S. 43(5): Loss on foreign currency forward contracts by a manufacturer/ exporter is a “hedging loss” and not a “speculation loss”

CIT vs. Friends And Friends Shipping Pvt. Ltd (Gujarat High Court)

The assessee, an exporter, entered into forward contracts with Banks to hedge against any loss arising out of fluctuation in foreign currency. The forward contract provided that the assessee would buy some quantity of dollars at a particular rate to cover export bill payment. The contract gave delivery option dates and the assessee had the option to cancel the contract and pay the loss to the Bank. The assessee suffered a loss of Rs. 15 lakhs on such cancellation. The AO & CIT(A) held that the loss constituted a “speculation loss” u/s 43(5) and could not be allowed as a deduction. On appeal, the Tribunal upheld the assessee’s claim. On appeal by the department, HELD dismissing the appeal:

Though the assessee is not a dealer in foreign exchange, it entered into forward contracts with banks for the purpose of hedging the loss due to fluctuation in foreign exchange while implementing the export contracts. The transactions in foreign exchanges were incidental to the assessee’s regular course of business and the loss was thus not a speculative loss u/s 43(5) but was incidental to the assessee’s business and allowable as such. The fact that there may have been no direct co-relation between the exchange document and the precise export contract cannot be seen in isolation if there are in fact several separate contracts with the bankers (Soorajmull Nagarmull 129 ITR 169 (Cal) & Badridas Gauridu 261 ITR 256 (Bom) followed; M. G. Brothers 154 ITR 695 (AP) distinguished)

Note: This has been followed in CIT vs. Panchmahal Steel (Guj) (included in file). The contrary view in S. Vinodkumar Diamonds (ITAT Mumbai) is not good law as it overlooked Badridas Gauridu 261 ITR 256 (Bom)