THE issue before the Bench is - Whether if a contract for sale or purchase is ultimately settled and no actual delivery of goods is effected under the settlement, it is to be treated as a speculative transaction. YES is the answer.
Facts of the case
The assessee company, engaged in the business of trading of cut and polished diamonds, filed its return of income declaring loss at Rs.2,19,91,359/-. AO finalised the assessment u/s 143(3) determining the total income of Rs.78,57,190/. Effective ground of appeal was about
disallowance of loss of Rs.2,98,48,551/- on account of cancellation of foreign currency forward contract. During assessment, AO found that the assessee had debited loss on account of exchange rate fluctuation amounting to Rs. 2.98 Crores and directed the assessee to furnish details on account of exchange rate difference and of forward contracts. After considering the explanation filed by assessee, AO observed that any loss incurred by an assessee on entering into currency derivatives, due to forward contract of foreign exchange (FE) rate, had to be taken as forex derivative loss, that such loss had to be on account of dealing in forex derivatives which had actually been incurred by way of settling the difference at the end of the expiry of period of derivative contract or its termination, that assessee had to prove that currency derivative losses incurred was on account of hedging (reducing) risk and had not been undertaken as a speculative transaction to earn more profit.
It was further held that the assessee had entered into 24 forward contracts, that total forward contract cancelled order were of Rs.28 Crores, that the total sales during the year was of Rs.27.78 Crores Referring to circular no. 23d dated 12.09.1960 of the CBDT, AO held that the intention of the assessee was to speculate, that the table furnished by the assessee proved that out of US $ 70,50,000 book transaction worth US $ 64,45,623 were cancelled, that none of the booking were utilised, that most of them were cancelled, that all the contracts had been honoured by cancellation, that delivery of currency had not taken place, that the assessee had not hedged its outstanding receipts by way of these forward contracts and due to cancellation of assessee's obligation to pay, that the assessee dealing in diamond and these contracts were in currency, that the assessee had not entered into certain number of contracts against specific bills or in the same commodity-diamond and out of those contracts of few were cancelled, that the transaction undertaken by the assessee did not suggest that those contracts were part of normal business activity of the assessee and the cancellation was incidental to the business, that none of the transaction could be categorised as hedging transaction, that the forward contracts were not relatable to the specific bills of the assessee, that the assessee could not relate any single bill to any of the contracts, that no purchase order had been provided during the course of assessment proceedings against which the forward contracts bad been booked, that the transaction in forward contracts cancellation had been carried out by the assessee were in a systematic manner,that the volume of transaction was quite substantial, that the volume and frequency of the assessee's transaction proved that it had systematically and in an organized manner carried out the business activity in currency forwards. It was also held that transactions of forex derivative undertaken by the assessee for the year under consideration did not satisfy any of the conditions given in proviso (d) to section 43(5), that forex derivative transaction were speculative in nature.
On appeal, CIT(A) held that assessee had claimed loss of Rs.2,98,48,551/- on account of forward exchange contracts, that the assessee was not a dealer in foreign exchange, that it was an importer-exporter of diamonds, that the assessee had cancelled relevant forward contracts of foreign exchange, that not a single forward contract was settled by actual delivery. Referring to the provisions of section 73 and 43(5), CIT(A) defined the term speculation loss. CIT(A) also made a reference to the cases of Seksaria Riswan Sugar Factory (121 ITR 196) Budge Budge Investment Co. Ltd (73 ITR 722) and Davenport & Co (P) Ltd. (100 ITR 715). It was further held that the expression 'Speculative transaction' meant and included a transaction of any commodity, including stocks and shares, periodically or ultimately settled otherwise than by actual delivery. Section 43(5) did not seek to expand the scope of expression commodity, that it merely emphasized that the transaction in commodity included transactions in stocks and shares, that transactions in future contracts, like transactions in stock and shares, when settled otherwise than by actual delivery would be speculative transactions u/s.43(5). CIT(A) relied upon the decision of the Bombay HC in the case of Bharat R Ruia (HUF) and held that only exchange traded derivatives were covered under clause (d), that the derivatives under dispute were not eligible transactions in respect of trading in derivatives, that the assessee had cancelled all relevant forward contracts in US Dollars which were booked during accounting year relevant to AY 2009-10 which resulted into net loss, that in respect of export of diamonds, the assessee had entered into forward contract in respect of foreign exchange to be received as a result of export, that it had undertaken the transactions to avoid the risk of loss due to foreign exchange fluctuation, that the assessee at the time of agreeing to export took into consideration its cost in rupees and also considered the spot price of rupee against foreign exchange, that during the course of assessment proceedings and during the course of appellate proceedings the fact remained uncontroverted that loss shown by the assessee was exclusively due to forward contracts against which no actual delivery of foreign exchange was made,that the forward contract was to be settled either by delivery or the difference was either credited or debited by the banker,that in the matter under appeal all relevant forward contracts were cancelled,that same were never settled by actual delivery or by transfer of the commodity. In the result, CIT(A) upheld the order of the AO.
Before the Tribunal, AR stated that the assessee was dealing in diamonds, that it had to cancel certain deals and had suffered losses, that total outstanding matched with total exports,that loss suffered by the assessee was not speculative loss, that facts of case of Bharat Ruia were different from the case under consideration. AR relied upon the cases of Intergold (I) Ltd. (ITA/1440&1900/Mum/2004), Bombay Diamond Co. Ltd. 2009-TIOL-760-ITAT-MUM, Balar Export, Surat(ITA/131/2013). and the judgments of High Courts of Bombay and Gujarat in the cases of Badridas Gauridu (261 ITR 256), Panchmahal Steel Ltd. 2013-TIOL-425-HC-AHM-IT and Friends and Friends Shipping Pvt. Ltd. (Tax Appeal 251 of 2010). On the other hand, DR had argued that the assessee had not matched the transaction with the export bills, that facts of the cases relied upon by the assessee were distinguishable from the facts of the present case.
Having heard the matter, the Tribunal held that,
++ as per the accepted principles of business and commercial world a forward contract is an agreement between a buyer and seller getting the seller to deliver a specified asset of specified quality and quantity to the buyer on a specified date at a specified place and the buyer in turn is obligated to pay the seller a pre-negotiated price in exchange of the delivery. FC can be entered into for exports also. In such transactions when the actual export is made, spot price may differ from the spot price on the date on which the appellant expected an export order. On the date or receipt of foreign exchange, if the spot price of rupee against foreign exchange increases/ decreases then the assessee may make profits or suffer losses. As per the details filed by the assessee it had entered into 24 such transaction during the year under consideration. It was claimed on behalf of the assessee that these transaction were not speculative transactions as held by the departmental authorities, as stated earlier Concepts of speculative transaction/hedging transactions are not new concepts of tax laws. Distinction between the two type of transactions is vital and both have different consequences in determining the tax liability arising out of them;
++ in our opinion, the definition of 'speculative transaction' in section 43(5), gives a simple test for deciding, for the purpose of Act, as to what a speculative transaction means. If a contract for sale or purchase is ultimately settled and no actual delivery of the goods is effected under the settlement then it has to be treated a speculative transaction. The requirement of section 30 of the Indian Contract Act of the existence of the intention of the parties even at the time of the original contract not to give or take delivery of the goods in order to make it a speculative/ wagering transaction is dispensed with for the purpose of the Act. Secondly, if actual delivery is not given/taken under the settlement of contract, then the intention of the parties at the time of the contract becomes immaterial. The true test is delivery of commodities/goods as per the contract, including a FC Profit/loss in respect of unperformed contracts is considered speculation profit or loss.In short, in order that a transaction may fall within the scope of the expression 'speculative transaction', it must be a transaction in which a contract for 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/scrips. It would be useful to appreciate as to how hedge transactions are commercially understood before determining the true scope,width and nature of proviso(a) to Sec. 43(5). So far as the profit or loss arising from a future delivery contract is concerned, it is determined on the date of actual delivery irrespective of the date on which the contract was entered into.In respect of a hedging contract, profit/loss arising there from can be ascertained or crystallised at fixed intervals of the term when the clearance takes place. While, however, the hedging operation protects the hedger against loss arising from adverse fluctuations in prices, it also prevents him from making windfall profit owing to favourable fluctuations in prices as well. The forgoing of such a possible windfall profit is the price which he pays for the insurance against loss. This well-known technique, of hedge trading clearly implies forward contracts both ways, namely, for sale and purchase with a view to guarding against adverse price fluctuations. These forward contracts by way of hedge transactions usually afford a cover to a trader inasmuch as his loss in the ready market is offset by a profit in the forward market and vice versa. It, therefore, follows that in order to effectively hedge against adverse price fluctuations of the manufactured goods or merchandise, a manufacturer or merchant has necessarily to enter into forward transactions of sale and purchase both, and without these contracts of sale and purchase constituting hedge transactions, there would be no effective insurance against the risk of loss in the price fluctuations of the commodity, manufactured or the merchandise sold. In other words,unless the assessee shows that there was some existing contract in respect of which he was likely to suffer a loss because of future price fluctuations and that it was to safeguard against such loss that he entered into the forward contracts of sale, he could not claim the benefit of clause (a) of the proviso to section 43(5);
++ from the principles laid down by above mentioned judgments one thing becomes clear that for hedging transaction commodity dealt should be the same. If the subject matter of the transactions is different it cannot be termed a hedging transaction. In the case of M.G. Brothers, the HC has held that the forward contracts entered into by the assessee in cotton seed oil and neem oil were not covered by cl. (a) of the proviso to s. 43(5) and were not hedging transactions. The forward transactions were speculative in character and the loss arising therefrom could not be set off against the assessee's income from the business in the manufacture and sale of groundnut oil. Similarly, in the case of Nuddea Mills Co.Ltd the assessee was a manufacturer of jute goods and it has entered into forward contracts of sale of standard jute goods. In view of overseas offer, it decided to manufacture special quality jute goods. Assessee entered in to forward purchases of standard jute goods and purchase back of forward contracts of sale. It incurred loss in covering its forward contracts of sale. In the appeal filed by the assessee, HC, confirming the order of the ITAT, held that losses suffered by the assessee were result of the speculative transactions. In the case of Delhi Flour Mills Co.Ltd, Delhi HC held that forward transactions made by the assessee in respect of matar (a substitute of gram) could not be treated as hedging transactions and the loss sustained by the assessee in such transactions could not be set off against its profits in the business of manufacturing atta (wheat flour) and other wheat products. In order that forward transactions in commodities may fall within proviso (a) to section 43(5), it is necessary that the raw materials or merchandise in respect of which the forward transactions have been made by the assessee must have a direct connection with the goods manufactured or the merchandise sold by him. In other words raw material in respect of which the assessee has entered into forward transactions must be the same raw material which is used by him in his manufacturing business. We find that in the case under consideration assessee was not dealing in Foreign Exchange, therefore transactions entered into by it in Foreign Exchange cannot be held to be hedging transactions. As the assessee is dealing in diamonds and FC entered into only for diamonds would have been covered by the proviso (a) to the section 43(5) of the Act. As held by the HC of Calcutta in the matter of Gourepore Co. Ltd.(135 ITR 606) onus was on the assessee to prove that the transactions in question were not of a speculative nature. We are of the opinion that it has failed to discharge the onus cast upon him by the statute. It was also not able to contradict the finding of fact that booking and cancellation of FC of foreign exchange were not in respect of specified export or import. Besides, finding of fact given by the Revenue Authorities remained un-contravened that loss in question, shown by it pertained to those FC transactions,against which no actual delivery of foreign exchange was made;
++ on appreciation of the facts surrounding the transaction we have reached at the conclusion that transactions entered in to by the assessee were speculative in nature and the case of the assessee is not covered by proviso(a) of the section 43(5). Now we would like to discuss the cases relied upon by the AR. In the case of Intergold (I) Ltd. the matter related to sections 10A and 80HHC. In the matter of Bombay Diamond Co. Ltd., the FAA had held that loss arising out of forex contract was business loss and the Tribunal had endorsed the view of the FAA. Thus, the case was limited to the facts of that case. In the case of Friends and Friends Shipping Pvt. Ltd. the Gujarat High Court had specifically mentioned that FC was entered in to by the assessee with the bank was for hedging losses,whereas in the present case the transactions are not of hedging nature. Even in the case of Badridas Gauridu the jurisdictional High Court had held that the transaction in question were hedging transactions and not speculative transactions and only a few of the contracts were cancelled. In the case under appeal the AO and the FAA given a categorical finding of fact that the disputed transactions were speculative and not hedging transaction, that the assessee could not relate any single bill to any of the contract and it had not provided detail of any purchase order relatable to specific transaction,during the assessment or appellate proceedings. Thus, the transactions undertaken by it have to be taken as transactions relatable to Foreign Exchange. We are of the opinion that the order of the FAA does not suffer from any legal or factual infirmity. Therefore, considering the peculiar facts and circumstances of the case,we confirm his order FAA and decide effective ground against the assessee. As a result,appeal filed by the assessee stands dismissed.
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