2025 (5) TMI 1705 - AT - Income Tax

Loss incurred on account of trading in gold derivatives - disallowance made by the AO treating it as speculative in nature u/s 43(5) - case of the AO for rejecting assesses claim is that the exception in 43(5)(a) of the Act excludes only hedging transactions entered into with the purpose of safeguarding loss through future price fluctuation in respect of contract of actual sale Benefit of the exclusionary clause to section 43(5) i.e. the same applies only to manufacturers and not to traders - HELD THAT - The repeated use of the word merchandise along with raw material merchandising business along with manufacturing business and merchandise sold along with sale of goods manufactured by him clearly reveals the intent of the legislature to include traders also in the exclusionary clause. We completely agree with the ld.CIT(A) that the finding of the AO that hedging transactions undertaken by the assessee in its capacity as trader of bullion would not be covered by proviso (a) to section 43(5) of the Act is contrary to settled law and based on an incorrect interpretation of the proviso(a) to section 43(5) of the Act. Interpretation of section 43(5) proviso (a) of the Act based on which the AO held the transactions undertaken by the assessee to be speculative in nature - assessee contended that courts as also CBDT have categorically ruled out genuine hedging transactions both of purchase and sale from being treated as speculative - HELD THAT - Hedging of purchases is also included in the exception carved to speculative transactions in proviso (a) to section 43(5) of the Act. The Revenue does not dispute the fact that the derivative transactions entered into by the assessee were genuine hedging transactions. Ld.CIT(A) has recorded the fact of the hedging transactions undertaken by the assessee not exceeding its total stock of raw material or merchandise which has remained uncontroverted before us. The interpretation by the AO of the proviso (a) to section 43(5) of the Act as not excluding hedging of purchase transactions from being treated as speculative we agree with the CIT(A) is incorrect. No infirmity in the order of CIT(A) deleting the disallowance of losses incurred by the assessee in derivative transaction. Trading in derivatives of commodities in the MCX platform has been excluded from the definition of speculative transaction only w.e.f. 01.01.2014 therefore was not entitled to any benefit of the exclusionary clause - While proviso (a) excludes hedging transactions from the purview of speculative transaction proviso (e) deals with a completely different set of and nature of transactions. Proviso (e) excludes all derivative transactions carried out on the MCX platform of trading of commodities transaction tax by all traders to be not speculative in nature. Therefore the scope of both the provisos are completely different. In the present case it is not the claim of the assessee that it was dealing on the MCX platform as a trader. On the contrary the claim of the assessee is that it was dealing in derivatives on the MCX platform for hedging its sale contracts. Therefore the assessee had rightly claimed benefit of exclusion from the definition of speculative transaction under proviso (a) proviso (e) not being not applicable to it at all. The grounds raised by the Revenue therefore are of no consequences. Disallowance by treating it as fines and penalties - CIT(A) has noted that the AO while making the disallowance had neither analysed the nature of expense nor did he seek any information or document about the said expense. DR was unable to controvert the above factual finding of the CIT(A). No reason to interfere in the order of the ld.CIT(A). CIT(A) after recording the facts relating to the impugned expenditure and deriving therefrom that they were in the nature of compensation paid by the assessee which finding both on facts and interpretation the ld. DR has been unable to dislodge before us has allowed the assessee s claim of expenditure. The ground of appeal raised by the Revenue is therefore dismissed.

Summary

The core legal questions considered in this judgment are:

1. Whether the loss incurred on trading in gold derivatives on the Multi-Commodity Exchange (MCX) is speculative in nature under section 43(5) of the Income Tax Act, 1961, or whether it qualifies for exclusion as a hedging transaction under proviso (a) to section 43(5).

2. Whether the proviso (a) to section 43(5), which excludes certain hedging transactions from being treated as speculative, applies to traders engaged in merchanting business or is limited only to manufacturers.

3. Whether the exclusion under proviso (a) covers hedging transactions relating to both purchase and sale contracts or is restricted only to sale contracts.

4. Whether the Revenue's contention that exclusion of derivative transactions on MCX from speculative transactions applies only from 01.01.2014 and not to the assessment year 2012-13 is valid.

5. Whether an expenditure of Rs. 1,30,452/- paid as fines and penalties is allowable as a business expense under section 37(1) of the Income Tax Act.

Issue-wise Detailed Analysis:

1. Nature of Loss on Gold Derivative Trading: Speculative or Hedging Transaction?

The relevant legal framework is section 43(5) of the Income Tax Act, which defines "speculative transaction" as one where contracts for purchase or sale of commodities are settled otherwise than by actual delivery. Proviso (a) excludes contracts entered into by a person in the course of manufacturing or merchanting business to hedge against loss through future price fluctuations in respect of contracts for actual delivery of goods manufactured or sold.

The Assessing Officer (AO) disallowed the loss of Rs. 27.84 crores on the ground that the transactions were speculative, arguing that the proviso applies only to hedging sales contracts and not purchase contracts, and that the assessee being a trader, not a manufacturer, was not entitled to the exclusion.

The Commissioner of Income Tax (Appeals) [CIT(A)] accepted the assessee's contention that the transactions were genuine hedging transactions undertaken to protect against price volatility in gold trading, which is the assessee's core business. The CIT(A) relied on the proviso (a) to section 43(5) to exclude these losses from speculative transactions.

The Tribunal concurred with the CIT(A), emphasizing that the proviso's language includes contracts in respect of both raw materials and merchandise entered into by persons engaged in manufacturing or merchanting business. The Tribunal noted the repeated use of the term "merchandise" alongside "raw materials" and "merchanting business" alongside "manufacturing business," indicating legislative intent to include traders within the exclusion.

Precedents relied upon include the Supreme Court decision in SK.AR.K.AR. Somasundaram Chettiar & Co., which held that proviso (a) applies to both manufacturers and merchants. The Bombay High Court's decision in CIT vs. Ramchandra Shivnarain was also cited, which clarified that proviso (a) is not confined to manufacturers but equally applies to merchants.

The Tribunal rejected the AO's argument that the exclusion applies only to manufacturers, holding that such interpretation is contrary to settled law and the clear legislative language.

2. Applicability of Proviso (a) to Hedging of Purchase Contracts

The AO contended that proviso (a) excludes hedging losses only on sales contracts and not on purchase contracts. The assessee argued, supported by judicial decisions and CBDT circulars, that hedging of both purchase and sale contracts is covered.

The Tribunal referred to the Full Bench decision of the Gujarat High Court in Pankaj Oil Mills vs CIT, which held that proviso (a) includes hedging contracts both for purchases and sales, provided they relate to raw materials or merchandise and are entered into to guard against loss through price fluctuations. The Court also set out conditions for valid hedging transactions, such as total hedging not exceeding stock held.

The CBDT Circular No. 23 (XXXIX-4) D dated 12.09.1960 was cited, which clarifies that hedging transactions to guard against risk of raw material or merchandise in stock falling in value are not speculative.

The assessee demonstrated through documentary evidence and examples that the derivative transactions undertaken corresponded to actual physical stocks and sales of gold, and the total derivative positions did not exceed the physical stock or purchase quantities.

The CIT(A) found these facts to be true and held that the transactions qualified as genuine hedging transactions under proviso (a). The Tribunal upheld this conclusion, rejecting the AO's restrictive interpretation.

3. Applicability of Exclusion for Trading on MCX Prior to 01.01.2014

The Revenue argued that the exclusion of derivative transactions on MCX from speculative transactions was introduced only from 01.01.2014 and therefore did not apply to the assessment year 2012-13.

The Tribunal distinguished between proviso (a) and proviso (e) to section 43(5). Proviso (a) excludes hedging transactions entered into by manufacturers or merchants to guard against loss on actual delivery contracts, while proviso (e) excludes all derivative transactions on MCX from being speculative from 01.01.2014.

The assessee's claim was under proviso (a) for genuine hedging transactions, not under proviso (e) which deals with a different category of transactions. The Tribunal held that the Revenue's argument was misplaced and that the assessee was rightly entitled to exclusion under proviso (a) for AY 2012-13.

4. Allowability of Rs. 1,30,452/- Paid as Fines and Penalties

The AO disallowed Rs. 1,30,452/- treating it as fines and penalties not allowable under section 37(1). The CIT(A) examined the nature of the payment and found it was a compensatory charge paid to the Delhi Bullion and Precious Metals Association Ltd. (DLB) for storage of gold due to delay in taking delivery beyond the agreed period. This payment was incidental to the business and not a penalty for breach of law.

The Tribunal found no reason to interfere with the CIT(A)'s factual finding and held the payment allowable as a business expense under section 37(1).

Significant Holdings:

"The repeated use of the word 'merchandise' along with 'raw material', 'merchandising business' along with 'manufacturing business' and 'merchandise sold' along with 'sale of goods manufactured' by him, clearly reveals the intent of the legislature to include traders also in the exclusionary clause."

"Clause (a) of the proviso contemplates and applies to a manufacturer as well as a merchant."

"Proviso (a) clearly states that for the purposes of this clause 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 merchandise sold by him shall not be deemed to be a speculative transaction."

"The interpretation by the AO of the proviso (a) to section 43(5) of the Act as not excluding hedging of purchase transactions from being treated as speculative, we agree with the ld.CIT(A), is incorrect."

"The assessee had demonstrated the derivative transactions to be genuine hedging transactions, based on equal value of underlying assets and not exceeding it, and considering the judicial decisions as also the CBDT Circular, the impugned transactions were rightly treated as non-speculative."

"The AO is therefore directed to allow the charges for late payment."

The Tribunal dismissed all grounds raised by the Revenue, confirming that the loss on gold derivatives trading was not speculative but genuine hedging under proviso (a) to section 43(5), that proviso (a) applies equally to traders and manufacturers, that hedging of both purchase and sale contracts is covered, and that the expenditure on compensatory charges was allowable.