DCIT, NEW DELHI vs. M/S ORIENT OVERSEAS PVT.LTD.,, DELHI

Date of Hearing : 02-08-2016 Date of Order : 09-08-2016

ORDER PER H.S. SIDHU : JM The Revenue has filed the present appeal against the impugned order dated 10/2/2012 passed by the Ld. Commissioner of Income Tax (Appeals)-XVI, Delhi on the following grounds relevant for the assessment year 2008

09. (wrongly mentioned as AY 1996-97 in Form No. 36 filed by the Revenue).

2. The appellant craves, leave or reserving the right to amend modify, alter, add or forego any ground(s) of appeal at any time before or during the hearing of this appeal.

The case was selected for scrutiny assessment and notices u/s 143(2) of the l.Tax Act dated 04.09.2009 was issued and duly served upon the assessee within prescribed statutory time limit.

Thereafter, notice u/s 142(1) of I.Tax Act dated 13.10.2010 was issued and served upon the assessee. In response to these statutory notices the Authorized Representative of the assessee company attended the assessment proceedings and filed necessary details/ documents as called for therein. These details were examined by the AO. Books of accounts were also produced and examined on test check basis. Thereafter AO observed that the damages paid by the assessee for cancellation of contract without taking any delivery of goods due to breach would constitute a speculative transaction and such speculative loss can only be adjusted against speculative income. Therefore loss of Rs. 2,89,15,250/- shown as damages paid for breach of contract is held to be a speculative loss and it cannot be allowed against the business profits. Accordingly an addition of Rs. 2,89,15,250/- was made and accordingly, AO assessed the income at Rs. 3,34,36,108/- vide his order dated 3.12.2010 passed u/s. 143(3) of the Act.

“6.1 I have carefully considered the facts of the case, the findings of the AO as well as the submissions of the A/R. Regarding ground nos. 1 & 2, the appellant is engaged in the business of trading in pulses and chemicals on whole sale basis for which it imports pulses and PVC resin in bulk quantities from foreign parties. The appellant company also carried processing activities to make dal from whole grain pulses. For import of the items it enters into contracts with foreign parties.

From the details of purchases given by the appellant it is apparent that its imports from top 15 parties is more than Rs. 54 crores including from JK International Pvt. Ltd. (Rs. 12.92 crores). It has Ltd. for the last several years. In the A.Y. 2008-09, constitute about 22.75% of total purchase of pulses of Rs.56.84 crores. As per purchase details the import of Rs.12.92 crores have been made during the year from J.K. International Pvt. Ltd. on the basis of contracts that were honoured. However, one particular contract for import of chick peas from J.K. International Pvt. Ltd. entered on 04/04/2007 was not honoured and finally settled between the parties on 17/05/2007 as under:-

Contract Date of Due date Date of Date of No. Contract of Breach settlement shipment of contract 13584 04-April- 30-April- 30-April- 17-May-07 07 07 07 The appellant paid damages of Rs.2,89,15,250/- to J.K. International Pvt. Ltd. as this contract could not be honored. According to the A.O., the loss was not by sale of pulses at prices lower than what they were bought but was by indemnification as it had to pay damages for the breach of contract. The contract was cancelled without taking deliveries. It was not an actual loss incurred by the assessee in regular course of business but a speculative loss.

The assessee paid difference of the purchase and sale prices in respect of goods which were not even in its hands. It was a sort of loss on trading in future options. The damages paid by the assessee for cancellation of contract without taking any delivery of goods due to breach would constitute a speculative transaction and such speculative loss can only be adjusted against speculative income.

The appellant submitted that the company had requested the party to delay the delivery of Chickpeas (Chana) due to lower demand and decline in local market rates. The party did not agree to it as it had a ready stock with it. Under pressing circumstances, the contracts came to an end due to non-performance. Thereafter, the company settled the breach with the said party and paid the damages.

6.2 From the memorandum of understanding between seller J.K. International Pvt. Ltd. and buyer, Orient Overseas Pvt. Ltd., the appellant company executed on 06/05/2003 the cl. (3) of terms of agreement says:-

"Cl (3). The buyer undertakes to submit the required documents and to accept the deliveries of goods within the agreed period failing which the buyer shall be deemed to have breached the contract and the seller has the right to claim damages from the buyers at the prevailing market price."

According to the above contract no. 13584 dtd 04/04/2007 the shipment period of 15,000 MT of chick peas @ $ 545 per MT is upto 30104/2007 during which appellant is required to open the letter of credit (UC) before the actual shipment. The appellant failed to provide the L/C within the agreed period. It is also noticed that market price of chick peas (chana) at MCX commodity exchange have fallen from Rs.2,474/- per 100 kgs as on 04/04/2007 to Rs.2, 188/- as on the date shipment on 30/04/2007. Therefore, to this extent the submission of the appellant that due to lower demand there is decline in market rate is found to be correct. From the chart of average cost of Chick Peas and estimated loss filed by the appellant it is also apparent that, if the appellant had imported the items at the agreed rice as per the import contract the appellant would have suffered a huge of loss of Rs.4. 5 crores. Therefore, the loss of Rs.2.89 crores suffered by appellant is a case of loss minimization.

6.3 From the email communication dated 04/05/2007 it is also evident that J.K. International Pvt. Ltd. has claimed an amount of $ 7,50,000/- [15,000 MT x $ 501- per MT] @ $501- per MT being the difference between contract price @$ 545/- and market price $ 495/- as the appellant has failed to open the L/C within the contract shipment period upto 30/04/2007. The above communication also suggests the fall in international market price of chick peas from the agreed rate of $5451- per MT as on 04/04/2007 to $4951- per MT as on 30/04/2007. From the email communication dt 04/05/2007 from the MD of the appellant company and dt 07/05/2007 from J.K. International Pvt. Ltd. it is also evident that the offer of $45 per MT by the Ltd. and finally it was settled at $ 47.50 per MT being the difference between contract p-rice ($545) and settled priced ($497.5). Accordingly, the price was settled $47.50 per MT on 17/05/2007 and the account of the appellant was debited by J.K.

International Pvt. Ltd. at the settled amount of $7,12,5001- [15,000 MT x $ 47.50].

The amount of $7,12,SOO paid by the appellant to J.K. International Pvt. Ltd. being Rs.2,89,15,250/- @ Rs.40.58, the exchange rate shown as on 17/O5/2007, was claimed as loss on account of damages paid for breach of contracts.

6.4 From the above, it is evident that the appellant committed a breach of contract by failing to open the letter of credit as per the memorandum of understanding dt 06/05/2003 and contract no. 13584 dt 04/04/2007 before the date of shipment upto 30/04/2007. Thereafter, the breach was settled on 17/0S/2007 because of the inability of the appellant to take the delivery of goods due to lower demand and decline in market rates. The settlement in this case was not by mutual consent to avoid delivery. It was settled because of inability of the appellant to provide the L/C to the supplier by the date of shipment. The appellant did not settle the contract before the expiry date but settlement was reached after the breach. Therefore, it is not a case of settlement of contract but a case of settlement of breach of contract. The assessee having committed a breach of contract had agreed to pay a sum of Rs.2,89,15,250/- to JK.

International Pvt. Ltd. by way of compensation.

Therefore, it is a case of settling the quantum of damages. As such the loss suffered by the appellant is a normal loss incidental to the business of the appellant, which is not covered by the definition of speculative transaction in see 43(5).

6.5 Hon'ble Jurisdictional Delhi High ,Court in the case of CIT vs. Bhagwan Dass Rameshwar Dayal 22 Taxman 462 (Delhi) have held that:

without actual delivery. If the contract is broken, i.e., for any reason one party is unable to give delivery or the other party is unable to take delivery, it is a case of breach of contract. It depends, therefore, on the facts and circumstances of the case as to whether there has actually been a "breach" of the contract or a "settlement" of the contract. A breach takes place on account of repudiation of the contract or failure to perform it or a contract may be terminated through frustration, impossibility or through any other cause which ends the contract under the contract Act or the sale of goods Act.

only covers cases where a contract is settled without breach, and not cases where there is a breach followed by a settlement of the quantum of the damages, we answer the question referred to us in the affirmative and against the department.

6.6 Hon'ble Calcutta High Court in CIT vs. Pioneer Trading Company (P) Ltd. 70 ITR 347 (Cal) have held that the meaning of a contract settled otherwise than by actual delivery or transfer of the commodity means a contract settled before a breach takes place. If there is a settlement after the breach, it is a case of settling the quantum of damages.

6.7 In the case of CIT vs. Indian Commercial Co.

(P) Ltd. 106 ITR 465 (Born), the assessee-company entered into an agreement with HSL for purchasing 250 metric tons of Hot Pressed Naphthalene, f.o.b., Calcutta. Under clause III, delivery of the goods was to be so arranged that the entire quantity would be shipped from Calcutta before 30-9-1961.

Under clause V, it was provided that a letter of credit was to be opened by the assessee-company forthwith. But the assessee-company failed and neglected to open any letter of credit, as it was required to do under the said agreement. The price of the said goods having gone down in foreign markets, the assessee-company which had failed to open a letter of credit as required by the agreement between it and the sellers, negotiated with the sellers, viz., HSL for an amicable settlement, as otherwise it would suffer substantial loss. The assessee-company requested HSL to accept the total sum of Rs. 50,000 'as a full settlement'. HSL accepted the full settlement as a very special case.

The appellant claimed the same as damages paid for breach on contract as business loss. The revenue disallowed the claim, treating it to be speculation loss. On appeal AAC reversed the decision allowing the appeal of the appellant and tribunal upheld the decision of AAC. On further appeal by the revenue, Hon'ble Bombay High Court have held that:

"In the view which the court had taken on the facts in the present case, viz., that the said sum of Rs. 50,000 had been paid to HSL after the breach by the assessee-company of its contract, it must be held that the settlement as a result of that payment was made, was not a settlement of the contract within the terms of section 43(5), but was a settlement of the assessee-company's liability for damages for the breach of that contract.

Following the view taken by the Calcutta High

Court, and by the Mysore High Court, it was held that the contract itself could not by reason of such settlement, be said to be a speculative transaction."

6.8 In the case of CTT vs. Andhra Oil & Fertilisers Co. [1983] 13 Taxman 64 (A.P.) The assessee-firm, carrying on business in manufacture and sale of rice bran oil, entered into contracts with reputed concerns for ready delivery of its products. In the assessment Ayrs. 1966-67 to 1971-72, the assessee, though having sufficient oil to deliver, could not do so on account of non-availability of wagons, and as per the contract, the assessee had to pay to the buyer the difference between the price at which the buyer purchased oil from the open market and the contract price. The assessee claimed these amounts as business losses. The ITO disallowed the same on the ground that the said contracts were speculative in nature, and hence the losses could be set off only against any profit arising from another speculative business. The AAC confirmed the findings of the ITO. On further appeal, however, the Tribunal allowed the impugned losses, holding that the contracts in question were not speculative transactions. On further appeal by the revenue, Hon'ble Andhra Pradesh High Court have held that.-

"It is settled that taxing law has to be construed literally, and literally speaking there is a distinction between settling the contract and settling the claim for damages arising from the breach of a contract. Both are not synonymous. In case of breach of contract, what is settled is the claim arising from the breach of the contract and not the contract.

Settling a contract so as to make a transaction a speculative one means settling the contract before the occurrence of the breach by payment of difference. Where the breach occurs and thereafter claims arising from the breach are settled between the parties to the contract, it would not amount to settling of contract.

In this view of the matter, the transactions in question did not amount to speculative transactions and, therefore, the assessee was entitled to treat the impugned amounts as business losses."

6.9 In view of the facts discussed above and following the above decisions, the payment made by the appellant for breach of contract after the expiry date is a normal loss incidental to the business of the appellant and not a speculation loss within the meaning of section 43(5) of the I.T. Act.

Appeal is allowed in respect of ground nos. 1 & 2 of appeal.”

7.1 We are also reproducing the relevant portion of the ITAT, ‘F’ Bench, Delhi decision dated 29.7.2015 in the case of ACIT vs. Ramji Lal & Sons (HUF) (Supra) as under:-

“7. Considering the above submission, we find that there is no dispute on the facts of the issue in the present case. We also find that facts of the present case are similar to the facts on the issue in the case of Orient Overseas Pvt. Ltd. as well as in the case of Singhal Agro Industries Pvt. Ltd. It is apparent from the record that both the contracts i.e. dated 15.9.2006 and 11.10.2006 entered between the assessee and Agro Corporation International Pvt. Ltd. for import of pulses, the agreed due date of shipment in the first contract was 30.9.2006 and in the another contract it was 31.10.2006. The assessee had requested the parties to delay the delivery of pulses due to lower demand in the local market to which the supplier did not agree and thus the assessee could not honour the said two contracts by due dates and thus the contracts came to an end due to non- performance of the assessee on 30.9.2006 and 31.10.2006. As a result, the supplier claimed damages for the breach of contract and the claim was settled in the case of contract dated 15.9.2006 and 17.10.2006 and in the case of contract dated 11.10.2006 on 30.11.2006. We thus find substance in tbe contention of the Learned AR that the Assessing Officer, before whom the assessee had placed a detailed explanation, copies of trade agreements, contract notes, details of the claims/damages paid against breach of contracts failed to appreciate the nature of claims to ascertain as to whether the contracts were settled before the due date of the contracts or after the breach of the contracts. The explanation of the assessee supported with the above stated documents, clearly suggest that the claims in this case were in the nature or damages paid after the breach of contract. The Learned CJT(Appeals) following the ratios of decisions cited before it on the issue was thus justified in coming to the conclusion that the damages paid were fully allowable under sec. 37(1) of the Act. The Learned CIT(Appeals) has taken a stand, which is supported by several decisions cited before it, including the decisions of Hon'ble Delhi High Court in the cases of err vs. Bhagwan Dass Rameshwar Dayal (1984) 149 ITR 387 (DeL) and CIT vs, Hans Machoo & Co. (20CH) - 2471TR 79 (Del.). In the case of Bhagwan Dass Rameshwar Dayal (supra), the Hon'ble Delhi High Court has been pleased to hold that if the contract is settled otherwise than by actual delivery or transfer of the commodity, it is a speculative transaction but if there is a settlement after the breach, it is a case of settling the quantum of damages and the loss is incidental to business and allowable as a business loss. Again in the case of Hans Machoo & Co.

(supra), the Hon'ble Delhi High Court has been pleased to hold that the ITAT having recorded a finding that there was a breach of contract and the assessee had to pay damages, it was justified in allowing deduction of amounts paid, such a transaction cannot be described as a speculative transaction within the meaning of sec. 43(5) of the Ltd., a sister concern of the assessee, the Assessing Officer in compliance of the directions of the 1TAT has decided the issue afresh vide order dated 24.11.2011 in favour of the assessee. It is pertinent to mention over here that the first appellate had decided the issue in favour of the assessee, which was questioned by the Revenue before the ITAT and the ITAT had set aside the matter to the Assessing Officer to decide the issue afresh as per observations/directions made therein by the ITAT.

Orient Overseas Pvt. Ltd. now is known as Sharp Corporation Ltd. In compliance of order dated 28.2.2011 of the ITAT in the case of Orient Overseas Pvt. Ltd., the Assessing Officer has also made the assessment afresh on the issue under sec. 254/143(3) of the Act with the following finding in para No.5 of the order:

"5. I have carefully examined the submissions made before me. The assessee was asked to produce the books of account and all other material, documents and correspondences etc. in its possession, regarding the claim of loss,

The books and other record were perused and the copies of the agreements, e-mails etc. were obtained and placed on record. As regards other objections regarding import licenses, it was submitted that the pulses were covered in OGL Scheme (open general license) and as such no import licenses were necessary for the import the pulses. The assessee has also put reliance on the judgment passed by the jurisdictional Delhi

High Court in the case of CIT vs. Bhagwan

Dass Rameshwar Dayal (1984) - 149 ITR 387

(Del.) on the basis of evidences produced and the legal judgment, it is hereby held that the damages were paid for breach of contracts and therefore, the same are outside the purview of speculative transaction as defined in clause 5 of section 43 of the Income-tax

Act, 1961."

8. We thus do not find reason to interfere with the First Appellate order on the issue. The same is upheld. the ground involving the issue

is accordingly rejected.

7.2 After going through the findings of the Ld. CIT(A) and the decisions of the different Hon’ble High Courts relied by the CIT(A) in his impugned order and also the decision dated 29.7.2015 of the ITAT, ‘F’ Bench in the case of ACIT vs. Ramji Lal & Sons (HUF)

(Supra) passed in (AY 2007-08), we are of the considered view that the issue in dispute is squarely covered by the decision of the Hon’ble High Courts as mentioned in the Ld. CIT(A)’s order as well as the decision dated 29.7.2015 of the ITAT, Delhi. Respectfully follow the precedents as aforesaid, we are of the considered view Ld. CIT(A) has rightly held that the payment made by the assessee for breach of contract after the expiry date is a normal loss incidental to the business of the assessee and not a speculation loss within the meaning of section 43(5) of the Income Tax Act, 1961. Hence, we uphold the well reasoned order passed by the Ld. CIT(A) on the issue in dispute and accordingly, dismiss the Appeal filed by the Revenue.

Order pronounced in the Open Court on 09/08/2016.