Income arising on forward exchange contracts by an assessee engaged in the business of import / export must be treated as Business income and not Speculation income

It is not in dispute that the assessee is doing business of import and export of diamonds and it entered into forward exchange contract in respect of import and export transactions. On cancellation of the contract assessee is either entitled to profit or loss depending on rates contracted and rates prevailing at the time of cancellation. The assessee entered into these forward exchange contracts in order to protect against the fluctuation in the rate of foreign exchange currency. The assessee in this case made net gains in respect of foreign exchange contract export as the value of the rupee was improving at that time.

The A O has also considered the above issue relating to income from cancellation of forward contract. It is, therefore, admitted fact that it was a case of cancellation of forward contracts entered by assessee with others. The detailed facts explained in the statement of facts by the assessee have not been disputed. ITAT Ahmedabad Bench in the case of the same assessee in preceding assessment year 2003- 04 in ITA No. 775/A hd/2007 (supra) considered the issue of deduction u/s 80 HHC of the IT Act on income from cancellation of forward exchange contract. The learned CIT (A) in this case allowed the claim of the assessee treating it as export profit by relying upon decision of Mumbai Bench in the case of D. Kirhorekumar and Co. Vs DCIT and directed the A O to compute the deduction u/s 80 HHC by including the profit realized by cancellation of forward exchange contract in the profit of the export business. The departmental appeal was considered by the Tribunal as above and by relying upon the decision in the case of D. Kishorekumar and Co. (supra) the departmental appeal was dismissed. The order of the Tribunal above was referred in this decision in which it was held that the credit shown in the profit/loss account as profit on cancellation of forward contract is as integral part of the export business as purchased or import. The copy of the order dated 30^th November, 2006 is filed at page 3 of the paper book. ITAT Mumbai Bench in the case of Voltas International Ltd. Vs ACIT (supra) held “payment by assessee to bank for cancellation of forward foreign exchange contract being in the nature of damages for non­performance of contract is allowable as business loss and it cannot be treated as speculative loss as there is no settlement of contract and section 43(5) is not attractive.” Considering the facts and circumstances of the case in the light of decisions of the Tribunal in the case of the same assessee for assessment year 2003-04 and in the case of Voltas International Ltd. (supra), we are of the view that provisions of section 43(5) of the IT Act would not apply to the case of the assessee. The income earned by assessee on account of cancellation of forward exchange contract should be treated as business income and not income from speculation. We accordingly set aside the orders of authorities below and direct the A O to treat the income on this issue as business income. As a result, this ground of appeal of the assessee is allowed.

ITAT AHMEDABAD “B” BENCH

ITA No. 2478/Ahd/2009

Assessment Year: 2006-07

Veer Gems

V/s.

Asstt. Commissioner of Income-tax

Date of Pronouncement    11.01.2013

O R D E R

PER: T.R.Meena, Accountant Member

This is an appeal at the behest of the assessee which has emanated from the order of CIT(A)-IV, Surat, order dated 22.07.2009 for A.Y. 2006-07. The effective grounds of appeal are as under:

“1. On the facts and in circumstances of the case as well as law on the subject, the learned CIT (Appeals) has erred in confirming the action of the Assessing Officer in making addition of Rs. 28,34,840/- on account of labour charges.

2. On the facts and in circumstances of the case as well as law on the subject, the learned CIT (Appeals) has erred in not adjudicating the ground regarding treatment to be given to income from foreign exchange forward contract of Rs. 79,05,013/- as speculative income as decided by the Assessing Officer or business income as claimed by the assessee.”

2. The factual matrix of the case is that the appellant filed return for A.Y. 06-07 on 29.12.2006 declaring total income of Rs.4,06,39,860/-. The assessee is engaged in the business of import of rough diamonds and manufacturing it into polished diamond. It had been submitted by the appellant that during the course of assessment proceedings that on receipt of the rough diamonds get it cut and polished through the parties of outside labourers. For the year under assessment the assessee had shown a turnover of Rs.170.95 crore showing a gross profit of Rs.10.69 crore being 6.25% as against a gross profit of Rs.7.88 crore and rate of G.P. @ 4.90% on a turnover of Rs.1 .61.01 crore in preceding year. The appellant had debited labour charges 22.75 crore on total 566967.26 cts as against Rs.30.31 crores on total 774064.21 cts claimed in the preceding year. The payment of labour charges to the contractors ranging from Rs.250/- to Rs. 600/- per carat to different job workers, which was found by the A.O., excessive, compared to prevailing in the market. Ld. A.O. gave reasonable opportunity of being heard on this issue. The ld. A.O. had also gathered the information u/s.133(6) of the IT Act and average rate of labour charges was worked out Rs.401 .38/- per carat as against Rs.391 .6 per carat in the preceding year. There was increase about 2.5%. He also compared the case of M/s. Jodhani Exports wherein per carat labour was paid Rs.265/-, in case of M/s. D. Nition & Co. labour charges paid Rs.160/- to Rs.180/- per carat. Thus, the A.O. found labour charges on higher side. Therefore, he made addition of Rs.28,34,840/- @ Rs.5/- per carat in the income of the assessee.

3. Being aggrieved by the order of the A.O., the assessee carried the matter before CIT(A) who has confirmed the addition by observing as under:

“I have considered the submissions of appellant and also the reasons given by Assessing Officer for making such dis allowance. I find that in the immediate preceding years also i.e. A. Y. 2004-05 and A. Y. 2005-06, similar dis allowance was made to the income of assessee and the said dis allowance had been confirmed vide order dated 14.08.2007 for A. Y. 2004-05 and 22.10.2008 for A. Y. 2005-06. As the issue involved is absolutely identical, the dis allowance made for the year under consideration is hereby confirmed following appellate orders passed in immediately preceding years.”

4. Now, the assessee is before us. Ld. Counsel for the appellant submitted that similar addition in A.Y. 05-06 had been made by the ld. A.O., which has been deleted by the Co-ordinate ‘D’ Bench in ITA No. 4136/Ahd/2008 in ground no.1 of assessee’s appeal. The Co-ordinate Bench has allowed the appeal in favour of the assessee. The operative portion of the order is as under:“12 We have heard the rival submissions and considered the material available on record. The AO disallowed Rs. 10 per carat labour expenses would prove that substantial explanation of the assessee has been accepted by the AO. The assessee produced all the details of the expenditure and books of account before the AO. The books of account of the assessee are audited. The GP rate is admittedly better in the assessment year under appeal as compared with the last year. The assessee is engaged in the business of purchase/import of rough diamonds and manufacturing of it and sale/export of polished diamonds. The labour charges expenses are the main component for earning the substantial income. The rates paid to the job workers ranges differently. According to assessee all the payments are made through account payee cheques only after making TDS. Therefore, considering the history of the assessee and nature of business and that profit is higher as compared to the preceding assessment year, would prove that assessee spent genuine expenditure wholly and exclusively for the purpose of business. We accordingly set aside the orders of the authorities below and delete the addition. This ground of appeal of the assessee is allowed.”

Therefore, he requested to delete the addition. Whereas, from the side of the Revenue, ld. Sr. D.R. relied upon the order of CIT(A) and requested to confirm the addition.

5. We have heard the rival contentions of the both sides and perused the material before us. Identical additions were made in A.Y. 05-06 at Rs. 77,40,640/- on account of labour charges @ Rs.10/- per carat. During the year, the appellant had shown better G.P. compared to preceding year. Therefore, we have considered view that CIT(A) was not right in confirming the addition on the basis of past history of the case, this ground of appeal is allowed in favour of the assessee.

6. The A.O. observed that the assessee had earned income from forward contract of fluctuation of exchange rate at Rs.79,05,01 3/- as against Rs.6,19,87,745/- in preceding year. The ld. A.O. gave reasonable opportunity of being heard on this issue as to this income should not be treated as speculation income of the assessee. The assessee’s reply was considered and a detailed discussion made by the A.O. from page nos. 5 to 13 of the assessment order. He also relied upon various case laws in assessment order and discussion made on Section 43(5) of the IT Act. He held that this income of Rs.79,05,013/- as speculative income.

7. The appellant carried this matter before the CIT(A) who held that it is academic for the appellant whether this income treated as speculative income or business income would not have any tax effect for the year under consideration. Thus, he had not adjudicated this issue.

8. Now, the appellant is before us. He submitted that similar issue was raised by him in A.Y. 05-06 in ground no.3 of Co-ordinate ‘D’ Bench decision in ITA No. 4136/Ahd/2008, wherein the Co-ordinate Bench has allowed the appeal in favour of the assessee. The operative portion of the order is as under:

“20. We have heard the rival submissions and considered the material available on record. It is not in dispute that the assessee is doing business of import and export of diamonds and it entered into forward exchange contract in respect of import and export transactions. On cancellation of the contract assessee is either entitled to profit or loss depending on rates contracted and rates prevailing at the time of cancellation. The assessee entered into these forward exchange contracts in order to protect against the fluctuation in the rate of foreign exchange currency. The assessee in this case made net gains in respect of foreign exchange contract export as the value of the rupee was improving at that time. The A O has also considered the above issue relating to income from cancellation of forward contract. It is, therefore, admitted fact that it was a case of cancellation of forward contracts entered by assessee with others. The detailed facts explained in the statement of facts by the assessee have not been disputed. ITAT Ahmedabad Bench in the case of the same assessee in preceding assessment year 2003- 04 in ITA No. 775/A hd/2007 (supra) considered the issue of deduction u/s 80 HHC of the IT Act on income from cancellation of forward exchange contract. The learned CIT (A) in this case allowed the claim of the assessee treating it as export profit by relying upon decision of Mumbai Bench in the case of D. Kirhorekumar and Co. Vs DCIT and directed the A O to compute the deduction u/s 80 HHC by including the profit realized by cancellation of forward exchange contract in the profit of the export business. The departmental appeal was considered by the Tribunal as above and by relying upon the decision in the case of D. Kishorekumar and Co. (supra) the departmental appeal was dismissed. The order of the Tribunal above was referred in this decision in which it was held that the credit shown in the profit/loss account as profit on cancellation of forward contract is as integral part of the export business as purchased or import. The copy of the order dated 30^th November, 2006 is filed at page 3 of the paper book. ITAT Mumbai Bench in the case of Voltas International Ltd. Vs ACIT (supra) held “payment by assessee to bank for cancellation of forward foreign exchange contract being in the nature of damages for non­performance of contract is allowable as business loss and it cannot be treated as speculative loss as there is no settlement of contract and section 43(5) is not attractive.” Considering the facts and circumstances of the case in the light of decisions of the Tribunal in the case of the same assessee for assessment year 2003-04 and in the case of Voltas International Ltd. (supra), we are of the view that provisions of section 43(5) of the IT Act would not apply to the case of the assessee. The income earned by assessee on account of cancellation of forward exchange contract should be treated as business income and not income from speculation. We accordingly set aside the orders of authorities below and direct the A O to treat the income on this issue as business income. As a result, this ground of appeal of the assessee is allowed.”

From the side of Revenue, it has been argued that the nature of the receipts are speculative. Therefore, the order of the A.O. should be confirmed.