PRINCIPAL COMMISSIONER OF IN vs. M/S.PRECOT MERIDIAN LTD.,

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TCA/271/2020HC Madras29 September 2020Bench: Hon`ble Mr Justice T. S. SIVAGNANAM10 pages
AI SummaryDismissed

What did the High Court hold?

The High Court dismissed the appeal filed by the Revenue. The Court found no ground to interfere with the impugned order passed by the Tribunal. The Tribunal had rightly held that the loss incurred on foreign exchange derivative could not be disallowed by holding it to be a speculative loss. The Tribunal had referred to decisions of the Bombay High Court in CIT Vs. Badridas Gauridu P. Ltd. and CIT Vs. D.Chetan & Co., and the Supreme Court in Sutlej Cotton Mills Ltd. Vs. CIT. The Tribunal noted that foreign exchange derivative transactions partake the character of the underlying transaction. If the underlying transaction was capital in nature, the derivative would also be capital, and if revenue, the derivative loss could be allowed as revenue loss. The Tribunal remanded the issue to the Assessing Officer to examine whether the foreign exchange derivative transactions were in respect of capital or revenue items, as the AO had not undertaken this exercise. The High Court relied on its own recent decision in CIT Vs. M/s.Celebrity Fashion Ltd., which dealt with a similar issue and held that losses on cancellation of forward contracts were not speculative losses under Section 43(5), especially when the transactions were incidental to the assessee's business (e.g., exporter hedging against forex fluctuations). The substantial questions of law were answered against the Revenue.

What were the facts?

The assessee, M/s. Precot Meridian Limited, engaged in manufacturing and selling cotton yarn, fabrics, garments, and generating electricity, filed its return for Assessment Year 2009-10 declaring a total loss. The assessee claimed a business loss arising from derivative transactions, which was adjusted against a general reserve. The Assessing Officer (AO) disallowed this claim, treating the loss of Rs. 28,97,50,845/- as speculative loss. The AO's reasoning included the assessee's use of USD/CHF derivative when it had no Swiss Franc transactions, the non-deliverable nature of the contract, and the fact that it was not transacted through a recognized stock exchange. The Commissioner of Income Tax (Appeals) upheld the AO's order. The Income Tax Appellate Tribunal (ITAT) allowed the assessee's appeal, remanding the issue to the AO for further examination.

What were the issues?

1. Whether the Appellate Tribunal was justified in law in holding that the loss on derivative transactions is business loss, overlooking that when no actual delivery took place, the transactions fall within the definition of speculative transaction as per Section 43(5) of the Income Tax Act? 2. Whether the Tribunal was justified in law in holding that forex derivative transactions carried on by the assessee through a banker as Over the Counter Transactions, and not through a recognized stock exchange, are covered by Proviso (d) to Section 43(5) when the preconditions laid by the Explanation to the said Proviso are not satisfied? 3. Whether the Tribunal was justified in law in deciding that the transactions in structured derivative contracts are incidental to the assessee's business when the correlation to specific export bills and the correlation of maturity of the hedge and the maturity of the underlying transactions are not established? 4. Whether the Tribunal was justified in law in deciding that the derivative transactions are incidental to the assessee's business when the assessee had taken the derivative on USD/Swiss franc combination whereas the assessee had no transactions in Swiss franc? Assessee's contentions: The judgment does not explicitly record the assessee's arguments before the High Court, but it notes that the Tribunal allowed the appeal and remanded the issue. The Tribunal's reasoning, which the High Court upholds, suggests the assessee argued that the derivative transactions were incidental to its business and not speculative. Revenue's contentions: The Revenue argued that the derivative transactions were speculative as no actual delivery took place, and they were not conducted through a recognized stock exchange. They also questioned the correlation of the structured derivative contracts to specific export bills and the maturity of the hedge, and the use of USD/CHF derivatives when the assessee had no Swiss Franc transactions.

Which sections of the Income-tax Act were involved?

Section 43(5),Section 260A,Section 115JB

AI-generated summary — verify with the full judgment below

TCA.No.271 of 2020 IN THE HIGH COURT OF JUDICATURE AT MADRAS DATED : 29.9.2020 CORAM THE HONOURABLE MR.JUSTICE T.S.SIVAGNANAM and THE HONOURABLE MRS.JUSTICE V.BHAVANI SUBBAROYAN T.C.A.No.271 of 2020 Principal Commissioner of Income Tax-1, Coimbatore

...Appellant Vs M/s.Precot Meridian Limited, Coimbatore-45.

...Respondent

APPEAL under Section 260A of the Income Tax Act, 1961 against the order dated 11.6.2019 passed by the Income Tax Appellate Tribunal, Chennai “B” Bench in I.T.A.No.131/Chny/2016 for the assessment years 2009-10.

For Appellant : Mr.T.R.Senthilkumar, SSC assisted by Ms.K.G.Usharani, JSC For Respondent : Mr.A.S.Sriraman

Judgment was delivered by T.S.SIVAGNANAM,J This appeal, filed by the Revenue under Section 260A of the 1/10 http://www.judis.nic.in TCA.No.271 of 2020 Income Tax Act, 1961 (‘the Act’ for brevity), is directed against the order dated 11.6.2019 passed by the Income Tax Appellate Tribunal, Bench ‘B’ Chennai (for short, the Tribunal) in ITA.No.131/Chny/2016 for the assessment year 2009-10. 2. The Revenue has filed this appeal by raising the following substantial questions of law:

“1. Whether the Appellate Tribunal is justified in law in holding that the loss on derivative transactions is business loss thereby overviewing the fact that when no actual delivery has taken place, the transactions in question fall within the definition of speculative transaction as per Section 43(5) of the Income Tax Act ? 2. Whether the Tribunal is justified in law in holding that the forex derivative transactions carried on by the assessee through a banker as Over the Counter Transactions and not through a recognized stock exchange are also covered by Proviso (d) to Section 43(5) when the preconditions laid by the Explanation to the said Proviso are not satisfied to constitute it as an eligible transaction ?

3.

Whether the Tribunal is justified in law 2/10 http://www.judis.nic.in TCA.No.271 of 2020 in deciding that the transactions in structured derivative contracts are incidental to the assessee's business when the correlation to specific export bills and the correlation of maturity of the hedge and the maturity of the underlying transactions are not established ? and 4. Whether the Tribunal is justified in law in deciding that the derivative transactions are incidental to the assessee's business when the assessee has taken the derivative on USD/ Swiss franc combination whereas the assessee had no transactions in Swiss franc ?” 4. The facts, which are necessary to answer the substantial questions of law raised for consideration are as follows : The assessee company is engaged in the business of manufacture and sale of cotton yarn, fabrics, garments and generation and sale of electricity. For the assessment year under consideration namely AY 2009-10, they filed the return of income on 21.9.2009 declaring a total loss of Rs.24,29,95,888/- under normal provision and book profit of Rs.6,99,37,975/- under Section 115JB of the Act. The assessee claimed business loss, which was adjusted against general reserve account and the current year loss was booked in the profit and loss account under the head 'administration expenses'. The Assessing 3/10 http://www.judis.nic.in TCA.No.271 of 2020 Officer disallowed the business loss and treated it as a speculative loss. 5. The Assessing Officer came to such a conclusion on the ground that the assessee had taken the derivative on USD/CHF combination when the assessee had no transaction in Swiss Franc; that the contract was for non deliverable derivative specifically cross country call option contract; that though, under Section 43(5) of the Act, commodities included stock, shares and non deliverable forex derivatives also, only when transacted through a recognized Stock Exchange, it could be counted for non speculative income as per Section 43(5)(d) of the Act; and that the assessee had not actually delivered the currency to banks. The Assessing Officer, after referring to various decisions of the Tribunal, disallowed the claim of derivative loss to the tune of Rs.28,97,50,845/- by holding that the forex derivative losses were speculative losses and not business losses. 6. Aggrieved by the same, the assessee preferred an appeal before the Commissioner of Income Tax (Appeals)-1, Coimbatore [for brevity, the CIT(A)] by filing Appeal No.225/11-12. The CIT(A) extracted the finding rendered by the Assessing Officer and concurred with him by the order dated 26.10.2015. 7. As against the said order passed by the CIT(A), the assessee filed an appeal before the Tribunal and it was allowed by the impugned 4/10 http://www.judis.nic.in TCA.No.271 of 2020 order. The Tribunal, while allowing the appeal, had taken note of the transactions done by the assessee wherein they had incurred loss of Rs.28,97,50,845/- and tabulated the details in paragraph 7 of the impugned order. 8. The Tribunal referred to (i) the decision of the High Court of Bombay in the case of CIT Vs. Badridas Gauridu P. Ltd. [reported in (2003) 261 ITR 256] and (ii) another decision of the Bombay High Court in the case of CIT Vs. D.Chetan & Co. [reported in 390 ITR 36] and held that the loss incurred on foreign exchange derivative could not be disallowed holding to be a speculative loss; that it was important to note that foreign exchange derivative transaction partook the character underlying the transaction of foreign exchange; and that if the transaction, in respect of which derivative transaction was undertaken, was capital in nature, even the derivative transaction would also be capital in nature. Therefore, the Tribunal further held that it needed to be examined as to whether the foreign exchange forward contract was undertaken in respect of capital items or revenue items. The Tribunal referred to the decision of the Hon'ble Supreme Court in the case of Sutlej Cotton Mills Ltd. Vs. CIT [reported in

(1979) 116 ITR 1] and held that in view of the legal position laid down in that decision, foreign exchange derivative loss in respect of 5/10 http://www.judis.nic.in TCA.No.271 of 2020 capital items was certainly a capital expenditure and could not be allowed as loss whereas in respect of revenue items, it could be allowed as revenue loss. 9. The Tribunal further held that the Assessing Officer had not undertaken the exercise of verifying as to whether foreign exchange derivative transaction were in respect of capital items or revenue items and that there was no material record to establish the nature of transactions and ultimately remanded the issue to the Assessing Officer for the purposes of examining the issue on the lines indicated by the Tribunal in the impugned order. The appeal filed by the assessee before the Tribunal was partly allowed and remanded to the Assessing Officer. 10. Before us, the Revenue has reiterated the contentions, which are, in fact, the opinion recorded by the Assessing Officer in the assessment order dated 27.12.2011. 11. Recently, we had an occasion to consider a more or less identical issue in the case of CIT Vs. M/s.Celebrity Fashion Ltd. [TCA.No.26 of 2018 dated 21.9.2020] wherein one of the substantial questions of law, which fell for consideration, was as to whether the Tribunal was right in holding that the loss incurred on account of cancellation of forward contracts was not speculative losses 6/10 http://www.judis.nic.in TCA.No.271 of 2020 falling within the provisions of Section 43(5) of the Act. The said question was answered in favour of the assessee on the following lines: “26. ........Be that as it may, we have considered the reasons assigned by the Tribunal in the assessee's own case for the earlier assessment year wherein the Tribunal rightly took note of the earliest decision of the Calcutta High Court on the said point in the case of Soorajmull Nagarmull and pointed out that under Section 43(5) of the 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, the assessee herein was not a dealer in foreign exchange, but was an exporter of cotton. Therefore, the Tribunal rightly took note of the transaction done by the assessee though, in order to hedge against the losses, the assessee booked foreign exchange in the forward market with the bank. However, the export contracts entered into by the assessee for the export of cotton in some cases failed and therefore, the assessee was held to be 7/10 http://www.judis.nic.in TCA.No.271 of 2020 entitled to claim deduction in respect of the said amount as business loss. ......... 29. It will be beneficial to refer to the decision of the Bombay High Court in the case of CIT Vs. Badridas Gauridu Pvt. Ltd. [reported in (2003) 261 ITR 256]. In that case, the assessee was not a dealer in foreign exchange, but was an exporter of cotton as in the case before us. The assessee therein booked foreign exchange contracts, which were held to be only incidental to the assessee's regular course of business. While testing the correctness of the order of the Tribunal, which held that the transaction was not a speculative transaction, it was observed 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" 8/10 http://www.judis.nic.in TCA.No.271 of 2020 has been defined to mean a transaction in which a contract for the purchase or sale of a 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 respect of Rs. 13.50 lakhs as a business loss. This matter is squarely covered by the judgment of the Calcutta High Court with which we agree, in the case of CIT Vs. Sooraj Mull Nagarmull [1981] 129 ITR 1691].” 12. The above decision in the case of M/s.Celebrity Fashion Ltd., would also come to the aid and assistance of the assessee. Thus, in the light of the law laid down by us in the above decision, we find that the Tribunal was right in its finding that the loss incurred on foreign exchange derivative cannot be disallowed holding it to be a speculative loss. In any event, the Tribunal remanded the matter to 9/10 http://www.judis.nic.in TCA.No.271 of 2020 T.S.SIVAGNANAM,J AND V.BHAVANI SUBBAROYAN,J

RS the Assessing Officer for a limited purpose, which has been clearly indicated in paragraph 7 of the impugned order. For the foregoing reasons, we find no ground to interfere with the impugned order passed by the Tribunal. 13. Accordingly, the above tax case appeal is dismissed, the impugned order passed by the Tribunal stands confirmed and the substantial questions of law are answered against the Revenue. No costs. 29.9.2020 To The Income Tax Appellate Tribunal, Chennai “B” Bench

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