DCIT 8(2), MUMBAI vs. HEXAWARE TECHNOLOGIES LTD, NAVI MUMBAI

5.5 I have considered the submissions of the appellant and the order of the AO. In November, 2007 the appellant became aware that one of its senior employees, Shri Naishad Desai, who was working as Company Secretary and AVP Legal arid Treasury has exercised unauthorized fiduciary powers and entered into contracts with various banks. It is pertinent to note that this employee was authorized to enter into hedging contracts with banks as a part of his normal duties and hedging contracts were entered by the said employee on specific authorization by the appellant's Board of Directors and the same were reported to the Company's Senior Management as a part of his duties. The Board of Directors had authorized the employee to take such positions only with HSBC Bank, lDBI Bank and Deutsche Bank. He was not authorized to enter into any transactions either with Yes Bank or Kotak Mahindra Bank.

A summary of the loss cost by the said employee of Rs. 102 crores as submitted by the appellant is as under:

Bank Option/contract no. Loss/gain Amount pd. Date of payment HSBC HXT020707001 31093850 31093850 03.12.2007 Bank HXT080301001 2823670 HXTEVOM23JAN0701-22 2425970 5249640 5249640 30.11.2007 HXT080301001 2643150 HXTEVOM23JAN0701-22 4497300 7140450 7140450 06.12.2007 714862-TO-67 (2292907) (2292907) 04.12.TO06. 12 41191033 IDBI FXO09142/9146 16173475 Bank Yes Bank 62870 65113871 400000000 07.01.2008 63300 269128820 202496416 30.01.2008 82482 50288189 51100 136617228 521617228 Forward contracts 129148108 (list annexed) 651132678 Kotak 225/226, K+21856 9495780 9495780 07.01.2008 Bank K+16008, 195223800 195223800 07.01.2008 16003/15999&16012 FXOPT-13389 93689775 93689775 08.01.2008 298409355 Deuts 15417881 10156228 che Bank 15418707 9657520 15539119 3227850 23041598 23041598 31.12.2007 Grand Total 1029948139 5.6 From the above, it can be seen that the appellant had made loss on account of transactions with five banks out of which three were authorized banks and two were not. Further, in the banks 6 & co200/13 where the employee was authorized to take hedging position, the aforesaid transactions were neither authorized nor was the transactions informed by the employee to the management. Hence, these transactions were in the category of unauthorized transactions. All the transactions with Kotak Mahindra Bank and Yes Bank were unauthorized. 5.7 The said employee forged or purportedly made true copies of board resolutions to enter into transactions with certain banks which were neither authorized nor part of the normal hedging programme. During investigation the accused employee confessed that between November 22, 2007 and November 25, 2007 he had entered into seven derivative option transactions with Kotak Mahindra Bank and Yes Bank which he had not informed with the Board or Senior Management. Similarly, the accused had entered into three foreign currency derivative option contracts with Kotak Mahindra Bank on 15.03.2007; 08.05.2007 and 05.11.2007. He had also entered into four derivative option contracts with Yes Bank on 16.01.2007, 20.04.2007, 14.05.2007 and 21.06.2007. The accused had submitted a certified true copy of the resolution based on the meeting of banking and operations committee of the Board of Directors held on 21.03.2006 to Yes Bank, Mahalaxmi Branch on 30.03.2006. However, in reality no such meeting had ever taken place on 2l.03.2006. There are four main contracts which resulted in loss of Rs. 52,11,48,108/- and a list of series of contracts had resulted in loss of Rs 12,99,84,570/-. The appellant paid for the losses of Rs. 65,11,32,678/- vide two cheques dated 07.01.2008 (Rs. 40 crores) and 30.01.2008 (Rs. 20,24,96,416/-), the amount paid was negotiated amount when the contracts were cancelled. 5.8 However, it can be seen from the above that in order to enter into these contracts with Yes Bank the appellant had used Board of Resolution dated 21.03.2006 which is almost a year before he entered into the first contracts with Yes Bank. 5.9 Similarly, the accused had filed a true copy of resolution based on the meeting of Board of Directors held on 27.04.2007 to Kotak Mahiridra Bank. However, in the meeting held on 27.04.2007 there was no such resolution or item passed in that Board meeting. However, the appellant had entered into transactions with Kotak Mahindra Bank from 5.03.2007 and had resulted in loss of Rs. 29,84,09,355/-. It can be seen that majority of the losses of Rs. 102 crores had resulted due to transactions with Yes Bank and Kotak Mahindra Bank and the appellant argued that any losses incurred on account of misconduct / negligence by an employee, but which is incidental to the carrying of the business is allowed as business loss. In support of this preposition the appellant relied on the following cases: • Badridas Daga vs. CIT (1958) 34 ITR 10 (SC) • ClT vs. Nainital bank (55 ITR 707) (SC) • G.G:Dandekar machine Works Ltd. Vs. ClT (202 ITR 161) (Born)

7 & co200/13 • Pandyan Builders vs. Inspecting Assistant Commissioner (45 TTJ 524) (Mad) • Eveready Industries India Ltd. Vs. DCIT (78 ITD 175) (CQ)) (TM) • Kothari & Sons vs. ClT (1966) (61 ITR 23) (Mad.) 5.10 The appellant also relied on CBDT’s Circular No.35-D(XLVII- 20)[F.No.10/48/65-IT-)A-1], dated 24.11.1965. Further appellant has mentioned that the loss was classified as exceptional due to requirement of Accounting Standard AS-5. Para 12 of AS-5 reads 'vas under: -12. When items of income and expense with profit or loss from ordinary activities are of such size, nature or incidence that their disclosure is relevant to explain the performance of the enterprise for the period, the nature and amount of such items should be disclosed separately." 5.11 The. appellant argued that foreign currency contracts have. been entered into by it in the earlier years and the same have been accepted as part of ordinary business activity by the tax authorities, which is because these transactions have been separately disclosed should not result in disallowance: Further it was argued that the loss is a non-recurring and accrued due to misconduct of the employee while discharging his duties, in the course of appellant's ordinary business and therefore the same is incidental to the business of the appellant. For this proposition the appellant relied on the following case laws: • Kedarnath Jute M/g. Co. Limited vs ClT (82 ITR 363) (SC) "Whether the assessee is entitled to a particular deduction or not will depend on the provision of law relating thereto and not on the view which the assessee might take of his rights nor can the existence or absence of entries in the books of account be decisive or conclusive in the matter" • CIT vs C. Parakh & Co. {India} Limited {29 ITR 661} {SC} "On the question of the admissibility of the deduction of Rs. 1,23,719, the contention of the appellant is that as the respondent had itself spilt up the commission of Rs. 3,12,699 paid to the managing agents, and appropriated Rs. 1,23,719 thereof to the profits earned at Karachi and had debited the some with it, it was not entitled to go back upon it, and claim the amount as a deduction against the Indian profits. We do not see any force in this contention. Whether the respondent is entitled to a particular deduction or not will depend on the provision of low relating thereto, and not on the view which it might take of its rights, and consequently, if the whole of the commission is under the law liable to the deducted against the Indian profits, the respondent cannot be estopped from claiming the benefit of such deduction, by reason of 8 & co200/13 the fact it erroneously allocated a pan of it towards the profits earned in Karachi. What has therefore to be determined is whether, notwithstanding the apportionment made by the respondent in the profit and loss statement, the deduction is admissible under the law" • ClT vs India Discount Co. Ltd. (75 ITR 191) (SC) "It is well established that a receipt which in law cannot be regarded as income cannot become so merely because the assessee erroneously credited it to the profit and loss account." • ClT vs Godavari Sugar Mills Ltd. (208 ITR 878) (Born) "It is now a well settled that the entries in the books of accounts of an assessee or the description given to a particular transaction or any assets or liability in its accounts is not conclusive. It is necessary to consider the true nature of the transaction or assets or liability" • Fort Properties Pvt. Ltd. vs CIT {208 ITR 232} (Bom) "It is well-settled that the way in which entries are made by an assessee in his books of account is not determinative of the question whether the asset was held as a capital asset or stock-in- trade. The assessee may, by making entries which are not in conformity with the facts of the case or the proper accountancy principles, conceal the real nature of the asset or the transaction. Entries made by him, therefore, cannot be regarded as conclusive one way or the other. The true nature of the transaction in each case has to be determined on consideration of the totality of the facts and circumstances of that case." CIT Vs. Gujarat Mineral Development Corporation {132 ITR 377} (Guj) 'The fact that certain entries were made or not mode in a particular year on account is totally immaterial and, in any event, such entries ore nat decisive or conclusive of the matter." 5.12 The appellant argued that the loss had arisen on cancellation of foreign currency derivative contracts which is legally permissible under FEMA. None of these acts were prohibited activities. The loss had arisen on cancellation of the foreign currency contracts executed by the employee exceeding his authority/fiduciary powers and making use of forged Board Resolutions. The appellant has not conducted any crime but has been a victim of misconduct of the employee in the course of his normal duties, therefore the said loss allowable u s. 37 1) for which the appellant relied on the cases of; CIT vs. Khemchand Motilal Jain Products (P) Ltd. (2011) 60 DTR 113) (MP) and State Bank of Saurashtra vs. DCIT (93 ITD 662).

5.13 The appellant argued that the loss is not in the nature of speculative loss. The appellant mentioned that the following four essential conditions have to be satisfied for transactions to be speculative. The :Contract. should be for purchase or sale; and The purchase or sale should be of commodity including stocks and shares; and • There should be periodical or ultimate settlement of the contract; and • Settlement should be otherwise than by actual delivery or transfer. 5.14 In this regard, the appellant mentioned that the foreign currency is not a commodity for which he relied on the following case laws: 4.10 "The word 'commodity' has not been defined under the Act. However, the said term has been analyzed by various judicial precedents. In this regard, we would like to draw the attention of your Honour to the following judicial precedents, wherein it has been held that 'foreign currency' is not a 'commodity'. • The Delhi ITAT in the case of Munjal Showa Ltd vs Dcn (191 Taxation 15.3), has held that foreign currency is not a commodity, placing reliance on the definition of the term 'goods' as defined in the Sale of Goods Act, 1930, relevant extract reproduced below: "Foreign currency, or any other currency, is neither commodity nor shares. The sale of Goods Act, specifically excludes cash from the definition of goods. Besides, no 'person other than authorised dealers and money changers are allowed in India to trade in foreign currency, much less speculate. Section 8 of the Foreign Exchange Regulations Act, 1973 provides that except with prior general or special permission of the RBI, no person other than an authorised dealer shall purchase, acquire, borrow or sell foreign currency." (emphasis supplied) • The Mumbai ITAT in case of Thomas Cook India Ltd vs DC IT (293 ITR 283), he id that foreign exchange cannot be considered as 'goods' (in terms of erstwhile Section 80HHC of the Act). While rendering the said decision the ITAT primarily placed reliance on the definition of the term 'goods' as contained in the Sale of Goods Act, 1930, which specifically excludes money from scope of the definition (relevant extract reproduced below): "Goods means every kind of movable property other than actionable claims but not money and include stocks and shares, growing crops, grass and things attached to or forming part of the land which are agreed to be severed before or under the contract of sale." (emphasis supplied)

The Mumbai ITAT in the case of M/s Gill and Co Ltd (ITA No.216/Mum/2002l, held that when the assessee is' not a dealer in foreign exchange and when the transaction is purely incidental to the assessee's regular course of business, the loss would be allowable. It has further been specifically held that foreign exchange cannot be claimed as a commodity in which the assessee was dealing and. therefore the transaction did not come within the substantial part of Section 43(5) itself" Therefore it was argued that cancellation of derivative option contracts cannot be regarded as speculative loss. 5.15 There was no settlement of contracts. The appellant argued that the contracts were cancelled and not settled. For this proposition the appellant relied on the following cases :- It is pertinent to note that the term settlement is different from cancellation and section 43(5) of the Act only covers a situation where contract is settled otherwise than by actual delivery/ transfer. Therefore, provisions of Section 43(5) of the Act should not apply to above loss which is incurred on cancellation of certain foreign exchange contracts. Reliance in this regard could be placed on the following decisions: • Voltas International Ltd v AClT (126 TTJ 702)(Mumbai Tribunal) • C/r vs. Badridas Gauridu {P} Ltd (261 ITR 256)(Bom HC) 5.16 The appellant argued that forex loss is not in the nature of speculative loss. The appellant mentioned that these transactions did not consider a separate and distinct business undertaken by the appellant. Further, the loss had arisen in the process of hedging activity which is not a continued activity or contemplated to be entered into with a profit motive. The transactions were entered in the course of normal business activity and were incidental to the same. In this regard, the appellant drew attention to provisions of section 73 and Explanation 2 to section 28 of the ITAct, 1961. The appellant also relied in the case of "In the case of Sri Ranga Vikas Ginning and Oils Mills vs ClT (133 ITR 85) (Mad), the Madras High Court emphasised that when a business is carried on in speculative transactions, that business is deemed by the said explanation 2 to Section 28 of the Act to be distinct and separate from any other business." 5.17 The appellant also argued that foreign currency hedging transactions are incidental to the main business activity of the appellant and not in the nature of business for which he relied on the following case laws: "CIT vs Badridas Gauridu (P) Ltd (2611TR 256) (Bombay HC)

11 & co200/13 CIT vs Soorajmull Nagarmull (129lTR 169) (Kolkata HC) D Kishore kumar Co vs DClT (2 SOT 769) (Mumbai ITAT) DClT vs Beautiful Diamonds Ltd (57ITATlNDIA 1024) (Mum ITAT) 5.18 Therefore, the appellants argument is that the loss arising on account of abuse of fiduciary powers by an employee are allowable as business loss u/s. 28(1) and the loss arisen out of cancellation of foreign exchange transactions does not partake the character of speculative transactions nor it qualified as a separate and distinct business to constitute the speculative business. 5.19 The above submissions of the appellant have been considered. The AO had made the disallowance as there were contradictions in FIR. A perusal of the FIR dated1.2008 filed with Sr. Inspector of Police, Turbhe Police Station, Turbhe and entered at Sr. No. 706 of the FIR register clearly indicates that the accused employee was authorized to undertake hedging transactions to counter the exchange fluctuation risk arising out of the export of software. However, the said employee exceeded his brief and using purportedly true copies of resolutions entered into Foreign Currency Derivative Transactions with the banks. • Firstly, the resolutions were off dates when either the meeting had not taken place or the said issue/resolution was not resolved in the said meeting. • Further the transactions entered into by the accused employee were not on individual name but in the name of the appellant. • Thirdly, these transactions were merged/mixed with the regular transactions making detection of the same defect. When the same was detected the appellant had undertaken immediate steps to suspend the employee, informed the Bombay Stock Exchange and SEBI of the same. Further with the advice of Foreign Exchange consultants, he cancelled the contracts which were unauthorized and booked the loss. The employee was later terminated from services and criminal complaint was also filed. All this shows that the loss is genuine and the said loss was a regular business loss as the transactions were entered by the accused employee with the banks in the name of the appellant. Hence, it was the appellant’s duty to bear the loss arising out of cancellation of such unauthorised contracts. 5.20 The AO has also stated that the loss has been classified as exceptional and hence it is not permissible. A perusal of the AS-5 which pertains to net profit or loss for the period, prior period items and changes in the accounting policies issued by the Institute of Chartered Accountants of India, such loss has to be notified. In this regard, it is pertinent to quote para 12 of AS-5 which reads as under:

12 & co200/13 12. When items of income and expense with profit or loss from ordinary activities are of such size, nature or incidence that their disclosure is relevant to explain the performance of the enterprise for the period, the nature and amount of such items should be disclosed separately" 5,21 Therefore, it can be seen that just by qualifying it as exceptional loss does not lose the character of business loss and hence has to be allowed. The AO has also without prejudice to the above mentioned that the loss is speculative in nature, In this regard, it is necessary to examine the definition of speculative transactions as given in section 43(5) which reads as under: 43 (5) "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 scripts: Provided that for the purposes of this clause- (a) a contract in respect of raw materials or merchandise entered into by a person in the course of his manufacturing or mercanting business to guard against loss through future price fluctuations in respect of his contracts for actual delivery of goods manufactured by him or merchandise sold by him; or (b) a contract in respect of stocks and shares entered into by a dealer or investor therein to guard against loss in his holdings of.' stocks and shares through price fluctuations; or (c) a contract entered into by a member of a forward market or a stock exchange in the course of any transaction in the nature of jobbing or arbitrage to guard against loss which may arise in the ordinary course of his business as such member; (d) an eligible transaction in respect of trading in derivatives referred to in clause 26[(ac)] of section 2 of the Securities Contracts (Regulation) Act, 195627 (42 of 1956) carried out in a recognised stock exchange28.] shall not be deemed to be a speculative transaction. [Explanation.-For the purposes of this clause, the expressions- (i) "eligible transaction" means any transaction,- (A) carried out electronically on screen-based systems through a stock broker or sub-broker or such other intermediary registered under section 12 of the Securities and Exchange Board of India Act, 199230 (15 of 1992) in accordance. with the provisions of the Securities Contracts (Regulation) Act, 1956 (42 of 1956) or the Securities and Exchange Board of India 13 & co200/13 Act, 1992 (15 of 1992) or the Depositories Act, 1996 (22 of 1996) and the rules, regulations or bye-laws made or directions issued under those Acts or by banks or mutual funds on a recognised stock exchange; and (B) which is supported by a time stamped contract note issued by such stock broker or sub-broker or such other intermediary to every client indicating in the contract note the unique client identity number allotted under any Act referred to in sub-clause (A) and permanent account number allotted under this Act; (ii) "recognised stock exchange" means a recognised stock exchange as referred to in clause (j) of section 2 of the Securities Contracts (Regulation) Act, 195631 (42 of 1956) and which fulfils such conditions as may be prescribed and notified by the Central Government for this purpose." 5.22 It can be seen from the above that there has to be purchase or sale of commodity and which has to be settled other than by delivery. In the present case, the transactions are pertaining to foreign exchange currency transactions. In various cases, it has been held that foreign exchange is not a commodity. Further there is a difference in cancellation of contract and settlement of contract. These cases are as under: "Voltas lnternational Ltd v AClT (126 TTJ 702)(Mumbai Tribunal) In this case, the assessee had entered into a contract for purchase of rice from an Indian party and contract for export of rice to a foreign party. The consideration receivable for export or rice was fixed in terms of the foreign currency. To hedge itself against exposure of fluctuation risk, the assessee had entered into forward contract with SBI for sale of foreign exchange to be received on export of rice. The Indian supplier defaulted on delivery of rice which consequentially led to cancellation of export as well as cancellation of forward contract. The ITAT held that the loss was an allowable loss and did not come within the purview of section 43(5). It was held that it is not a case of settlement of a contract but it is a case of cancellation of a contract, as is evident from the cancellation charges paid to the bank and such cancellation charges are in the nature of damages paid for non-performance of contract and thus, the transaction cannot be said to be transaction for settlement of the contract to attract the provisions of section 43(5). The ITAT also held that the case was covered by Bombay High Court decision in the case of CIT vs. Badridas Gauridu (P) Ltd. 5.23 Hence, it can be seen that the foreign exchange is not a commodity. Further in the instant case, there is no settlement but it is a cancellation of contracts due to extra ordinary circumstances and here too there has been payment made by the appellant of 14 & co200/13 equivalent amount in rupees which indicates that delivery has taken place. It has also been held that settlement is different from cancellation. It is pertinent to note that the term 'settlement' is different from 'cancellation' and section 43(5) of the Act only covers a situation where contract is settled otherwise than by actual delivery/ transfer. Therefore, provisions of Section 43(5) of the Act should not apply to above loss which is incurred on cancellation of certain foreign exchange contracts. 5.24 Further in the earlier .years also, the appellant was entering into regular foreign exchange hedging 'transactions and which were .settled in similar manner i.e. by payment/receipt of equivalent amount of Indian Rupees, therefore there is no difference in the mode of settlement/cancellation of foreign exchange derivative contracts. The AO had confused the statements of foreign exchange contracts with actual physical delivery of shares or other valuable commodities wherein there is actual delivery of that item which is not the case in foreign exchange derivative contracts entered for the purpose of hedging in India against the risk of exchange' fluctuation arising out of export sales. Therefore, the transactions cannot be held as speculative purpose. 5.25 The AO has also referred to section 73. Section 73 reads as under: 73. Losses in speculation business (I) Any loss, computed in respect of a speculation business carried 0/\ by the assessee, shall not be set off except against profits and gains, if any, of another speculation business, (2) Where for any assessment year any loss computed in respect of a speculation business has not been wholly sett off under sub- section (I), so much of the loss as is not so set off or the whole loss where the assessee had no income from any other speculation business, shall, subject to the other provisions of this Chapter, be carried forward to the following assessment year, and- (i) it shall be set off against the profits and gains, if any, of any speculation business carried on by him assessable for that assessment year; and (ii) if the loss cannot be wholly so set off, the amount of loss not so set off shall be carried forward to the following assessment year and so on. (3) In respect of allowance on account of depreciation or capital expenditure on scientific research, the provisions of sub-section (2) of section 72 shall apply in relation to speculation business as they apply in relation to any other business, (4) No loss shall be carried forward under this section for more than 1[four] assessment .years immediately succeeding the assessm.ent year for which the loss was first computed. 2[Explanation.:-Where any part of the business of a company (3[other than a company whose gross total income consists 'mainly of income which is, chargeable under the heads, "Interest on securities"4, "Income from house property",' "Capital gains" and "Income from other sources"], or a company the principal business of which is the business of banking or the granting of loans and advances) consists in the purchase and sale of shares of other companies, such company shall, for the purposes of this section, be deemed to be carrying a speculation business to the extent to which the business consists of the purchase and sale of such shares. 5.26 In this connection, it is pertinent to note Explanation 2 to section 28 which reads as under: Explanation 2.-Where speculative transactions carried on by an assessee are of such a nature as to constitute a business, the business (hereinafter referred to as "speculation business"] shall be deemed to be distinct and separate from any other business. It can be seen from the above that speculative business has to be a separate and a distinct business and whereas in the instant case, the foreign exchange hedging contracts are entered in the normal course of business and are incidental to the same." There is no irrelevant motive or profit while entering into the transactions. The only purpose of these transactions is to hedge against any possible loss arising out of exchange fluctuation on account of export sales. Hence the said foreign exchange hedging transactions of the appellant cannot be said to be a separate speculative business of the appellant. In order to hold such transactions as business it is necessary that they have the following features: • The activity should be in the nature of trade • The activity should be real, substantial, systematic or organized and should be undertaken with a set purpose. • Such activities are carried out on a regular basis. • The activities should be carried out with a intent to earn profit. 5.27 However, in the instant case, in the business of intend to earn profit and there being no ingredients of the trade in the same and hence the said transactions cannot be held as speculative business. In this regard, it is necessary to quote the following cases: • ClT vs Badridas Gauridu (P) Ltd (261.ITR 256) (Bombay HC) "The assessee was not a dealer in foreign exchange. The assessee was a cotton exporter. The assessee was an export house.

16 & co200/13 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" 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 cantracts 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 lacs 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 ClT v. Soorajmull NagarmulJ". (emphasis supplied) ClT vs Soorajmull Nagarmull (1291TR 169) (Kolkata HC) "Here there is no finding that entering into foreign exchange contract was the nature of the business of the assessee. This was only an incidental part of the business operation for the export and import of the goods by the assessee. The assessee was not a dealer in foreign exchange contracts as such. Foreign exchange contracts were only incidental to the assessee's regular course of business. Therefore, all the arguments regarding whether it comes within the Explanation 2, in our opinion, is not quite relevant because the loss was not sustained in speculative transactions which are in the nature of the business of the assessee" (emphasis supplied) D Kishore kumar & Co vs DClT (2 SOT 769) (Mumbai ITAT) "These details clearly show that all the forward exchange contracts were in respect of each specific import order placed by the assessee. The purpose of these transactions was clearly to minimise assessee's risk on account of fall in value of rupee, but file quantum of foreign exchange covered by these forward contracts was limited to the extent of assessee's actual exposure in respect of import value commitments. That aspect is not disputed. "On these. facts, even though the transactions having been settled without delivery, the conditions of section 43{5}, describing speculative transactions, are clearly fulfilled, the requirement of Explanation 2 to section 28 is not fulfilled inasmuch as it cannot be concluded that the transactions are such a nature as to constitute a business by itself In our understanding of the situation, these transactions are genuine business transaction to hedge against increased cost of purchases of rough diamond imports, It is a commonly accepted part of the financial management practices 17 & co200/13 today that tile risk element, due rise the value of foreign currency in respect of the import transactions entered, is minimised by entering into forward contracts for purchase of that currency. This is particularly necessary in a market in which the value of domestic currency IS falling, which is evident from the fact that the assessee realized profits on cancellation of those contracts. These transactions are integral part of the export business and cannot be considered in isolation of the export business in the course of which the transactions have been entered into. As a matter of fact, this profit on cancellation of forward contracts is generally revenue neutral because the question of profit on cancellation of forward contracts can only arise in a situation when the value of foreign currency is increasing vis-a-vis domestic currency, .and when the foreign exchange value is so increasing the ultimate payment made in foreign exchange by the assessee also increases. In the case, the value of foreign currency was not to go up, there would not have been gains on cancellation of contracts but then the actual costs, in terms of domestic currency, that the assessee pays when he has to pay for imports in foreign currency does not also go up. Since it is an undisputed position that the imports, in connection with which the assessee had entered into forward contracts, actually took place, this profit on cancellation of forward foreign exchange contracts effectively only reduces the costs of purchases in respect of those imports, and cannot be, by any logic, construed as transactions independent of assessee's business of importing rough diamonds and exporting cut and polished diamonds." The fact of premature cancellation, therefore, cannot alter the nature of transaction. For all these reasons, the credit shown in the P&L a/c as 'profit on cancellation of forward contracts' is as integral part of the export business, as purchases or imports". {emphasis supplied} • DCIT vs Beautiful Diamonds Ltd {57ITATlNDIA 1024} {Mum ITAT} "Hearing the rival submissions and going through the orders of the lower authorities we are of the view that the ClT{A} has rightly pointed out that the Assessing Officer completely missed the point. At one point the Assessing Officer says that the assessee has not actually delivered or transferred any commodity or scrip and therefore it is to be treated as speculation and not covered by exceptions provided below section 43(5) and in another place he says that assessee has already sold the goods and he rates has been fixed before the forward contract and as such where there was no scope for any variation in the sales price of the commodity manufactured or sold by the assessee. As rightly noted by the ClT{A} the business has been carried on by the assessee as per the norms of the RBI. Assessee's accounts are audited well before the Assessing Officer and as such there is no element of speculation in these transactions. The appeal of the Revenue on this ground fails."

18 & co200/13 5.28 In view of the above, the disallowance made by the AO of Rs.102 crores cannot be sustained and the ground of appeal of the appellant is allowed.”

5. During the course of assessment the AO also made disallowance u/s.14A, which was confirmed by the CIT(A) to the tune of Rs.84,30,296/-, against which assessed has filed present cross objection.

6. We have considered rival contentions and found from the record that assessee had computed disallowance u/s.14A to the tune of Rs.3,56,103/-, however, the AO computed disallowance at Rs.87,86,399/- We found that during the year under consideration, the assessee had earned dividend income of Rs. 15,32,00,621/- mainly from Mutual Funds, which has been claimed as exempt u/s.10(3) of the Act. In its return of income for the subject AY, the assessee had made a suo-moto disallowance of Rs. 3,56,103/- u/s. 14A as being expenditure attributable to earning of such exempt dividend income. In the course of the assessment proceedings, assessee's representative filed written submissions explaining the basis of 14A disallowance made by the assessee company. By the impugned order, CIT(A) confirmed the disallowance. Against the above order of CIT(A), revenue is in appeal before us with regard to disallowance of foreign exchange loss of Rs.102.99 crores, whereas in the cross objection assessee is aggrieved for disallowance of Rs.84,30,296/- made u/s.14A of the I.T.Act.

7. We have considered rival contentions and carefully gone through the orders of authorities below and also deliberated on the judicial pronouncements referred by lower authorities in their respective orders as 19 & co200/13 well as cited by ld. DR and AR during the course of hearing before us. From the record we found that the assessee is engaged in the business of export of software services to various customers across the world. In the course of carrying out its above export business, the assessee enters into customer contracts denominated in foreign currency. There existed an inherent foreign currency fluctuation risk with respect to such exports. For the purpose of de-risking the foreign currency fluctuation risk, the assessee has a treasury department which attempts to de-risk the above risk, by inter-alia, entering into foreign currency hedging contracts/options with the banks. The said contracts are either short-term or long-term. In around November, 2007, the assessee became aware that one of its senior employees had exercised unauthorized fiduciary powers and entered into foreign currency contacts with various banks which resulted into huge losses. The assessee company took a prudential business decision to cancel some of the said contracts to safe guard further loss, in the subject financial year (FY) itself i.e. FY 2007-08, consequently resulting in loss of Rs. 1,02,99,48,137/-. In support of its above claim regarding allowability of said loss as business loss the assessee furnished various documents vide its submission dated 23.11.2011, inter-alia including copies of the foreign currency contacts which were cancelled, press release issued by the assessee reporting the said loss, copy of FIR lodged against employee, disclosures in the notes to accounts, quarterly disclosures to stock exchanges etc. After considering all these documents, the CIT(A) had recorded a finding to the effect that the loss 20 & co200/13 was incurred on account of misconduct / negligence by an employee and the same was incidental to carrying of the business of assessee, therefore, allowable as a business loss.

8. From the record we also found that the loss had arisen on cancellation of foreign currency derivative contracts which is legally permissible under FEMA. None of these acts were prohibited activities. The loss had arisen on cancellation of foreign currency contracts executed by the employee exceeding his authority / fiduciary powers and making use of forged Board Resolutions. Thus, we found that assessee company has not conducted any crime but has been a victim of misconduct of the employee in the course of his normal duties, therefore, the said loss is allowable u/s. 37 (1). We also found that loss was not in the nature of speculative loss in so far as loss was not occasioned due to any purchase or sale of commodity, but a foreign currency which is not a commodity. The CIT(A) has dealt with threadbare with each and every objection of the AO and after applying judicial pronouncements to the facts of instant case reached to the conclusion that loss was incurred in the normal course of assessee’s business and the same was not in the nature of speculative loss. We also found that the contract entered by the employee was not settled but these were cancelled by the assessee company, therefore, not coming in the mischief of section 43(5) which covers a situation where contract is settled otherwise than by actual delivery/ transfer. Therefore, provisions of Section 43(5) of the Act should not apply to above loss which is incurred on cancellation of certain foreign exchange contracts. Our view is duly 21 & co200/13 supported by the decision of the Bombay High Court in case of Badridas Gauridu (P) Ltd (261 ITR 256) and also by the decision of ITAT Mumbai Bench in case of "Voltas International Ltd (126 TTJ 702). Considering the documents placed on record and findings recorded by the CIT(A), we found that foreign currency hedging transaction so entered into on behalf of assessee company are incidental to the main business activity of the assessee company and not in the nature of main business. Our view is duly supported by the decision of Bombay High Court in case of Badridas Gauridu (supra), ITAT Mumbai Bench in case of D Kishore kumar Co (2 SOT 769) and Beautiful Diamonds Ltd (57 ITD 1024).

22 & co200/13 Accordingly, it was the assessee’s duty to bear the loss arising out of cancellation of such unauthorised contracts.

11. Now coming to the objection of the AO that loss has been classified as exceptional hence, not permissible as per para 12 of AS-5. When items of income and expense with profit or loss from ordinary activities are of such size, nature or incidence that their disclosure is relevant to explain the performance of the enterprise for the period, the nature and amount of such items is required to be disclosed separately . Thus, merely by qualifying it as exceptional loss does not lose the character of business loss and hence has to be allowed.

10. In the aforesaid background, now, we may examine the facts of the present case. In this case, assessee has earned by way of dividends a sum of Rs.5,45,58,685/-, which is exempt u/s 10(38) of the Act and thus the same does not form part of the total income under the Act. In the computation of income, assessee having regard to section 14A of the Act, determined the amount of expenditure incurred in relation to such income at Rs.5,00,000/-. The Assessing Officer has not found it acceptable and has instead determined the amount of expenditure in relation to such income by applying rule 8D of the Rules. Ostensibly, the action of the Assessing Officer cannot be upheld unless he has complied with the pre-requisite of invoking rule 8D of the Rules, namely, recording of an objective satisfaction with regard to the claim of the assessee that an expenditure of Rs.5,00,000/- has been incurred in relation to the exempt income, is incorrect. In order to examine the aforesaid compliance with the pre-condition, we have perused the para 4 to 4.2 of the assessment order and find that no reasons have been advanced as to why the disallowance determined by the assessee was found to be incorrect, having regard to the accounts of the assessee. The only point made by the Assessing Officer is to the effect that “the said disallowance was not acceptable”. In-fact, we find that the assessee made detailed submissions to the Assessing Officer, which have been reproduced by the CIT(A) in para 3.2.1 of his order. As per the assessee, the determination of disallowance u/s 14A of the Act of Rs.5,00,000/- was based on the employee costs and other costs involved in carrying out this activity. Further, assessee also explained that the shares which have yielded exempt income were acquired long back out of own funds and no borrowings were utilized. The mutual fund investments were claimed to be also made out of surplus funds. It was specifically claimed that no fresh investments have been made during the year under consideration in shares yielding exempt income. All the aforesaid points raised by the assessee have not been addressed by the Assessing Officer and the same have been brushed aside by making a bland statement that the disallowance is “not acceptable”. Therefore, in our view, in the present case, the Assessing Officer 29 & co200/13 has not recorded any objective satisfaction in regard to the correctness of the claim of the assessee, which is mandatorily required in terms of section 14A(2) of the Act and therefore his action of invoking rule 8D of the Rules to compute the impugned disallowance is untenable. Accordingly, the orders of the authorities below are set-aside on this aspect and the Assessing Officer is directed to retain the disallowance u/s 14A of the Act to the extent of Rs.5,00,000/-, as returned by the assessee.

12. In conclusion on the basis of the aforesaid discussion, we hold that the lower authorities were not justified in enhancing the disallowance u/s 14A of the Act to Rs.1,05,46918/- against Rs.5,00,000/- disallowed by the assessee company in its return of income.”