Case Law Details
Nand Nandan Agrawal Vs Dy. CIT (ITAT Agra)
Impugned contract for derivatives in foreign currency was commodity as defined under section 43(5) and was entitled to exemption from being treated as speculative provided all other conditions as stipulated under section 43(5) were complied with. All such transactions in foreign currency derivatives were conducted through a recognized broker and were supportedby time-stamped contract notes. Also accounts of assessee, including those related to the foreign currency derivatives, were duly audited. Therefore, in view of proviso (d) to section 43(5), transaction in question could not be regarded as speculative and the assessee was entitled to set off of resulting loss against normal business income.
FULL TEXT OF THE ITAT JUDGMENT
These are assessee’s appeals for assessment years 2013-14 and 2014-15, issue involved therein, they are being disposed of by this composite order.
2. Facts, for convenience, are being taken from ITA No. 349/Agra/2016, wherein, the following grounds have been taken:
“1. Because on due consideration of facts, circumstances of the case more particularly in view of the fact that transactions in currency derivatives made by the ‘assessee’ which were all supported by time-stamped contract notes conducted at the floor of recognized stock exchange resulting into loss of Rs. 1,709,121, learned ‘CIT (Appeals)’ has erred in law holding the same as ‘speculative transactions’ and thereby not allowing set off of same against other business income of the ‘assessee’.
2. Because while holding so, ld.CIT(A)has erred on fact in binding himself with the authoritative decisions referred and relied upon before him.
3. Because ld.CIT(A)has further erred in holding that transactions in currency derivatives were ‘marked to market’ transactions and liable to be treated as ‘speculative transactions’ ignoring that there were no derivative contracts outstanding as on 03.2013, which at any rate could be termed as ‘notional loss’.
4. Because without prejudice to the aforesaid grounds, the order dated 28.10.2016 passed by the ‘CIT’ is wrong and illegal in so far as disallowance of Rs. 1,709,121 has been confirmed.”
3. The facts of the case are that the assessee is a trader in non-ferrous metal scrap under the name and style of Kanishk Metalloys. During assessment year 2013- 14, the assessee undertook trading in currency derivatives, and suffered loss of Rs. 1,709,121/- in such activities. The said loss of Rs. 1,709,121/- and activities relating thereto were duly disclosed in the e-return filed by the assessee, on being advised that that transaction in ‘currency derivatives’ was liable to be held as ‘speculative’ within meaning of section 43(5) of the Act, he did not claim set-off of the same with other income under the business head, or under any other head of income. The assessee’s accounts in respect of the regular business, as well as the derivative transactions, were duly audited. The amount of turnover and other details declared in ITR -4, as well as the audit report, contained amounts of both segments. Similarly, for assessment year 2014-15, the loss suffered on trading of currency derivatives amounted to Rs. 1,184,370/-.
4. The case of the assessee for assessment year 2013-14 was selected under scrutiny and during the course of the assessment proceedings, the assessee, vide letter dated 26.12.2014 (APB 246 – 254), submitted that:-
“5.2 Since the assessee has not claimed the loss sustained in currency derivative segment because he was advised that such transaction may fall in the category of ‘speculative transactions’ as defined under section 43(5) of the ‘Act’, the only transaction requires your kind consideration are transaction relating to trading in metal scrap carried under the name of ‘Kanishk Metalloys’. We may mention that by saying that your attention is not required on currency derivative transactions, does not mean that no enquiry can be made in that aspect of matter. We rather, submit the copies of contract notes and statement issued by the Broker, The assessee made payment of Rs, 3,205,000 to M/s Mansukh Securities & Finance Ltd. where after sustaining loss of Rs. 1,709,120.61, net balance as on 31.03.2013 remained at Rs. 1,495,879.39. The sources of funds of payments to M/s Mansukh Securities and Finance Ltd. are explained from the bank statements of the assessee, which are being submitted in reference to other queries in later part of this submission.”
Vide letter dated 20.04.2015 (APB 255 – 256), the assessee made claim before the AO that the loss suffered by him on transaction of currency derivatives was entitled not to be treated as a ‘speculative loss’ and that it was entitled to be adjusted against income from regular business.
5. The AO, however, did not allow the claim of the loss of Rs. 17,09,121/-, assigning the following short reason:-
“4. The loss amounting to Rs. 1,709,120.61 sustained on account o\ trading in currency derivatives is not allowed to be set off against business income as the same has not been claimed by the assessee and also being speculative loss.”
6. The ld. CIT(A), after considering the submissions of the assessee, decided the issue of loss not claimed in the return in favour of the assessee, but on merits, decided the issue of allowing loss against the assessee as per his findings recorded in para 8.2 and para 8.21 of the impugned order. The ld.CIT(A), besides, taking note of CBDT Instruction no. 3/2010 dated 23.03.2010, further observed that no loss had occurred to the assessee as the transactions in currency derivatives were ‘marked to market’ and the loss sustained was a ‘notional loss’.
7. Challenging the impugned order, the ld. Counsel for the assessee has contended that the ld. CIT(A) has erred in holding the transactions in question as speculative transaction and not allowing the set-off thereof against other business income of the assessee; that while doing so, the ld. CIT(A) has failed to take into consideration the fact that all the transactions in currency derivatives made by the assessee were duly supported by the time and stamped contract notes conducted with a recognized stock exchange, resulting into loss; that the ld. CIT(A) has further erred in holding that the said transactions were ‘marked to market’ transactions, overlooking the fact that there was no derivative contract outstanding as on 31.03.2013, concerning A.Y. 2013-14, which could be termed as a notional lass; that the ld. CIT(A) has also erred in ignoring the fact that even as on 31.03.2014, with regard to A.Y. 2014-15, there was no derivatives contract outstanding, which could be termed as a notional loss.
8. The ld. DR, on the other hand, has placed strong reliance on the impugned order
9. I have heard the parties and have perused the material on record. In the order for A.Y. 2013-14, the ld. CIT(A) has made the following relevant observations:
“8.2 The second reason for disallowance of the loss from trading of foreign currency derivatives, as mentioned by the A.O., relates to the question about its nature. The assessee has stated in his submission before the A. O. that he is engaged in the business of trading in non-ferrous metal scrap and major portion of his purchases are from overseas market. It has been stated by him that during the impugned year, he has also entered into transactions of purchase and sale of derivatives in foreign currency. All such transactions in foreign currency derivatives were conducted through a recognized broker and said to be supported by time- stamped contract notes. It is also submitted that the accounts of the assessee, including those related to the foreign currency derivatives, are duly audited.
Having considered the assessee ‘s above submission, the facts of the case, and the judicial precedents in this case, I am not inclined to agree with the assessee ‘s contention that the loss of Rs. 17,09,120.61 suffered by the assessee on its foreign currency derivative transactions qualifies to be deducted from his income from business.
The provisions of section 43(5) of the Act lay down the meaning of “speculative transactions”. The five provisos to section 43(5) list the transactions that will be deemed to be not speculative in nature. In the assessee ‘s case, theoretically speaking, only two provisos namely, proviso (a) and proviso (d) to section 43(5), can assist him to allow his foreign currency derivatives transactions to be deemed to be non-speculative in nature.
Proviso (a) is relevant to those transactions which are related to a contract in respect of raw materials or merchandise entered into by a person in the course of his manufacturing or merchanting business to guard against loss through future price fluctuations in respect of his contracts for actual delivery of goods manufactured by him or sold by him. The assessee has not explicitly pleaded in the present proceedings that he had entered into any contract of the nature^ specified in proviso (a) to section 43(5). He has also not furnished any evidence to substantiate this possibility. Further, it is observed that as against a turnover of Rs. 34.23 crores from the trading of non-ferrous scrap the turnover of his foreign currency derivatives is Rs. 84.26 crores approximately for which he had entered into as many as 15,558 contracts during the period between 13.09.2012 and 31.03.2013. This relative mismatch between the volume of operations in the scrap and the foreign currency derivative trading businesses, points to the fact that the transactions in the latter were not carried out by the assessee in order to hedge the transactions of the scrap business. Hence, in view of the above facts, the only conclusion which I can draw out of these facts is that the assessee had not carried out trading in foreign currency derivatives for the purpose of hedging his scrap- trading transactions.
Proviso (d) to section 43(5), excludes from the ambit of ‘speculative Transactions” all “eligible transactions” in respect of trading in derivatives referred to in clause (ac) of section 2 of the Securities Contracts (Regulation) Act, 1956 carried out in a recognized stock exchange. Vide paragraph 6.3 of his submission dated 08.09.2016 reproduced above, the assessee’s A.R. has given his arguments why the said loss should be allowed and as regards to A. O. ‘s finding that the transactions were speculative, reliance has been placed on the following cases:
a) IVF Advisors (P) Ltd. vs. ACIT reported as (2015) 55 com469 (Mumbai -Trib)
b) Adani Enterprises Ltd. vs. Addl. CIT reported as (2015) 55 com375 (Ahmedabad -Trib)
c) Majestic Exports vs. JCIT reported as (2015) 172 TTJ 504 (Chennai -Trib.)
d) Inventurus Knowledge Services (P) Ltd. vs. ITO reported as (2016) 156 ITD 727 (Mumbai-Trib).
8.21 In the above context a quick reference to the provisions of section 73(1) of the Act, in my opinion, is warranted. It states that any loss, computed in respect of a speculation business carried on by the assessee, shall not be set-off except against profits and gains, if any, of another speculation business. This means that for any loss to escape the restriction imposed by the provisions of section 73(1), it will have to comply with the following two conditions :-
(a) It should be a “loss”, and
(b) It should be computed in respect of a “speculation business” carried on by the assessee.
The concept of loss is not specifically defined in the Act even though it is referred to in the Act more than once. However, as regards the meaning of the term “speculation business”, Explanation 2 to section 28 of the Act states:
“Where speculative transactions carried on by an assessee are of such nature as to constitute a business, the business (hereinafter referred to as “speculation business”) shall be deemed to be distinct and separate from any other business.”
The provisions of section 43(5) of the Act lay down the meaning of “speculative transactions.
A conjoint reading of the provisions of section 73(1), section 43(5) and explanation 2 to section 28 of the Act reveals that, out of all the transactions carried out by an assesses, some may be classified as “speculative transactions” in conformity with the provisions of section 43(5). Further, a direct implication of the provisions of Explanation 2 to section 28 is that out of such “speculative transactions” of the assessee, only those that are of such nature as to constitute a business, shall be further categorized as a “speculation business”. The provisions of section 73(1), on their part, stipulate that for any loss to be eligible to be set-off against business income, will have to comply with two conditions-that it should be a “loss”, and that it should be computed in respect of a “speculation business” carried on by the assessee.
The factual matrix in the present case is that the assessee is a trader of non- ferrous metal scrap and during the year under consideration, he has shown loss of Rs. 17,09,120.61 on its foreign currency derivative transactions. This loss is reflected in the Statement of account for the period 01 .04.2012 to 31.03.2013 issued by his broker, Mansukh Securities & Finance Ltd, Delhi. A perusal of the said Statement of account and copies of the related contract notes filed by the assessee with his submission, reveals that all the assessee ‘s foreign currency derivative transactions have been reported therein on ‘marked to market basis’. Hence, in my opinion the first condition of section 73(1) about there being a “loss”, is not satisfied in the assessee’s case. CBDT’S Instruction no. 3/2010 dated 23.03.2010 has dwelled upon the impugned issue and has pointed out that losses on foreign currency derivative transactions computed on ‘marked to market basis’ are notional losses and not actual losses, and therefore not allowable as deduction from business income.
The assessee ‘s reliance on certain judgments, with due respect to those, will not come to his rescue because the provisions of section 73(1) allow set-off against business income, of actual losses, and not notional losses.
Ground no. 1 to 3 are decided accordingly. The assessee ‘s plea of set-off of his loss from foreign currency derivatives against business income is not acceded to but his argument that it should not have been rejected merely on the ground of his failure to claim it in his return of income, is accepted.”
10. The ld. CIT(A) has, therefore, considered the transactions entered into by the assessee, to be speculative transactions. The loss incurred by the assessee has, thereby, not been allowed to be set off against other business income of the The ld. CIT(A) has held that these transactions in currency derivatives, ‘marked to market’ transactions.
11. Now, the Explanation 2 below section 28 of the Act provides that where speculative transactions earned by an assessee are of such nature as to constitute a business, the said speculation business shall be deemed to be distinct and separate from any other business. Section 73(1) prohibits the loss on speculation business being adjusted against income from any other business. Thus, the main issue up for consideration is whether the trading currency derivative transactions conducted by the assessee constitute ‘speculative transactions’.
12. The term ‘speculative transaction’ has been defined under section 43(5) of the Act to mean a transaction in which a contract for the purchase or sale of any commodity, including stock and shares is periodically or ultimately settled otherwise than by actual delivery or transfer of the commodity or script. However, there are five exceptions to this general rule provided by way of a proviso containing clauses (a) to (e), where the transaction, despite having been settled otherwise than by actual delivery, is not to be treated as a ‘speculative transaction’. The assessee’s contention is that his case falls under clause (d) of the proviso to section 43(5) of the IT Act.
13. Clause (d) of the proviso to section 43(5) provides that ‘an eligible transaction in respect of trading in derivatives referred to in clause (ac) of section 2 of the Securities Contract (Regulation) Act, 1956 (42 of 1956) carried out in a recognised stock exchange shall not be deemed to be a speculative The explanation 1 to section 43(5) of the IT Act further defines certain words referred to in the said clause (d), as under:-
(i) “eligible transaction” means any transaction,-
(A) carried out electronically on screen-based system through a stock broker or sub-broker or through …
(B) which, is supported by a time stamped contract note issued by such stock broker or sub-broker or … indicating in the contract note the unique client identity number allotted any Act referred to in sub-clause (A) and the permanent account number allotted under this Act;
(ii) “recognised stock exchange” means a recognised stock exchange as referred to in clause (f) of section 2 of Securities Contract (Regulation) Act, 1956 (42 of 1956) and which fulfills such conditions as may be prescribed and notifies’ by the Central Government for this purpose”
14. Concerning the satisfaction of the condition with regard to an eligible transaction, it is a perusal of the contract notes, placed at APB 56 to 237 shows that the transactions are in relation to transactions carried out through an on-screen based system (Currency Derivatives Segment of MCX Stock Exchange Ltd.), through a stock broker, namely, Mansukh Securities & Finance Ltd. (SEBI Regn. No. INE260781431, Trading Member Code No.38500, PAN: AAACMIV01D). The contract notes bear the unique identity code AZNNI and PAN of the assessee i.e., AQZPA3204D. The contract notes also mention order numbers, order time, trade no. and trade time, besides other details. Thus, all the conditions of an ‘eligible transaction’ are satisfied. So far as the condition of a ‘recognised stock exchange’ is concerned, the transaction has been carried out at MCX Stock Exchange Ltd., which is recognised by SO 1327(E) dated 22.05.2009 (note 24 at page 1.322 of Taxmann’s Income tax Act, 2017). Thus this condition is also satisfied.
15. The third condition is ‘trading in derivatives’ referred to in clause (ac) of section 2 of the Securities Contract (Regulation) Act, 1956 (42 of 1956). In the case of ‘IVF Advisors (P) Ltd. vs. ACIT’, (2015) 39 ITR (T) 541 (Mumbai Trib.) (APB 272 – 277), the Mumbai Tribunal, has referred to the definition of derivatives as contained in clause (ac) of section 2 of the Securities Contract (Regulation) Act, 1956, referred to by the Hon’ble Madras High Court in its decision in the case of ‘Rajshree Sugar & Chemicals Ltd. vs. Axis Bank Ltd.’, AIR 2011 Mad 144, where the term ‘derivatives’ has been defined to include foreign currency as underlying security of derivatives, also referred to FAQ available on the SEBI website and the fact that the SEBI permitted exchange traded currency derivatives in August, 2008 and came to the conclusion that (para 7.5, APB 276) derivatives include foreign currency and call option/put option, are transactions of derivative markets. Thus, as rightly submitted, the trading of currency derivatives made by the assessee is covered by the definition of ‘derivatives’ as contained in clause (d) of the proviso to section 43(5) of the IT Act. This position also stands accepted by the CBDT in its Instruction no. 3/2010 (APB 342 -343). Thus, the assessee fully complies with the conditions prescribed under clause (d) of Proviso to section 43(5) of the Act, read with the explanation thereto.
16. The ld. CIT(A) has taken due note of the contention of assessee that the transactions of currency derivatives were conducted through a recognised stock broker, on a rccognised Stock Exchange and they were duly supported by time stamped contract notes. He examined the provisions of section 43(5) of the IT Act and the proviso thereto and held that the case of the assessee could not be covered under clause (a) of the proviso to section 43(5) of the Act (i.e., the transactions could not be treated as hedging transactions), but to be considered under clause (d) of the proviso to section 43(5) of the IT Act and in the light of the cases relied on by the assessee. He has then referred to section 73(1) and explanation 2 to section He also referred to CBDT Instruction no. 3/2010 dated 23.03.2010 and based on his interpretation of the said Instruction, it was held that the loss incurred by the assessee was a notional loss as being carried out in ‘marked to market’ and thus, the ld. CIT(A) denied the benefit of set off of losses.
17. Instruction no. 3/2010, dated 23.03.2010, issued by the CBDT (APB 342- 343) as rightly contended, is an internal instruction issued by the Board for the guidance of its officers with regard to the matter pertaining to trading in currency It is broadly divided into two parts. One is actual loss in forex derivatives. The Board has drawn the attention of the officers to the statutory provisions contained in clause (d) of the proviso to section 43(5) read with the explanation thereof. This part of the Instruction supports the case of assessee, as above. The second part of the said Instruction is regarding loss on account of ‘marked-to-market’ losses. As per the Instruction, losses arising on account of the position held in a financial instrument based on market price on the closing day of an accounting period is not the actual loss. Rather, it is a notional loss and should not be allowed.
18. The ld. CIT(A), without looking into the position held by the assessee as on the close of the financial year and as to what was the loss on such position, which, at most, in accordance with the Board’s Instruction, may be held to be a notional loss, has held the whole of the trading loss to be a notional loss. The assessee contends that though the transactions entered by it in currency derivatives are ‘marked-to-market’, there was only transaction of 1,200 nos. of lot of currency derivatives sold by the assessee for a total amount of Rs. 65,555,211, which, on account of being ‘marked to market’, resulted into a loss of Rs. 5 1,789/- (APB 240) against a total loss of Rs. 1,709,120.61/- and hence, going by the reasoning of the ld. CIT (A), at the most, loss of Rs.51,789/- only could be disallowed and the balance Rs. 16,57,332/- was liable to be allowed. Even the said (notional) loss of Rs. 51,789/- was liable to be allowed for assessment year 2014-15, together with the loss of Rs.1,184,370/- sustained during assessment year 2014-15, as there no contract outstanding as on 3 1.03.2014. It has been clarified that the assessee had traded in total seven series of contracts during the year (APB 238). Ledger accounts in respect of each series of contracts are placed at APB 239 to 245. All series of contracts except for USD (26.04.20 13) (APB 240) had expired before the close of the financial year, on 31.03.2013 and thus, there was no occasion that contracts for those series of transactions could be outstanding as on 31.03.2013.
19. The logic of the Board in terming loss in respect of unexpired contracts (or, in other words, in respect of position held as at the close of accounting period) has not found favour with the Courts and even the loss on account of ‘marked to market’ in respect of such outstanding position could not be treated as notional loss, because same is based / on the time-tested and well accepted theory of valuing stock at lower of cost or market value. The Hon’ble Bombay High Court, by its order dated 15.10.2016, in ITA No. 896/2014, in ‘CIT vs. Munjani Brothers’ (copy placed on record), dismissed the revenue’s appeal, where the substantial question of law for the consideration of the Hon’ble High Court was as under:
“Whether on the /acts and in circumstances of the case and in law, the Tribunal was right in deleting the addition of Rs. 59,90,341/- made by the Assessing Officer on account of disallowance of mark to market loss on foreign exchange forward contract loss and not appreciating the fact that the said loss was not a notional loss and cannot be allowed”
The said appeal arose from the order dated 19.09.2013 passed by theITAT, Mumbai, passed in ITA no. 7628/Mum/201 1 (copy filed). A Similar view was taken by the Hon’ble Tribunal in the case of the same assessee in ITA No. 6065/Mum/2012, vide order dated 2.12.2014 (cope placed on record). The Hon’ble High Court, held that no substantial question of law was involved in the matter in view of its order dated 1.10.2016, passed in the case of ‘M/s D. Chetan & Co.’, in ITA No. 278 of 2014. A copy of the said order has been filed.
20. The Hon’ble Bombay High Court, in ITA No. 30 of 2015, vide Order dated 24.07.2017 in the case of ‘CIT vs. Paper Products Ltd.’ (copy filed), relying on the Supreme Court decision in the case of ‘CIT vs. Woodward Governor India (P) ’, 312 ITR 254 (SC), held that the loss due to foreign exchange fluctuation in foreign currency transactions in derivatives has to be considered as on the last date of the accounting year and is deductible under section 37(1) of the Act and affirmed the order dated 28.03 .2014 passed by the Tribunal in ITA No. 7761/Mum/2012.
21. Remarkably, though the reasoning of the Board to term the loss on account of ‘market to market’ transactions, as contained in Instruction no. 3/20 10, was disapproved by the Courts, it resurfaced in the Income Computation and Disclosure Standards (the ‘ICDS’) notified on 29.09.2016, made effective from the accounting period beginning on 1.04.2016, i.e., assessment year 2017-18. The ‘ICDS’ -1 relating to accounting policies, in paragraph 4 held that:-
“4. Accounting policies adopted by a person shall be such so as to represent a true and fair view of the state of affairs and income of the business, profession or vocation. For this purpose,
(i) The treatment and presentation of transaction and events shall be governed by their substance and not merely by the legal form; and
(ii) Marked to market loss or an expected loss shall not be recognised unless the recognition of such loss is in accordance with the provisions of any other Income Computation and Disclosure Standard.”
22. The Hon’ble Delhi High Court, by its recent decision in the case of ‘The Chamber of Tax Consultants & Others vs. Union of India &, Others’, reported as (2017) 87 taxmann.com82 (Delhi), while holding certain ‘ICDS’ as ultra-virus, held that non-acceptance of the concept of prudence in ICDS I is per se contrary to the provisions of the Act and therefore, it cannot be countenanced. While holding so, the Hon’ble Delhi High Court in para 61 of its judgment held that:-
“The Petitioners rightly point out that cases not governed by any specific ICDS are governed by ICDS-I, CBDT has in ICDS-I notified that expected losses and marked-to-market losses are not be recoginized/allowed. It is rightly pointed out by the Petitioners that the concept of prudence is embedded in Section 3 7(1) of the Act which allows deduction in respect of expenses “laid out” or “expanded” for the purpose of business. The concept of prudence is inherent in this.”
23. Thus, the instruction no. 3/2010 dated 23.03.2010 is not in accordance with law, in so far as it terms the loss in respect of the position held as at the end of the accounting period as a ‘notional loss’ and calls for disallowance of the same and this aspect was discussed in various cases referred before learned CIT (Appeals)
24. The assessee also placed reliance on the order dated 13.02.2017 passed by the Income tax Appellate Tribunal, ‘SMC -3’ Bench, New Delhi, in the case of ‘Sri Kamal Kishor vs. ACIT’ in (ITA No. 4952/Del/2016 (page 74 – 85). In this case, adjustment to the returned income was made by the AO under section 143(1) of the Act in respect of loss of Rs. 1,550,100 on foreign currency derivatives. The Tribunal, allowing the appeal on the merits of the case, followed the decision of the ITAT, Mumbai in the case ‘IVF Advisors (P) Ltd.’ (APB 272 -277) and in the case of ‘Inventures Knowledge Services (P) Ltd.’ (APB 317 -341).
25. In the case of ‘Inventures Knowledge Services (P) Ltd. vs. ITO’, (2016) 156 ITD 727 (Mumbai -Trib) (APB 317 to 341), both the issues, i.e., applicability of clause (d) of the proviso to section 43(5) and the notional loss in respect of unexpired / unsettled contracts were discussed.
26. In ‘Inventures Knowledge Services’ (supra), it has been held as follows:
“7. Ld. DR on the other hand relied upon the orders of the authorities below. The Ld. DR submitted that these forward foreign exchange contracts are not backed by any business transactions and these are not hedging transactions and marked to market transaction cannot be allowed as per Instruction of CBDT no. 3/2010 dated 23th March 2010. The Ld DR relied upon the orders of Tribunal Mumbai in Araska Diamond (P.) Ltd. v. Asstt. CIT [2015] 152 ITD 203 (Mum.) to contend that these losses are speculative in nature and cannot be allowed to be set off against business income other than speculative income.
8. We have heard the rival submissions and carefully perused the relevant material on record and case laws relied upon by the parties. We have observed that the assessee company is a domestic company registered with the Development Commissioner, Vishakhapatnam Special Economic Zone as an approved SEZ and is a KPO primarily involved in the revenue cycle management for the clients across America and the assessee company is billing its overseas clients in foreign currency. The assessee company has a turnover of Rs. 5.83 crores during the assessment year under consideration. We have observed that assessee company has entered into forward foreign exchange contracts and the contract worth USD 4 Million were outstanding as un-expired as on 31st March 2009 on which the assessee company has booked marked to market loss of Rs. 1,09,98,560/- on the date of Balance Sheet as at 31st March 2009 based on the movement of value of United States Dollar vis-a-vis in relation to Indian Rupees based on prevailing rate as on 31-03-2009.
Before we proceed further, it would be relevant to analyse the provisions of Section 43(5) of the Act read with proviso (d) and explanation 1 to Section 43(5) of the Act which reads as under:
‘Definitions of certain terms relevant to income from profits and gains of business or profession.
43. In sections 28 to 41 and in this section, unless the context otherwise requires-
XX XX XX
(5) “speculative transaction” means a transaction in which a contract for the 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 or scrips:
Provided that for the purposes of this clause-
(a) to (c) xx xx xx
(d) an eligible transaction in respect of trading in derivatives referred to in clause (ac) of section 2 of the Securities Contracts (Regulation) Act, 1956 (42 of 1956) carried out in a recognised stock exchange; or
(e) xxx xx xx
shall not be deemed to be a speculative transaction, Explanation 1. – For the purposes of clause (d), the expressions-(i) “eligible transaction” means any transaction,-
(A) carried out electronically on screen-based systems through a stock broker or sub-broker or such other intermediary registered under section 12 of the Securities and Exchange Board of India Act, 1992 (15 of 1992) in accordance with the provisions of the Securities Contracts (Regulation) Act, 1956 (42 of 1956) or the Securities and Exchange Board of India Act, 1992 (15 of 1992) or the Depositories Act, 1996 (22 of 1996) and the rules, regulations or bye-laws made or directions issued under those Acts or by banks or mutual funds on a recognised stock exchange; and
(B) which is supported by a time stamped contract note issued by such stock broker or sub-broker or such other intermediary to every client indicating in the contract note the unique client identity number allotted under any Act referred to in sub-clause (A) and permanent account number allotted under this Act;
(ii) “recognised stock exchange” means a recognised stock exchange as referred to in clause (f) of section 2 of the Securities Contracts (Regulation) Act, 1956 (42 of 1956) and which fulfils such conditions as may be prescribed and notified by the Central Government for this purpose;’
Section 43(5) of the Act provides that a transaction in which a contract for the purchase or sale of any commodity, including stocks and shares, is periodically or ultimately settled otherwise than by actual delivery or transfer of the commodity or scrips while proviso(d) to Section 43(5) of the Act inter-alia provides that an eligible transaction in respect of trading in derivatives referred to in clause (ac) of Section 2 of the Securities Contracts (Regulation) Act, 1956 carried out in a recognized stock exchange shall not be deemed to be a speculative transaction.
We would, also like to refer to the relevant definitions as contained in the Securities Contract (Regulation) Act, 1956 as under:
Section 2(ac) of the Securities Contract (Regulation) Act, 1956 reads as under:
Section 2 in the Securities Contracts (Regulation) Act, 1956
2 Definitions. – In this Act, unless the context otherwise recjuires, –
XX XX XX
(ac) “derivative” includes-
(A) a security derived from a debt instrument, share, loan, whether secured or unsecured, risk instrument or contract for differences or any other form of security;
(B) a contract which derives its value from the prices, or index of prices, of underlying securities;
Section 2(h) of the Securities Contract (Regulation) Act, 1956 reads as under:
Section 2 in The Securities Contracts (Regulation) Act, 1956
2 Definitions. – In this Act, unless the context otherwise requires,-
(h) “securities” include-
XX XX XX
(ia) derivative;
XX XX XX
From the above, it is clear that speculative transaction is a transaction in which contract for purchase and sale of any commodity is settled otherwise than by actual delivery. It is not in dispute that in case of transaction in derivatives, the transaction is always settled otherwise than by actual delivery. The derivative derives its value from underlying asset which can be securities, commodities, bullion, currency etc. and in this instant case, tlie derivative transaction undertaken by the assessee company, the underlying asset of derivative transaction is foreign currency. The word commodity is used in broadest sense in Section 43(5) of the Act as it mentions in the Section 43(5) of the Act that the commodity includes stock and shares. Thus, derivative will be included in the definition of the word ‘commodity’ as held in Shree Capital Services Ltd. (supra). Hence, derivative transactions in foreign currency shall be exempted from purview of speculative transactions u/s 43(5) of the Act provided other conditions as contained in proviso (d) read with Explanation 1 to Section 43(5) of the Act are fulfilled. Our view is fortified by the Memorandum explaining the provisions in the Finance Bill, 2005 which introduced clause (d) ((2005) 194 CTR(St.) 147, the purpose of introduction of clause (d) has been explained, which reads as under:
“Measures to rationalize the tax treatment of derivative transaction.
Under the existing provisions (cl.(5) of s.43) a transaction for the purchase and sale of any commodity including stocks and shares is deemed to be a ‘speculative transaction’, if it is settled otherwise than by actual delivery. However, certain categories of transactions are excluded from the purview of said provision. Further, the unabsorbed speculation losses are allowed to be carried forward for eight years for set-off against speculation profits in subsequent years. These restrictions were essentially designed as an anti-evasion measure to prevent claims of artificially generated losses in the absence of an appropriate institutional infrastructure.
Recent systemic and technological changes introduced by stock markets have resulted in sufficient transparency to prevent generating fictitious losses through artificial transactions or shifting of incidence of loss from one person to another. The screen based computerized trading provides for an excellent audit trail. Therefore, the present distinction between speculative and non- speculative transactions, particularly relating to derivatives is no more required.
The proposed amendment therefore, seeks to provide that an eligible transaction carried out in respect of trading in derivatives in a recognized stock exchange shall not be deemed to be a speculative transaction. The proposed amendment also seeks to notify relevant rules etc. regarding conditions to be fulfilled by recognized exchanges in this regard. Further it is also proposed to amend sub-s. (4) of s. 73 so as to reduce the period of carry forward of speculation losses from eight assessment years to four assessment years.
These amendments will take effect from 1st April 2006 and will, accordingly, apply in relation to asst. ys 2006-0 7 and subsequent years.”
From the above it is evident that the eligible transactions in derivatives carried out through recognized stock exchanges are exempted from the purview of speculation transactions u/s 43(5) of the Act provided other conditions are satisfied because of recent and systemic and technological changes introduced by stock exchanges.
We have observed that the assessee company has entered into derivative transactions in foreign currency through SEBI registered broker who is a member National Stock Exchange of India Limited and these derivative transactions are carried on through National Stock Exchange of India which is a recognized stock exchange and these transactions are backed by time stamped contract notes carrying unique client identity number and PAN allotted under the Act. The reliance of the Ld. DR on the case of Araska Diamond (P.) Ltd. (supra) is misconceived as in this case the assessee did not fulfill the conditions as stipulated under section 43(5) of the Act read with proviso and Explanation thereto to entitle the assessee to bring forward contract in foreign currency within four corners of exemption from being treated as non-speculative transaction as per mandate of Section 43(5) of the Act.
Thus, we hold that these derivative transactions in foreign currency as entered into by the assessee company duly fulfil all the conditions as specified u/s 43(5) of the Act read with proviso (d) and Explanation 1 to Section 43(5) of the Act. We further hold that these transactions are covered by the exception as contained in proviso (d) to Section 43(5) of the Act and hence are not speculative transactions as defined under Section 43(5) of the Act. Thus, we hold that loss of Rs. 1,09,98,560/- incurred by the company on derivative transactions in foreign currency in the instant appeal is not a speculative loss within the definition as contained in Section 43(5) of the Act.
Regarding contention of the Revenue that, these marked to market loss of Rs. 1,09,98,560/- as at 31st March 2009 is a notional or contingent loss and cannot be allowed as revenue expenditure as in view of Revenue the assessee company has claimed the losses on unexpired derivative transactions in foreign currency based on the prevailing exchange rates of
United States Dollar vis-a-vis in relation to Indian Rupee as on the date of Balance Sheet as at 31st March 2009 while the actual loss has not yet crystallized in the view of revenue because the derivative transactions had not yet been squared/settled as on the date of Balance Sheet as at 31st March 2009, we are guided by the decision of Tribunal Special Bench, Mumbai in Bank of Bahrain & Kuwait (supra) as detailed here in under:
“…, 59. We, accordingly, hold that where a forward contract is entered into by the assessee to sell the foreign currency at an agreed price at a future date falling beyond the last date of accounting period, the loss is incurred to the assessee on account of evaluation of the contract on the last date of the accounting period i.e. before the date of maturity of the forward contract.
The transaction in derivatives in foreign currency as entered into by the assessee company are similar to forward contract in foreign currency as discussed in the decision of Bank of Bahrain & Kuwait (supra). Respectfully following the decision of Tribunal, Special Bench, Mumbai in Bank of Bahrain & Kuwait (supra) we hold that the marked to market losses of Rs. 1,09,98,560/- determined by the assessee company due to the movement in the prevailing exchange rate of foreign currency i.e. United States Dollar vis-a-vis in relation to Indian Rupee as on the date of Balance Sheet viz 31st March 2009 is not a notional or contingent loss rather it is an ascertained liability which has crystallized whereby a pending obligation of derivative contract on the balance sheet date i.e 31st March 2009 is determinable with reasonable certainty and accuracy. The Accounting Standard-11 prescribed by ICAI also stipulate that in situation like this when the derivative transaction in foreign currency has not been settled/squared during the accounting period, the effect of exchange rate difference on the un-expired foreign currency contracts as at the end of accounting period is to be accounted for in the books of account prepared for the afore-stated accounting period. The reliance of the DR on instruction no 17/2008 dated 26th November 2008 is misconceived as in the instant case under appeal it is not a contingent or notional liability rather it is an ascertained liability which has crystallized and can be determined with reasonable certainty based upon the adverse exchange rate prevailing between United States Dollars vis-a-vis in relation to Indian Rupees as on the date of Balance Sheet as at 31st March 2009. Hence , We hold that the said loss of Rs. 1,09,98,560/- incurred by the assessee company on account of marked to market loss arising on the date of Balance Sheet as at 31st March 2009 on account of un-expired derivative transactions in foreign currency entered by the assessee company arising due to the adverse movement in the exchange rate prevailing between United State Dollar vis-a-vis in relation to Indian Rupee as on the date of Balance Sheet as at 31st March 2009 can not be considered as notional or contingent loss rather it is an ascertained loss which has already occurred during the assessment year which can be computed with reasonable certainty and accuracy and is a fait accompli as held in Oil & Natural Gas Corpn. Ltd. (supra).
9. Thus in view of our above foregoing discussions, we allow the appeal of the assessee company on following reasons:
1. That the assessee company has entered into derivative transactions in foreign currency through recognised stock exchange and has complied with the other conditions as stipulated in Section 43(5) read with proviso(d) and Explanation 1 to the said Section 43(5) of the Act for which cogent material is brought on record.
2. That the contract for derivatives in foreign currency are commodity as defined u/s 43(5) of the Act, the underlying asset being foreign currency and are hence entitled for exemption from being treated as speculative provided all other conditions as stipulated u/s 43(5) are complied with.
3. A binding obligation accrued against the assessee the minute it entered into contract for derivative in foreign currency
4. A liability is said to have crystallized when a pending obligation on the balance sheet date is determinate with reasonable certainty. The considerations for accounting the income are entirely on different footing.
5. As per AS-11, when the transaction is not settled in the same accounting period as that in which it occurred, the exchange difference arises over more than one accounting period.
6. The contract for derivative in foreign currency have all the trappings of stock-in-trade.
7. In the ultimate analysis, there is no revenue effect and it is only the timing of taxation of loss/profit and in case the derivative contract is squared off/settled in the succeeding year, the difference in loss/profit will be brought to tax in the succeeding assessment year and hence its allowability in the current year is tax neutral.”
27. These discussions were relied on by the assessee before the Authorities
28. Thus, as rightly contended, not only were the losses incurred by the assessee entitled to be held as non-speculative, but also the whole of the loss sustained by him was entitled to be allowed to be set off with other income and no part of such loss could be disallowed by holding it to be a ‘notional loss’.
29. The facts of the case for assessment year 2014 -15 are in pari materia with those of assessment year 2013-14, except for the fact that there was, undisputedly, no outstanding position as on 31.03.2014 and hence, the observations with regard to assessment year 2013-14 would, mutatis mutandis, apply to assessment year 2014-15 also.
30. The ld. DR has sought to place reliance on the Foreign Exchange Management (Foreign Exchange Derivatives Contracts Regulations), 2000 and the Foreign Exchange Control Manual, Chapter -3 Securities Service Contracts (Regulation) Act, 1956. However, neither the aforesaid Regulations, nor the Manual were the subject matter of consideration before the Authorities below.
31. In view of the above, the grievance of the assessee for both the years under consideration is found to be justified and is accepted as such. Both the orders under appeal are reversed. Respectfully following the case laws as discussed hereinabove, it is held that the transactions in currency derivatives as entered into by the assessee, were not speculative transactions. There were no derivative contracts outstanding on 31.03.2014, which could be termed as a notional loss. Accordingly, the loss sustained by the assessee in trading of currency derivatives, amounting to Rs.17,09,121/- for A.Y. 2013-14 and Rs.11,84,370/- for A.Y. 2014- 15 are allowed to be set off against the other business income of the assessee. So far as regards A.Y. 2013-14, the assessee has contended that alternatively there were only transactions concerning 1200 currency derivatives sold by the assessee for Rs.6,55,55,21 1/-. Thus, on account of being ‘marked-to-market’, resulted into a loss of Rs.51,789/- against a total loss of Rs.17,09,120.61. In this regard, the assessee has placed on record, at APB 238 to 245, stock results in the books of account of the assessee, in respect of the currency derivatives. The relevant ledger is at APB 240. These documents are stated to have been filed before the AO as well. Accordingly, as per the assessee it is only this loss of Rs.51,789/-, which could have been disallowed. However, since the transactions have, as above, been held to be not speculative transactions, this alternative argument of the assessee is not required to be gone into. Ordered accordingly.
32. In the result, both the appeals are allowed.
Order pronounced in the open court on 18/01/2018.
