JAYANT KUMAR BHURA,MUMBAI vs. I.T.O WD - 35(2),KOLKATA, KOLKATA

The only issue in this appeal of assessee is against the order of CIT(A) confirming the disallowance of business loss treating the same as speculation loss arising out of foreign exchange contracts. For this, assessee has raised following ground nos. 1 to 6: “1. On the facts and in the circumstances of the case, the learned CIT(A) erred in confirming the business loss of Rs.3,78,44,872j - as speculation loss, which is bad in law, wrong and contrary to the facts and evidence on record.

The appellant prays that the booking of forward contracts in foreign exchange was in ordinary course of appellant's business for hedging against export sale contracts and loss incurred on such contracts being business loss it be allowed accordingly.”

Briefly stated facts are that the assessee an individual is engaged in trading and export of agro products such as raw cotton, sugar, maize, sesame seeds, sorghum, bajra, groundnut, ginger seeds, etc. to foreign countries like USA, Portugal, Spain, Malayasia, Taiwan etc. for last several years under the trade name of M/s. Navjyot International. The assessee is a recognized Export House. The assessee does not have any other business and he is not a dealer in foreign exchange. The particulars of the assessee’s export sales in the preceding three years are as follows: Assessment year Export sale US$ Export sale in Rupees 2006-07 98,76,644.18 44,89,23,474 2007-08 1,90,78,433 87,49,14,679 2008-09 2.08,24,334 85,80,57,226 The assessee during the assessment year under consideration entered into forward contract in foreign exchange in order to hedge his loss on account of fluctuations in foreign exchange rates. In the course of export business assessee claimed to have incurred total loss of Rs.3,87,50,017/- consisting of Rs.3,78,44,872/- on account of cancellation of forward contracts in foreign exchange and Rs. 9,05,145/- being expenditure on account of foreign exchange difference. During the course of assessment proceedings, the assessee explained before the AO that his is a recognized export house recognized by Ministry of Commerce & Industries, Govt. of India. He also explained that forward contract in foreign exchange were entered into by the assessee through authorized bank following the procedures prescribed by RBI. According to assessee, he claimed the loss of Rs.3,87,50,017/- as hedging loss in term of proviso (a) to section 43(5) of the Act and requested for treating of the same as ordinary business loss being eligible for set off with other business income. But the AO rejected the claim of the assessee and treated the hedging loss as speculation loss. Aggrieved, assessee preferred appeal before CIT(A).

The CIT(A) confirmed the action of AO, who observed that there is very thin line of difference to treat the nature of any transaction as to whether it is hedging or speculation. Accordingly, held that the assessee had carried on independent business of dealing in forward contract in foreign exchange and it is not linked to the export business of the assessee. For this, CIT(A) observed in para 3.2 as under: “3.2. “I have perused the assessment order and considered the submission of the appellant. The fact of the case is that the A.O. observed that the appellant was engaged in trading including export of sesame seeds, raw cotton, maize, bazaar etc. The appellant had not claimed to be ill the business of dealing in foreign exchange. The A.O. noticed that the appellant was dealing in forward contracts in foreign exchange. The forward contracts were settled otherwise than by the actual delivery and the transfer resulted in loss of Rs 3,78,44,872/-. Such loss was claimed by the appellant in his computation of total income as business expenditure and not as speculation loss even though the dealing in forward contracts in foreign exchange constituted an independent business as understood under explanation 2 of sec. 28 read with sec. 43(5) of the Income Tax Act, 1961. The appellant debited Rs 3,87,50,017/- to the P & L A/c of his proprietorship concern M/s Navjyot International on account of Foreign Exchange Difference on cancellation or forward bookings. From the details submitted, it was observed that out of the toted debit of Rs 3,87,50,017/-, a sum of Rs. 9,05,145/- pertains to expenditure claimed on account of foreign exchange difference and the balance of Rs 3,78,44,872/- was loss on cancellation of forward contracts in foreign exchange booked with his bank. The A.0. asked the appellant to explain as to why the said transact ion of forward contracts settled otherwise than actual delivery should not be treated as speculative transaction within the meaning of sec. 43(5) of the Income Tax Act, 1961. The appellant submitted that the forward contracts in foreign exchange were cancelled on account of cancellation of export contracts/sale due to global crisis and ban for sale of yellow maize. The booking of forward contracts in foreign exchange was hedging against export sales. But facts on records revealed that even before this ban the export of yellow maize constituted only 7.41% of his total export (01.04.2008 to 30.06.2008). The appellant submitted that due to ban on export of yellow maize he was unable to execute export contracts. But the facts on record did not show any such export contract of yellow maize having been cancelled due to this ban. Further, the appellant was also unable to prove that the cancelled forward contracts were in respect of any export order for yellow maize. The appellant was unable to adduce supporting documents in support of his contention though ample opportunities was given to him by the A.O. the appellant neither could prove that the forward contracts were in respect of export order for yellow maize nor he could produce any evidence for cancellation of such export order. The appellant was, thereby, unable to discharge his onus to prove that the transactions were hedging in nature. The forward contract were mostly booked in assessment year 2008-09 but the corresponding export sale were claimed to have been effected subsequently in the next assessment year 2009-10 exceeding the reasonable time limit. Further, the appellant was unable to prove that the forward contracts booked were to the extent of confirmed export sales. The appellant was unable to substantiate that at the time of booking of forward contracts he had reasonable equivalent export contracts. Further, the guidelines of RBI might have been followed in booking of forward contracts but the resultant loss/income has to be computed in accordance with the provisions laid down in the Income Tax Act. Most of the forward bookings were made in the FY 2007-08 whereas ban on export of yellow maize came into effect from the month of July 2008 (FY 2008-09). The appellant was also unable to prove that there had been contracts for export sale at the time of booking of forward contracts which were subsequently cancelled due to global recession/depression. He entered into oral contracts which were subsequently cancelled but could not produce any evidence in support of such claim. The oral testimony was not supported by any corroborative evidence. The claim of oral contract is afterthought on the part of the appellant. The appellant had failed to put forward any plausible explanation to deny that the substantial number of forward transactions had been undertaken which could be held to be constituting on independent business within the meaning of explanation 2 to sec. 28 of I.T. Act. Thereby, he could not explain as to how the provisions as per explanation 2 to sec 28, sec 43(5) and sec 73 of Income Tax Act were not applicable in his case. After analysis of the facts on record it had been concluded that the said loss of Rs .3.78,44,872/- was speculation loss and not allowable against the business income of export sales. The appellant was unable to prove with evidence in support of his claim that booking of forward contracts were hedging ill nature against his export sales. For this, he was required to prove the existence of export sales and that he had entered into the forward contracts only fm safeguarding the loss which might have occurred due to future price fluctuation in foreign currency. However, he could not prove the same with supporting documentary evidences. It was found that there was no reasonable equivalence between the period of subsistence of two contracts and the amounts involved in the two contracts. It was also found that cancellation of 9 forward contracts in foreign exchange aggregating 28,00,000 USD resulted in a loss of Rs 2,33,23,750/-. But the appellant failed to identify the corresponding export/sale contract against which the said 9 forward contracts were booked and thus, the appellant could not prove his claim that the transactions were hedging in nature. In respect of the claim of loss for the remaining amount of Rs.1,45,21,122/- (3,78,44,872 - 2,33,23,750) the appellant could come forward with some transactions but there was no reasonable equivalence of period and amount between the two contracts. Thus, the facts and circumstances of the case did not support the claim of the appellant that booking of forward contracts were hedging against his export sales. The transactions in forward contracts of foreign exchange which were settled otherwise than by actual delivery are nothing but 'speculative transaction' as per the provisions of sec 43(5). The claim of the appellant that the transactions in forward contract of foreign exchange were hedging against export sales is not acceptable in view of the discussions above. By virtue of provisions of sec 43(5), Explanation 2 to sec. 28 and sec. 73, the loss of Rs.3,78,44,872/- in forward contract, set off with the income from export business is not allowable. Facts in the cases on which case laws relied upon by the appellant, are not identical with the facts of the present case. On perusing the contents of the assessment order and after going through the submission of the appellant, it is observed that there is very thin line of difference to treat the nature of any transaction as to whether it is of hedging or speculation. It depends on facts of each case, even in the same line, the small deviation of facts may change the nomenclature of the transaction. In the instant case, looking to the facts and circumstances of the case, this view is stronger that the intention of the appellant during this particular year was to speculate in the foreign exchange rather than hedging. Further, the facts are distinguishable in the case laws relied upon by the appellant. Under these circumstances, I find no infirmity in the A.O's order, hence appeal is dismissed.”

Before us Ld. Counsel for the assessee aggrieved against the aforesaid treatment of hedging loss as speculation loss stated the brief procedure of the business of the assessee 5 Jayant Kr. Bhura AY 2000-10 that in the assessee’s business, export orders are sometimes received for shipments staggered over a period of several months and sometimes for immediate shipment or shipment in the next month and the export orders are denominated in foreign currency. He explained that the sale value in Indian currency which the assessee realises depends on the rate of exchange prevailing at the time of presentation of the export invoice for payment and due to adverse fluctuations in the exchange rate, it can so happen that the assessee realises lesser amount in Indian currency than that contemplated at the time of negotiation of the export contract. The Reserve Bank of India permits Indian exporters to enter into forward contracts in foreign exchange with an authorised dealer category-I banks in India to hedge the exposure to exchange risk in such cases. Such forward contracts with a validity period of one year can be booked based on past performance of the average of previous three financial years' actual export turnover or the previous year's actual export turnover whichever is higher. It is permissible to cancel such forward contracts. For the same Ld. Counsel referred to the relevant period’s RBI's master circular No. 6/2007-08 dated July 2, 2007. According to him, booking of forward contracts in foreign exchange is a necessary incident of the assessee’s export business. Such forward contracts are booked in the normal and usual course of the assessee’s export business. Ld. Counsel explained the facts of this case that most of the forward contracts in question were entered into in the preceding financial year 2007-08 on the basis of the export orders in hand. Some of such export orders had shipment periods falling partly in the financial year 2007-08 and partly in the financial year 2008-09. Some of such export orders received during 2007-08 provided for shipment during 2008-09. The assessee could enter into forward contracts in the year of receipt of the export orders, namely, financial year 2007-08, covering the entire shipment period because the contracts had a validity period of one year. He explained the fact that at the time of booking of the forward contracts, the assessee had export orders in hand for US$ 2,16,08,278 but booked forward contracts only for US$ 1,00,70,000. The assessee had booked the forward contracts in round sums against the confirmed export orders but not exceeding the value of the export orders. At any point of time the assessee had more export orders in hand than the forward booking amount. Relevant details in this behalf were furnished in a statement which is part of assessee paper book as annexed “A”. Even Ld. Counsel referred to copies of the export orders which are annexed in assessee’s paper book.

On the other hand Ld. SR DR argued that the assessee was unable to prove with evidence that booking of forward contracts were hedging against export sales. According to him, assessee was required to prove the existence of export sales and that he had entered into the forward contracts only for safeguarding the loss which might have occurred due to future price fluctuation in foreign currency. But he could not prove the same with 7 Jayant Kr. Bhura AY 2000-10 documentary evidences. He drew our attention to assessment order and stated that the complete facts were discussed by AO and it was found that there was no reasonable equivalence between the period of subsistence of two contracts i.e. forward contracts and export sales contracts and the amount involved in the two contracts. According to him, the cancellation of nine forward contracts in foreign exchange aggregating to 28,00,000 US$ resulted in a loss of Rs.2,33,23,750/- but the assessee failed to identify the corresponding export/sale contracts against which the above stated nine forward contracts were booked and thus the assessee could not prove his claim that the transactions were hedging in nature. In respect to the claim of hedging loss for remaining amount of Rs.1,45,21,122/- the assessee could come forward with some transactions but there was no reasonable equivalence of period and amounts between the two contracts. Accordingly, the lower authorities have rightly treated the loss as speculative transaction as per the provisions of section 43(5) of the Act as the transaction in forward contract of foreign exchange was settled otherwise than by actual delivery. According to ld. Sr. DR, the lower authorities have rightly treated the loss claimed by the assessee on account hedging loss as speculation loss by virtue of provisions of section 43(5) of the Act, explanation (2) to section 28 and section 73 of the Act. Accordingly, he urged the bench to uphold the orders of the lower authorities.

We have heard rival submissions and gone through facts and circumstances of the case in hand. We have also perused the case records. We find from records that, against the export orders for US$ 2,16,08,278, exports of US$ 41,76,126 were made during the financial year 2007-08 but during the financial year 2008-09 exports worth only US$ 57,59,208 could be made. But the balance export orders could not be executed because of world-wide slowdown, global recession and sluggish market conditions, which is a matter of public record. We observed that the Indian Government banned the export of maize in July, 2008, consequently, the pending export orders for the maize commodity had to be cancelled and no further orders could be booked. The assessee has produced the relevant details of the cancelled export orders (including for maize), which are furnished in a statement annexed to assessee’s paper book. Copy of the circular relating to ban on export of maize is annexed in the assessee’s paper book. The assessee had confirmed orders for export of maize to the tune of US$ 36,62,000. The assessee exported maize of the value of 8 Jayant Kr. Bhura AY 2000-10 US$ 7,57,159 during the financial year 2008-09 before imposition of the ban. Due to the sudden ban by the Government of India on the export of maize on July 3, 2008 the assessee had to cancel all the pending orders worth US$ 29,04,841 and was left with no other option but to cancel the forward booking as well. The details of export orders for maize to the extent executed before the ban and subsequently cancelled on imposition of ban are furnished in a statement annexed to in assessee’s paper book.

We find from the above facts that the entire basis for disallowance of loss for AO was on the assumption as if ban on export of maize was the sole reason for cancellation of the export orders. He lost sight of the fact that the assessee exported diverse commodities and cancellation of export orders took place not only because of ban on export of maize but also because of global recession and world-wide slow down. Admittedly, the assessee had Shipped part quantities against several of the export orders and the exports proceeds were converted at the forward contract rate. Since the buyers did not open the letters of credit and thus cancelled the balance quantity, the assessee had no other alternative but to cancel the forward contracts to the extent unutilised. The assessee had the option to convert the export proceeds at the rate stipulated in the forward contract or alternatively at the spot market rate. In the latter case, the forward contract had to be cancelled. As a prudent businessman, in respect of export proceeds of US$ 31,15,167.41, the assessee opted for conversion at the spot market rate instead of the rate stipulated in forward contracts of the value of US$ 28,00,000. The option exercised by the assessee resulted in higher export realisation to the extent of Rs.1,35,1l,357. Additionally, the assessee was able to obtain higher export incentives by way of drawback, OEPB, etc. with reference to the higher export realisation. Such forward contracts for US$ 28,00,000 were consequently cancelled but the higher export realisation to the extent of Rs.1,35,1l,357 and the higher export incentives went to offset the loss arising from such cancellation. To minimize the loss, the assessee took the spot rates which were more beneficial instead of conversion as per forward contract rates. Relevant details in this behalf are furnished in a statement annexed to the paper book of the assessee. Even, copies of the relevant export orders are included in the paper book. Due to cancellation of the forward contracts partially or fully, the assessee had to pay the difference between the contract rate and the market rate to the bank. Such payment was a business loss incurred by the assessee in course of its export business and is 9 Jayant Kr. Bhura AY 2000-10 an allowable deduction. The assessee had filed before the AO copies of all the 16 material export orders in the forward contracts relating to which loss of Rs.3,78,44,872/- was incurred in support of his contention that forward contracts were made on the basis of export orders in hand. The purported findings of the AO that the assessee had not submitted the export orders or that forward contracts were booked without having export orders in hand are contrary to the record. The assessee has since obtained from the AO certified copies of the export orders filed by him in course of the assessment proceedings which bear out the assessee’s contention. Even AO has not correctly prepared Annexures A and B to the Assessment order as he has omitted to incorporate in the said Annexures the details of the export orders in respect of which the forward contracts were booked. As such, the Bank in its response to the AO, stated that the forward contracts were booked based on past performance but simply because the assessee did not submit copies of the export orders to the Ban does not mean that the assessee did not in fact have the export orders in hand. As against export orders of US$ 2,16,08,278, the assessee had entered into forward contracts only for US$ 1,00,70,000. Due to market conditions, such forward contracts could be utilised only to the extent of US$ 53,32,334.34 and the remaining contracts for US$ 47,37,665.66 had to be cancelled. We further observed that the findings of the AO that the assessee dealt in forward contracts or that it was an independent business are without any basis. Indisputably, the assessee is in export business. The booking of forward contracts in foreign exchange is a normal and necessary incident of the export business. This position is also borne out from the RBI circular. The forward contracts were booked to hedge the assessee’s exposure to exchange risk in his export business as permitted by the RBI. The loss arising to the assessee upon cancellation of the forward contracts was referable to and related to the assessee's export business and arose out of the export business. The booking of forward contracts was not the assessee’s business. It was not permissible for the assessee to carry on any business in forward contracts in foreign exchange. The AO also admitted that the forward contracts were made by the assessee in accordance with RBI guidelines. The AO and CIT(A) were wholly unjustified in treating the business loss as speculative in nature.

This issue is now covered by the judgment of the Hon'ble Calcutta High Court in CIT v Soorajmull Nagarmull, (1981) 129 ITR 169 (Cal), wherein the assessee was a firm 10 Jayant Kr. Bhura AY 2000-10 engaged in the business of import and export of jute and in course of business, the assessee would enter into forward contract in foreign exchange in order to cover the loss which may arise due to difference in foreign exchange valuation. In one such contract, the assessee had to pay to the Bank difference of Rs.80,491/- which was claimed by the assessee as revenue expenditure. The Assessing Officer disallowed the claim. The Hon’ble High Court held that the assessee was not a dealer in foreign exchange and the foreign exchanges were only incidental to the assessee's regular course of business and the loss was thus not a speculative loss but incidental to the assessee's business and allowable as such. Facts in the present case are very similar. Admittedly, the assessee is not a dealer in foreign exchange. For the purpose of hedging the loss due to fluctuation in foreign exchange while implementing the export contracts, the assessee had entered into forward contract with the banks. In some cases, the export could not be executed and the assessee had to pay certain charges to the Bank and thereby incurred certain expenses. These expenses the assessee claimed by way of expenditure towards business. Accordingly, Hon’ble High Court held that the transaction can be stated to be in speculation as to cover under sub-section (5) of section 43 of the Act.

Further, this issue is also covered by the judgment of Hon'ble Bombay High Court in CIT v Badridas Gauridu (P) Ltd., (2003) 261 JTR 256 (Bom), wherein, the judgment of the Hon'ble Calcutta High Court was followed. To quote from the judgment of the Hon'ble Bombay High Court (at pages 257-8 of 261 HR) : "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 a commodity is settled otherwise than by the actual delivery or transfer of such commodity. However, as stated above, the assessee was not a dealer in foreign exchange. The assessee was an exporter of cotton. In order to hedge against losses, the assessee had booked foreign exchange in the forward market with the bank. However, the export contracts entered into by the assessee for export of cotton in some cases failed. In the circumstances, the assessee was entitled to claim deduction in respect of Rs. 13.50 lakhs as a business loss. This matter is squarely covered by the judgment of the Calcutta High Court with which we agree, in the case of CIT Vs. Sooraj Mull Nagarmull (1981) 129 ITR 169.”

In view of the above facts and circumstances of the case, we are of the view when the assessee is not a dealer in foreign exchange but an exporter of commodities and 11 Jayant Kr. Bhura AY 2000-10 assessee had entered into forward contracts with banks in respect of foreign exchange but some of these contracts could not be honoured by the assessee for which it has to pay and which was debited to the P&L Account and claimed the same as business loss/hedging loss. In order to hedge against losses, the assessee had booked foreign exchange in the forward market with the bank but the export contract entered into by the assessee for export of commodities in some cases failed, the assessee is entitled to claim for deduction of loss as a business loss. Accordingly, respectfully following Hon’ble jurisdictional High court in the case of Soorajmull Nagarmull, supra, we allow the claim of the assessee. This issue of assessee’s appeal is allowed.