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Income Tax Appellate Tribunal, ‘A’ BENCH: CHENNAI
Before: HON’BLE SHRI V. DURGA RAO & HON’BLE SHRI G. MANJUNATHA
आदेश / O R D E R PER G. MANJUNATHA, ACCOUNTANT MEMBER: This appeal filed by the Revenue is directed against the order of the Commissioner of Income Tax (Appeals)-2, Chennai, dated 29.11.2019 and pertains to AY 2009-10.
The Revenue has raised the following grounds of appeal:
1. The order of the learned CIT(A) is contrary to law, facts and circumstances of the case? 2. The learned CIT(A) erred in allowing forex derivative loss as non-speculative and a business loss? 3. The Id. CIT(A) failed to appreciate the derivative transactions entered into by the assessee with State Bank of India is not in the ordinary course of business of the assessee who is an exporter of granites and the Export bills or receivables of the assessee cannot be linked to the derivative transactions?
4. The Id. CIT(A) failed to appreciate the assessee by entering into a currency derivative transaction the assessee is clearly taking a speculative bet on the movement of Japanese Yen with US Dollars during a fixed period which are in the nature of a wager contract and hence the loss on the same is not an allowable business expenditure?
5. The Id. CIT(A) failed to appreciate the forex derivative transactions undertaken by the assessee are not settled by actual delivery of foreign exchange but only the difference between the agreed price on the maturity date that is credited or debited to the account of the assessee and hence would fall within speculative transaction?
6. The Id. CIT(A) failed to appreciate neither the bank nor the assessee has analyzed or stated any specific underlying exposure or balance sheet exposure of the assessee in the derivative transaction?
7. The Id. CIT(A) failed to appreciate a Forex derivative transaction, if it is a hedge should reduce the risk and loss to the assessee but the perusal of the contract notes and corresponding huge loss incurred by the assessee during the short period would indicate that the derivate transactions have only increased the risk to the assessee and not reduced the risk like as a 'hedge'?
8. The ld. CIT(A) failed to appreciate the decision of Hon’ble Mumbai ITAT in the case of Shri Vinodkumar Diamonds (P) Ltd. vs. Additional Commissioner of Income lax (2013) 35 Taxmann 337, wherein it was held 'In order that forward transactions in commodities may fall within proviso (a) to section 43(5) of the Act, it is necessary that the raw materials or merchandise in respect of which the forward transactions have been made by the assesses must have a direct connection with the goods manufactured or the merchandise sold by him. In other words, raw material in respect of which the assesses has entered into forward transactions must be the same raw material which is used by him in his manufacturing business. We find that in the case under consideration assesses was not dealing in Foreign Exchange, therefore transactions entered into by it in Foreign Exchange cannot be held to be hedging transactions. Assessee is dealing in diamonds and FC entered into only for diamonds would have been covered by the proviso (a) to the section 43(5) of the Act. Assessee was also not able to contradict the finding of fact that booking and cancellation of FC of exchange were not in respect of specified export or import. Besides, finding of fact given by the Revenue Authorities remained un-contravened that loss shown by the assessee pertained to these PCs transactions, against which no actual delivery of foreign exchange was made. On appreciation of the facts surrounding the transaction we have reached at the conclusion that transactions entered in to by the assessee were not hedging transaction, but same were speculative and thus the case of the assessee is not covered by proviso(a) of the section 43(5) of the Act'?
For these and other grounds that may be adduced at the time of hearing, it is prayed that the order of the learned CIT(A) may be set aside and that of the Assessing Officer restored.
The brief facts of the case are that the assessee is engaged in the business of export of granite blocks to overseas market including Japan and China. The assessee has filed its return of income for the AY 2009-10 on 30.09.2009 declaring carry forward loss of Rs.2,10,82,712/-. For the year 2007, the assessee had entered into sale agreements with two or three of Japanese Companies to supply different quantities of monument granite blocks through their Chinese Intermediaries during the ensuing three-year period. The Chinese would be making the payment in USD with a future possibility of the direct payment by the Japanese customers. The assessee had entered into hedging contract with State Bank of India to hedge the foreign currency risk to minimize the loss for USD at Japanese end. The assessee has accounted profit or loss arising on account of fluctuation in foreign currency as income or expenses, as the case may be, in the relevant AYs. During the year under consideration, the assessee has claimed foreign exchange fluctuation loss amounting to Rs.5,45,96,356/-. During the course of assessment proceedings, the AO on the basis of details filed by the assessee and also an analysis of provisions of Sec.43(5) of the Income Tax Act, 1961 opined that loss incurred by the assessee on account of fluctuation in foreign currency, is in the nature of speculative transaction and consequent loss is to be treated as speculative loss. The AO discussed the issue at length in light of provisions of Sec.43(5) of the Act and Securities Contracts (Regulation) Act, 1956 and opined that the claim of the assessee that derivatives comes under the proviso (d) to Section 43(5) of the Act, is not acceptable, because, said proviso does not give blanket exclusion to all derivative contracts, but only to such contracts that are treated in the recognized Stock Exchange. Therefore, by following certain judicial precedents, rejected the arguments of the assessee and made additions towards foreign exchange fluctuation loss of Rs.5,45,96,356/-.
Being aggrieved by the Assessment Order, the assessee preferred an appeal before the Ld.CIT(A). Before the Ld.CIT(A), the assessee has filed detailed Written Submissions on this issue, which has been re-produced at Page Nos.3-13 of the Ld.CIT(A)’s Order. The sum and substance of the arguments of the assessee before the Ld.CIT(A) are that Forex derivative contracts entered into with State Bank of India is mainly for hedging, possible fluctuation in foreign currency on account of receivables from exports. Therefore, loss incurred on foreign exchange fluctuation is in the nature of Revenue expenditure, which is covered by proviso (d) to Sec.43(5) of the Act.
5. The Ld.CIT(A) after considering the submissions of the assessee and also by following certain judicial precedents including the decision of the Hon’ble Supreme Court in the case of CIT v. Woodward Governor India Pvt. Ltd. reported in (2009) 312 ITR 254 (SC) held that exchange loss incurred by the assessee on account of fluctuation in foreign currency is arised out of forward contracts entered into by the assessee with State Bank of India for hedging export receivables, which is in the nature of business loss, which cannot be considered as speculative loss within the meaning of Sec.43(5) of the Act. Therefore, opined that profit or loss arises to the assessee on account of appreciation or depreciation in the value of foreign currency held by it on conversion into another currency, such profit or loss would ordinarily be a trading profit or loss, if the foreign currency held by the assessee on Revenue account or as a trading asset or as a part of circulating capital embarked in the business. Therefore, rejected the reasons given by the AO to make addition towards foreign exchange fluctuation loss and deleted the additions made by the AO. The relevant findings of the Ld.CIT(A) are as under:
Let us now come to the facts of the present case. The appellant is into the business of export of monument granite block to the Japanese market through Chinese intermediaries.
5.1 In the year 2007, Kunnam Granite Works entered in to sale agreements with two or three of Japanese Companies to supply around 6 to 8 different qualities of Monument granite blocks to them through their Chinese intermediaries during the ensuing 3 year period. The supplies are in the form of granite Blocks which will be shipped to Chinese Intermediaries and the Chinese, after completing the monument making process, will supply to the end user of Japanese buyers. This arrangement was suggested by the Japanese Customers in view of the inexpensive cost of labour in China. The Chinese would be making the payments in US $ with a future possibility of the direct payment by Japanese customers in Japanese Yen depending on the Currency fluctuation. As estimated, these shipments would run into several crores in the coming years and since the orders were assured, Kunnam Granite Works in consultation with State Bank of India took steps to hedge the foreign currency risk involved in these transactions by entering into certain long term USD - JPY currency contracts.
5.2 From appellant's records, it was noted that for the year 2007-08 the Firm has made some gains in Forward Contracts which was accounted as Income from Foreign Exchange Gain and was assessed as Business Income. However, in the years to come starting 2008 till date, the JPY currency had appreciated greatly against the USD which meant that the currency equation went in the direction opposite of what was anticipated by the Bank and the appellant at the time of entering the contract.
5.3 The appellant is not a dealer in foreign exchange and has entered in to forward contracts with the bank, as per the advice given by the bank, for the purpose of hedging the future loss due to fluctuation in foreign exchange. While performing the export contract some of these contracts could not be honoured for which the assessee has paid exchange loss to the bank amounting to Rs.5,45,96,356/- for the relevant Financial Year which is debited to the Profit & Loss Account as loss from Foreign Exchange.
5.4 It appears that the AO has overlooked the fact that the appellant, being a prudent business entity entered into a foreign exchange contract with the hope that it may recoup any future losses due to the vageries of the currency market. In the circumstances, therefore, the loss it suffered cannot be considered as a speculative loss within the meaning of Section 43(5) of the Income-tax Act, in my considered view. The appellant has elaborately argued and stated its case in the Grounds of appeal which is found in Pages 5 to 13 of this order, and the contents of which do not require to be reproduced here once again for the sake of brevity. From the facts of the appellant's case, it would have to be agreed that the exchange loss incurred is in the nature of "business loss" only and not speculative loss as purported by the AO. The case laws cited by the appellant are also squarely applicable to the appellant's case and hence appellant cannot be denied relief on this score. 5.5 The AO's objections are, therefore, liable to be rejected in the light of the factual matrix of the appellant's case.
The Ld.DR submitted that the Ld.CIT(A) erred in not appreciating the fact that the derivative transaction entered into by the assessee with State Bank of India, is not in the ordinary course of business of the assessee, who is an export of granites and the export bills are receivables of the assessee, cannot be linked to the derivative transactions. The Ld.DR, further, submitted that the Ld.CIT(A) failed to appreciate the fact that Forex derivative transactions undertaken by the assessee, are not settled in light of delivery of foreign exchange, but only the difference between the agreed price on the maturity date i.e. credited or debited to the accounts of the assessee and hence, would fall within speculative transaction.
The Ld.AR for the assessee, on the other hand, supported the order of the Ld.CIT(A) and submitted that the assessee had entered into forward contract with State Bank of India to hedge possible fluctuation in foreign currency on account of export receivables, which is evident from the fact that the assessee is in the business of export of granite blocks to Japan and further the export sales of the assessee for the year under consideration is more than Rs.50 Crs. whereas, the derivative contracts entered into by the assessee is only Rs.5 lakhs USD per month, which is much lower than the value of exports. The Ld.AR further submitted that it is a well settled principle of law by the decision of various Courts including the decision of the Hon’ble Supreme Court in the case of CIT v. Woodward Governor India Pvt. Ltd. (supra) that profit or loss arises on account of conversion of one currency into another currency, is Revenue in nature, if such foreign currency is held in the ordinary course of business of the assessee as a trading asset or circulating capital. In this case, the assessee has entered into forex derivative to hedge the possible loss in fluctuation in currency, which resulted in loss for the year under consideration. The assessee has accounted profit or loss as an income or expenses in the relevant AY and further, whenever, the assessee had earned profit on account of appreciation in foreign currency, the same has been offered as income and the Department has accepted the same. Therefore, the AO cannot take a different view for the year under consideration when there is no change in the facts and circumstances of the case.
We have heard both the parties, perused the materials available on record and gone through orders of the authorities below. The facts borne out from record clearly indicated that assessee had entered into business of export of monument granite blocks to Japan Companies through their Chinese Intermediaries. The Chinese Intermediaries would be making the payment in USD with a future possibility of the direct payment by Japan customers in Japanese Yen depending on the currency fluctuation. As agreed by the parties, the assessee had achieved export sales of Rs.50.53 Crs. for the FY relevant to the AY 2009-10. Since, the assessee had huge export receivables from customers, it had entered into a Forex derivative transaction with State Bank of India to hedge the foreign currency risk involved in these transactions. The assessee has treated profit or loss arised on account of fluctuation of foreign currency as income or expenses, as the case may be, in the relevant AYs. The Department has accepted the income declared by the assessee on account of Forex gain whenever the assessee has earned gain from appreciation in foreign currency. However, disputed loss claimed for the year under consideration only on the ground that derivative transactions entered into by the assessee is in the nature of speculative transaction, which does not come under proviso (d) to Sec.43(5) of the Act.
9. We have gone through the reasons given by the AO to treat Forex loss incurred by the assessee on account of derivative transactions as speculative transactions in light of various arguments advanced by the Ld.AR for the assessee and we ourselves do not subscribe to the reasons given by the AO for the simple reason that the assessee being an export of goods to Japan Company had entered into hedging transactions with State Bank of India by entering into Forex derivatives to minimize possible loss in fluctuation in USD, because the Japanese Companies agreed to make the payments through their Chinese Intermediaries by USD. Further, during the year under consideration, the assessee achieved an export turnover of Rs.50.53 Crs. which is much more than the amount of derivative contracts entered into by the assessee with State Bank of India. We further noted that when the assessee enters into a hedging transaction to minimize the possible loss from fluctuation in foreign currency, then profit or loss arises on account of appreciation or depreciation in the value of foreign currency held by it on conversion into another currency, such profit or loss would ordinarily be a trading profit or loss, if the foreign currency is held by the assessee on Revenue account or as a trading asset or as a part of circulating capital embarked in the business, if the underline asset is more than the amount of forward contracts entered into by the assessee. This legal principle is supported by the decision of the Hon’ble Supreme Court in the case of CIT v. Woodward Governor India Pvt. Ltd. (supra), and it is also supported by the principles laid down by the Hon’ble Bombay High Court in the case of CIT v. V.S. Dempo & Co. Pvt. Ltd. reported in (1994) 206 ITR 291 (Bombay), wherein, it was held that the loss arising in the process of conversion of foreign currency, which is part of trading asset of the assessee, is a trading loss as any other loss. In this case, the facts available on record clearly shows that the assessee being an export of goods had huge receivables from customers entered into a hedging contract with its bankers to minimize the possible fluctuation in foreign currency, which resulted in loss and the same has been treated as Revenue expenditure or business loss. The Ld.CIT(A) after considering the relevant facts has rightly held that loss incurred by the assessee on account of fluctuation in foreign currency, is in the nature of business loss, but not speculative loss, which is covered u/s.43(5) of the Act. Facts remain unchanged. The Revenue failed to bring on record further evidences to prove the findings of facts recorded by the Ld.CIT(A) are incorrect. Hence, we are inclined to uphold the findings of the Ld.CIT(A) and dismissed the appeal filed by the Revenue.
In the result, the appeal filed by the Revenue is dismissed.
Order pronounced on the 10th day of February, 2022, in Chennai.