Loading judgment…
No AI summary yet for this case.
Income Tax Appellate Tribunal, “H” BENCH, MUMBAI
स्थधमी रेखध सं./जीआइआय सं./PAN. :AACCHO427M अऩीरधथी ओय से / Assessee by Shri Vijay Mehta प्रत्मथी की ओय से/Revenue by Shri Vijay Soni सुनवधई की तधयीख / Date of Hearing : 6.1.2016 घोषणध की तधयीख /Date of Pronouncement: 20.1. 2016 आदेश / O R D E R
Per B R Baskaran, AM:
The assessee has filed this appeal challenging the order dated 15.04.2013 passed by Ld CIT(A)-10, Mumbai and it relates to the assessment year 2009-10. The assessee is aggrieved by the decision of Ld CIT(A) in confirming the disallowance of claim of Rs.7.84 crores relating to the loss suffered in cancellation of foreign currency forward contracts by treating the same as speculation loss.
The facts necessary for the disposal of the above said issue are set out in brief. The assessee is engaged in the business of importer, manufacturer and exporter of diamonds. It is also engaged in generation and distribution of power by windmill. The AO noticed that the assessee has entered into forward contracts in foreign exchange to hedge against foreign currency fluctuation risks. The assessee had declared a loss of Rs.7.84 crores on cancellation of foreign exchange forward contracts. It is pertinent to note that the assessee had revalued the outstanding receivables in foreign currency and declared a gain of Rs.20.39 crores. The assessee had also declared a loss of Rs.5.29 crores on revaluation of outstanding payable in foreign currency. The AO did not disturb both the items stated above. 3. The assessee submitted that it, being an exporter of diamonds, enters into sales transactions in US$ and hence it is required to hedge the foreign exchange loss by entering into forward contracts. Accordingly, it was contended that the same forms integral part of the export business. Accordingly, it was claimed that the loss of Rs.7.84 crores suffered on account of cancellation of foreign exchange forward contracts was allowable as business expenditure. However, the same was not acceptable to the assessing officer. The AO took the view that the assessee, being a dealer in diamonds, has entered into a separate business transaction of dealing in foreign currency and the same has been settled otherwise than by actual delivery. Accordingly the AO took the view that the forward contracts have not been entered into ‗diamonds‘ and hence the forward contracts entered into ―foreign currency‖ cannot be linked with the business of diamonds. He further took the view that the ―derivatives‖ is also a commodity. Accordingly, the AO took the view that the activity of the assessee in entering into forward contract in foreign currency is a speculative transaction and hence the loss suffered by the assessee is a speculative loss. In this regard, the AO took support from the decision rendered by Bangalore bench of Tribunal in the case of ACIT Vs. K.Mohan & Co. (Exports) P Ltd reported in 126 ITD 59. The Ld CIT(A)
AO by following the decision rendered in the case of M/s S.Vinodkumar Diamonds P Ltd (ITA No.506/M/2013).
We heard the parties and perused the record. The decision rendered by the Bangalore bench of Tribunal in the case of K. Mohan & Co. (Exports) P Ltd (supra) was considered by another bench of Bangalore Tribunal in the case of ACIT Vs. M/s Hanuman Weaving Factory in its order dated 28.10.2013 passed in ITA No.1112/Bang/2012. The issue before the Tribunal in the case of M/s Hanuman Weaving factory (supra) was identical to the one contested before us, viz., whether the expenditure incurred on cancellation of forward contract was a speculation loss or not. The above said assessee was exporter of silk fabrics and it has claimed the loss arising on cancellation of forward contract in foreign currency as deduction. The AO rejected the claim by holding the same was speculative loss and the same was confirmed by Ld CIT(A). The Tribunal proceeded to adjudicate the issue by duly considering the decision rendered in the case of K. Mohan & Co. (Exports) P Ltd, and held as under:- ―In K. Mohan Exports case, it was concluded by the Hon‘ble earlier Bench that- ―Assessee-exporter having entered into forward contracts in respect of foreign exchange receivable as a result of export in respect of the export turnover and settled the same without actual delivery, the profit from such forward contract is assessable as profit from speculation business in view of Expln. 2 to s. 28 r/w s. 43(5), and speculation business not being the business of assessee‘s undertaking, profit from forward contracts could not be included in the profits of the business of the undertaking for the purposes of computing deduction under s. 10B.‖ With due regards, we have perused the above findings and of the firm view that the issue itself was on different footing. To be Bench was deduction u/s 10B and whether the profits from forward contracts can be said to be derived from the assessee‘s undertaking for the purpose of deduction u/s 10B of the Act whereas the issue on hand is entirely different. The above reasoning has been fairly conceded by the CIT(A) in her findings. For ready reference, the relevant portion of her reasoning is extracted as under (at the cost of repetition): ―4.6………………………………..This aspect has been dealt with in detail by the Hon‘ble ITAT, Bangalore in the case of Shri K.Mohan Exports & Co in 126 ITD 0059 (Bang.). Although the issue on hand was in a different context as to whether income from speculation profits can be said to be income ‗derived from exports‘ for the purpose of section 10B or not,……..‖ 5.5.4 On the other hand, we find that the issue in question is squarely covered in favour of the assessee from the following judgments of Hon‘ble Bombay and Gujarat High Courts: (i) CIT Vs. Badridas Gauridu (P) Ltd – (2003) 261 ITR 256 (Bom):…… (ii) CIT-III Vs. Panchmahal Steel Ltd (2013) 33 taxmann.com 10 (Guj)‖ Thus, the Bangalore bench of Tribunal has taken the view that the decision rendered by the co-ordinate bench in the case of K. Mohan & Co. (Exports) (supra) shall not be applicable to the facts considered by it. Accordingly, by following the two decision of Hon‘ble Bombay and Gujarat High Courts (referred supra), the Bangalore bench concluded in the case of Hanuman Weaving Factory (supra) the loss on cancellation of foreign exchange forward contract is allowable as deduction.
The Ld A.R brought to our notice the decision dated 11.10.2013 rendered by the co-ordinate bench of Mumbai Tribunal in the case of London Star Diamond Company (I) P Ltd Vs. DCIT (ITA No.6169/Mum/2012), wherein also the Tribunal considered the issue relating to the disallowance of loss arising on cancellation of foreign exchange forward contracts. It is pertinent to note that the co-ordinate bench also considered the decision rendered by another co-ordinate bench in the case of S.Vinod Kumar Diamonds Pvt Ltd (supra), on which the Ld CIT(A) had placed reliance. The Tribunal examined following two questions in the case of London Star Diamond Company (I) P Ltd (supra):-
(i) if the Forward Contracts entered into with the Bank constitutes the integral or incidental to the activity of export of the diamonds by the assessee, who is not the dealer in foreign exchange. (ii) if the AO was justified in not setting off against the profits on actual realization or revaluation as speculative profits.
The co-ordinate bench also examined the provisions of sec. 43(5), which defines the expression ―Speculative transactions‖ and finally decided the issue in favour of the assessee. The relevant discussions made by the Tribunal are extracted below, for the sake of convenience:-
―17. Before declaring the decisions of the Tribunal on the issues raised before us, we find it relevant to scan the relevant provisions ie section 43(5) of the Act, Explanation to section 28 etc. Definitions of the speculation transaction on speculation business: 18. The provisions of section 43(5) provides for definition of „speculation transactions‟. The said provisions read as under: ―43. (1)… (2)…. (3)… (4)…. (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 scrips: 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 merchanting 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; [or] [(d) an eligible transaction in respect of trading in derivatives referred to in clause [(ac)] of section 2 of the Securities Contracts (Regulation) Act, 1956 (42 of 1956) carried out in a recognized stock exchange; [or]] (e) an eligible transaction in respect of trading in commodity derivatives carried out in a recognised association, shall not be deemed to be a speculative transaction……….‖ 19. The above provision provides that a transaction in which a contract in respect of trading of ‗any commodity‗ including stocks and shares is settled otherwise than by the actual delivery or transfer of commodity / scrips. Here the meaning of expression “any commodity” is a matter of debate. This definition provides for exclusion of certain specified contracts discussed in clause (a) to (e) of the proviso to section 43(5) of the Act. Clause (a) of the proviso deals with the hedging contracts entered into in the course of manufacturing and merchandizing of the business to guard against the losses through future price fluctuations in respect of contracts for actual deliver. Clause (b) deals with the contracts entered into by dealer or investor in respect of Stock Exchange and Clause (d) deals with an eligible transaction in respect of trading Stock Exchange. Clause (e) deals with eligible transactions in respect of the trading in commodity derivatives carried out in a recognized association. These five types of contracts / eligible transactions shall not be deemed as speculative transactions. Although there is decision of the Tribunal where it is held that the FCs are not commodities, considering the judgment of Hon‗ble High court of Calcutta in the case of Sooraj Muill Magarmull supra, which was followed by the judgment of jurisdictional High Court in the case of Badridas Gauridu Pvt Ltd (supra), needs to be followed by us. The principle of “judicial discipline‟ assumes importance and therefore, the ―commodity‖ includes the ‗forward contract‘. Thus, in principle, the forward contracts, being commodity, should fall in the definition of ‗speculation transaction‘ and the same is subjected to fulfillment of other conditions specified in sub-section (5) of section 43 of the Act. Having held so, we shall now examine if the impugned contracts/transactions constitute “hedging transactions‖ and covered by the exclusion provisions of clause (a) to the proviso to section 43(5) of the Act. The clause (a) of the proviso to section 43(5) provides for exclusion of the ‗hedging transaction‗ from the definition of the ‗speculation transactions‘. There are number of judgments in support of the assessee and relevant „ratios‟ or conclusions are discussed in the succeeding paragraphs.
Before taking up these discussions, we shall now take up the provisions of the Explanation to section 28 of the Act, which also provide definition of ‗Speculative Business‟. The said explanation 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.
Explanation to section 28 uses the expression ‗speculative transactions carried on by an assessee are of such a nature as to constitute a business‗, and thus, considering the nature of these transactions, the impugned FCs cannot be deemed as the speculation business without going into the “nature of the transactions‖. For analyzing the nature, we need to examine why the FC transactions are entered, how these transactions are dealt with during their sustenance till they are cancelled by the assessee or terminated by the Banks and if they constitute hedging transactions etc. Basing on the ―nature‖, certain speculation transactions shall constitute as speculation business and such speculation business shall be deemed to be distinguished and separate from any other business. Further, the provision of section 73 relating to “loss in speculation business‖ is another relevant provision in this regard. Thus, the Explanation 2 to section 73 also deals with deemed speculation business where there is some trading activity of shares by the assessee being other business activity. Now, we shall take up relevant judgments on the subject raised before us.
Relevant judgmental laws: In this regard, relevant decisions include the decision in the case of D Kishore kumar and Co supra, binding judgment of the Bombay High Court in the case of CIT vs. Badridas Gauridu Pvt Ltd (supra), judgment in the case of Sooraj Muill Magarmull 129 ITR 169 (para 3) from Calcutta High Court. The judgments from the High Court of Ahmedabad in the cases of Friends and Friends Shipping Pvt. Ltd (supra) and in the case of Panchamahal Steel Ltd (supra) are also relevant. These decisions / judgments are unanimously relevant for the proposition that the FC transactions, when entered into with the banks for hedging the losses due to foreign exchange fluctuations on the export proceeds, are to be considered integral or incidental to the export activity of the assessee. Therefore, the losses or gains constitute the business loss or gains and not the speculation activities. In the preceding paragraphs of the order, in the portions assigned to the AR‗s arguments, we have analyzed these issues and the DR has not provided any reasons to reject the said arguments of Ld Counsel for the assessee. Therefore, in principle, we agree with the arguments of Ld Counsel for the assessee. Further, we also agree with the Ld Counsel‗s argument that the ‗fact of premature cancellation cannot alter the nature of the transaction‗. Thus, Ld Counsel‗s comments on CIT(A) conclusions on treating or equating the FCs as ‗derivatives‘ of currency is also allowed considering the specific definition provided to derivatives in section 2(ac) of Securities Contract Regulation Act, 1956 and it is not the requirement of the law that the 1:1 correlation between the FCs and the export invoices should exist and should be established by the assessee. So long as the total value of the FCs does not exceed, the claim of the assessee is sustainable as business loss. We have also analyzed the decisions relied on by Ld DR and find they are distinguishable. Now, we shall proceed to import some conclusions of the said decisions.
Relevant judgmental laws – Conclusions & Held portions 23. Relevant extracts from the cited judgments are inserted in the succeeding paragraphs here as under: A. Held portion in the case of D. Kishorekumar 2 SOT 769 (Mum) ―The details of forward exchange contract 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 the 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 s. 43(5), describing speculative transactions, are clearly fulfilled, the requirement of Expln. 2 to s. 28 is not fulfilled inasmuch as it cannot be concluded that the transactions are such a nature‟ as to constitute a business by itself. 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 today that the risk element, due rise in 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-avis domestic currency, and when the foreign exchange value is so increasing the ultimate payment made in foreign exchange by the assessee also increases. …… 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. There is one more aspect of the matter, and that is the reason as to why the forward contracts were cancelled midway and the profits were booked on the same instead of using these contracts to actually meet the foreign exchange requirements at the time of paying the import bills……. The due dates of payment at that point of time were only 16 days to 77 days away. The decision as to whether further hedging against the increase in foreign currency is warranted or not is essentially a commercial decision which depends on a number of factors, most important factor being the trend of currency markets at that point of time and businessman‟s perception about future trends of the currency market. For example, when a businessman perceives that the market value of foreign currency vis-a-vis the domestic currency will not go any higher or when the market starts the declining trend, he may see business expediency in cancellation of contract. 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….. The assessee succeeds on this issue. In the result, the appeal is allowed.‖ 24. Although, the said decision was pronounced in the context of section 80HC of the Act, the ratio of the said decision is of paramount importance. B. Bombay High Court judgment in the case of CIT vs. Badridas Gauridu (P) Ltd. [2004] 134 Taxman 376 (Bom.) 25. In this case, Honble High Court of Bombay answered the following question in favour of the assessee and the question reads that,- ―Whether, where assessee, not being a dealer in foreign exchange but an exporter of cotton, had booked foreign exchange in forward market with bank in order to hedge against losses, to claim deduction in respect of loss suffered by it as a business loss‖- Held yes. 25.1. Relevant finding is discussed in para 3 of the judgment and the same reads 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‖ 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 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 in the case of CIT vs. Sooraj Mull Nagarmull (1981) 129 ITR 169.‖ Judgment of Calcutta High Court in the case of CIT vs. Sooraj Mull Nagarmull [1981] 129 ITR 169 (Cal.) Held: The assessee used to carry on export and import of jute business. In the course of normal business it used to enter into foreign exchange contracts in order to cover up loss and difference in foreign exchange valuation. The assessee utilized part of the amount of the foreign exchange covered. This finding of fact has not been challenged. If in the course of normal carrying on of business certain loss or obligation or interest arise these must be deferrable to the carrying on the business and these must be incidental to the carrying on of the business. Undoubtedly, the contract for foreign exchange as such can be treated as a contract for commodity………….‖ The Conclusion of this judgment as reported reads as under: Where in the normal course of business of import and export of jute, the assessee entered into foreign exchange contract to cover up the losses and differences in exchange valuation, the transaction is not a speculative transaction.
The above extracts unanimously support that the FCs entered by the assessee, an exporter and not the dealer in foreign exchange, with the Banks as incidental to the export business, are business transactions and loss or gains is notof speculation nature. The only relevant decision cited by Ld DR is the one delivered in the case of S.Vinodkumar Diamonds Pvt. Ltd, (supra) and in this case, AO allowed the relevant loss as business loss and relevant portion is extracted as under: ―4……………He further held that losses incurred by the assessee during the year on account of change in value of currencies at the time of payment was allowed while finalising the assessment, that M to M losses were of notional losses and contingent in nature. Finally, loss on a/c. of outstanding forward contract as on 31.03.2008 were disallowed by him…………‖
Correlation of forward contracts vis-à-vis export invoices: Assessee filed a chart furnishing the export invoices raised in the year under consideration and related forward contracts booked and matured in the year under consideration. The details suggest that there is a broad connection is established and of course it is not up to the extent of rupee. It is the case of the Revenue that the correlation should be precise to the last rupee of the invoice amount. The said argument was made out by the assessee relying on the judgment of the Gujarat High Court in the case of Friends and Friends Shipping Pvt. Ltd (supra) and Panchamahal Steel Ltd (supra). Considering the above stated scope of the relevant provisions on one side and the precedents on the other, now we shall take up the core issue of adjudication of the grounds raised in the appeal and the fate of the impugned losses of Rs. 4,69,42,680/-. Relevant portion from the judgment of the Gujarat High Court in the case of Friends and Friends Shipping Pvt. Ltd (supra) is as follows: ―It is true that the CIT (A) has made some observations which would prima facie suggest that there was no direct co-relation between the exchange document and the precise contract. However, such observations cannot be seen in isolation…………….
………….We find that the decisions of the Bombay High Court and the Calcutta High Court noted above would cover the situation.
From the above analysis and summary of judgments, it is safely concluded that the impugned FCs are “commodities‖. However, considering the fact that these FCs are integral part or incidental to the core business of export of diamonds or the outstanding receivables of export proceeds, in principle, the impugned FCs constitute ―hedging transaction‟ and not the “speculative contracts‟. As such, the banks do not entertain FCs of speculative nature with the customers like the assessee, the exporter. As such, the extension of FCs, in case of non-receipt of export proceeds on the due dates, is not allowed without cancelling the existing FCs. However, the onus is on the assessee to explain satisfactorily why the assessee resorted to premature cancellation of some FCs. Further, it is not the requirement that there must be 1:1 precise correlation between FC and the corresponding export invoice. So long as the total FCs does not exceed the exports of the year plus outstanding export receivable, the FCs can constitute ‗hedging transaction‗. Further also, the ‗premature cancellation of FCs may not alter the above conclusions so long as the assessee has valid and acceptable explanation for such cancellations. It should not be the case, to start with, FC can be a ‗hedging transaction‘ but the ending of such FC is ‗speculation‘. In the light of this synopsis of our views in the matter, we shall not deliberate on the impugned losses.
The subdivisions of the loss of Rs. 4,69,42,680/-: we have already tabulated above the three subdivisions of the impugned losses based on the timing of the cancellation of the FCs. Broadly the loss is divided into two types and the adjudication of the each subdivision of loss is given as under: (a) Loss on Cancellation of Matured FCs amounting to Rs 4,14,88,805/- relates to the FCs cancelled or terminated on or after the due date. In other words, the FCs booked as integral part of the export invoices lived its booking period in full and they were either terminated by the Bank on or after due date of maturity date of the contract as the actual realization were not received in time. These are not premature cancellations by the assessee and therefore, in our considered view, the said loss of Rs 4,14,88,805/-, being related to the FCs which are High Court or Tribunal decisions/judgments in the case of D Kishore kumar and Co (supra), Badridas Gauridu Pvt Ltd (supra), Sooraj Muill Magarmull, (supra) etc. Thus, loss arising from cancellation of the matured contracts is allowed in favour of the assessee. Thus, this part of the ground of the assessee is allowed.‖
Accordingly, the Tribunal came to the conclusion that the Forward contracts entered into with the banks for hedging the losses due to foreign exchange fluctuations on the export proceeds are to be considered integral or incidental to the export activity of the assessee. It was further held that there is no requirement of law that there should be 1:1 correlation between the Forward Contracts and Export invoices and so long as the total value of forward contracts does not exceed, the claim of the assessee is sustainable as business loss. Accordingly, it was held that the forward contracts entered by the assessee, an exporter and not the dealer in foreign exchange, with the Banks as incidental to the export business, are business transactions and loss or gains is not of speculation nature. It was further specifically held that the loss arising on cancellation of matured forward contracts was allowable as deduction and for arriving at this decision, the Tribunal has placed reliance on the following case laws:- (a) CIT Vs. Badridas Gauridu Pvt Ltd (261 ITR 256)(Bom) (b) CIT Vs. SoorajMull Magarmull (129 ITR 169)(Cal)