on the MCX platform as a trader. On the contrary, the claim of the assessee is that it was dealing in derivatives on the MCX platform for hedging its sale contracts. Therefore, the assessee had rightly claimed benefit of exclusion from the definition of speculative transaction under proviso (a), proviso (e) not being not applicable to it at all. The grounds raised by the Revenue, therefore, are of no consequences.

In view of the above, grounds No.1 and 2 raised by the Revenue are dismissed.

Ground No.3 raised by the Revenue reads as under:- 13 “3. That on facts and circumstances of the case and in law, the Ld. CIT(A) has erred in deleting the addition of Rs. 1,30,452/- paid on account of fines and penalties as this is not an allowable expense u/s 37(1) of the I.T. Act, 1961.”

The Revenue in the above ground is aggrieved by the order of the ld.CIT(A) in deleting the disallowance of Rs.1,30,452/- made by the AO treating it as fines and penalties. The findings of the ld.CIT(A) in this regard are contained in para 6.2 as under:-

On going through the same we find that the ld.CIT(A) has recorded a categorical finding of fact that the impugned amount was paid by the assessee to DLB for storage in its vault the gold purchased from it and the said payment was made on account of delay in taking delivery of the said gold beyond the agreed period. It was the charges paid due to additional time taken by the assessee in identifying buyers. The ld.CIT(A) has noted that the AO while making the disallowance had neither analysed the nature of expense nor did he seek any information or document about the said expense. The ld. DR was unable to controvert the above factual finding of the ld.CIT(A). In the light of the same, we see no reason to interfere in the order of the ld.CIT(A). The ld.CIT(A), after recording the facts relating to the impugned expenditure and deriving therefrom that they were in the nature of compensation paid by the assessee, which finding both on facts and interpretation, the ld. DR has been unable to dislodge before us, has allowed the assessee’s claim of expenditure. The ground of appeal No.3 raised by the Revenue is, therefore, dismissed.