Case Law Details
Foreign exchange forward contract Gain/Loss to Assessee engaged in exports business : Speculative or Business?
Justification for Premature Foreign exchange forward contract if assessee takes the same as business transaction.
Briefly stated relevant facts of the case are that the assessee is engaged in the business of trading and manufacturing of rough and polished diamonds and filed the return of income declaring the total income of Rs. 35,29,042/-.
Assessment was completed u/s 143(3) of the act determining the total income of Rs. 5,04,71,720/-. Assessing Officer made addition of Rs. 4,69,42,680/-. Relevant facts leading to the said addition include that the assessee being an exporter, made export of diamonds and outstanding receivable in foreign currency and entered into forward contracts with the Banks to hedge the exchange loss if any. Further, in accordance with the statutes, he also revalued the outstanding export receivable too. The total gain on account exchange difference on exports is Rs. 679.75 lacs on account of both actual realization and revaluation of outstanding receivables. The loss incurred on account of forward contracts to safeguard the outstanding receivables is Rs. 469.43 lacs. Accordingly, assesse set off the loss against the said gain and credited the net amount/ profit of Rs. 210.14 lacs to the profit and loss account. During the assessment proceedings, AO made various enquiries with regard to this credit entry and in response, assessee filed letters dated 29th and 30th November, 2011 which formed part of the assessment order. In these letters, the assessee provided numerous statistical data to justify its stand. In brief, total forward contracts entered into during the year works out to Rs. 135.99 Crs and the total cancellation is Rs. 126.3 Crs, the net forward contract is Rs. 9.95 Crs. The total exports in the year works out to Rs. 107.57 Crs. Total outstanding receivable in foreign exchange is much higher than any of these figures. Briefly, the stand of the assessee is that it entered into forward contracts with the banker to safeguard against the exchange fluctuations of export considerations/sale profits. It is the stated reasoning of the assessee, being an exporter, he has outstanding receivables whose value in US dollar is always subjected to market fluctuations internationally. Therefore, he needs to hedge the receivable against the exchange loss if any. Accordingly, he entered into the forward contracts with the Banks as per the RBI guidelines. Thus, the gains as well as the loss constitute business gains and loss and entitled for set off before the net gains is credited to the P and L Account. In this regard and before the AO, the assessee relied on the exemptions provided in clause (c) of the proviso to section 43(5) of the Act which provides for the definition of “speculation transaction”. Clauses (a) to (e) of the said section provides for exemption of certain facts from the definition of ‗speculation transaction‟. Thus, the assesse contended that the impugned loss is outside the scope of the ‗‗speculation transaction‟‘ and the loss being integral part of the export business constitutes ‗business loss‘. Consequently, the same is eligible for set off against the foreign exchange gains earned by the assesse both on account of actual realizations and revaluation of the outstanding receivables. Eventually, AO considered the above submissions of the assessee and also examined the applicability of the provisions of section 43(5) of the Act in general and clause (c) of the proviso to section 43(5) in particular and held that the impugned transactions do not satisfy in all the conditions specified in the said provisions. Relevant discussion is given in para 9 of the assessment order. AO dismissed the applicability of clause (a) of the proviso to section 43(5) stating that the assessee failed to demonstrate that the impugned transactions were incurred for hedging the risk against the raw material or merchandize. Similarly he rejected the applicability of clause (b) of section 43(5) of the Act too. AO opined that the same applies to the stocks and shares. On the applicability of clause (c) to section 43(5), AO dismissed the submissions of the assessee stating that the said provisions apply only to a case of contract entered into by a member of a forward market or an exchange which is not the case here. Finally, on the applicability of clause (d) of the proviso to section 43(5), AO ruled out the same considering the unfulfillment of the conditions specified therein. Thus, the AO concluded that the foreign exchange contracts constitute speculative transactions u/s 43(5) of the Act. AO also discussed the provisions of Explanation 2 to section 28 of the Act which provides for the explaining the deemed ‘speculation business‖ and held that the profit and loss arising from such transactions have to be computed separately and treat the same as per the provisions relating to the ‗speculation business‘. In this context he also referred to the provisions of Explanation to section 73 relating to ‗speculation loss‘. Relying on the principles relating to the onus AO held that the assessee failed to demonstrate that the transactions in question relates to hedging transactions. AO analyzed the principles laid down by the AAR- New Delhi, in the case of Sopropha S.A., re [2004] 268 ITR 37 and held that the said principles are found unfulfilled for calling the impugned transactions as hedging transactions. On the burden of proof issues, AO relied on the judgment of the Hon‘ble Supreme Court in the case of CIT vs. Joseph John [1968] 67 ITR 74 (SC). Referring to the Delhi High Court judgment in the case of Delhi Flour Mills Co. Ltd vs. CIT [1974] 95 ITR 151 (Delhi), AO opined that the foreign exchange transactions cannot have any nexus with the export of diamonds. In this regard, AO is of the opinion that the person selling cotton cannot enter into forward contract, say for gold. He also discussed the judgment of Bombay High Court in the case of CIT vs. Arjan Khimji& Co. [1980] 121 ITR 421 (Bom). Thus, AO concluded by stating that the foreign exchange / currency derivative transactions are not covered by the exclusions provided in the proviso to section 43(5) of the Act. Further, he held that assessee failed to the establish that the transactions in question have the nature of hedging transactions and he treated the loss of Rs. 4,69,42,680/- as the speculation loss and made the addition. So far as the profit earned on actual realization of export proceeds and the profits on revaluation of the outstanding receivable is concerned, the AO taxed the as the business income of the assesse and accordingly, denied the set off of the loss of Rs. 4,69,42,680/- against the gains of Rs. 679.75 lacs. Please become a Premium member. If you are already a Premium member, login here to access the full content.
