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M/s. S.P. Apparels Ltd. Versus The deputy Commissioner of Income Tax

2015 (4) TMI 1049 - ITAT CHENNAI

Loss incurred on account of forex derivative contracts - AO treated as speculative loss and thereby not allowing the assessee to set off the same against its business income - Held that:- In the present case, the assessee is a manufacturer and exporter of garments and the assessee has entered into foreign currency derivative transactions to guard against future currency fluctuations which has a close proximity to the business of the assessee. On the other hand, if it is treated as stock /shares, .....

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teristic of the currency and stock/shares are not the same and therefore, currency cannot be held as stock or shares.

The loss incurred by the assessee on its derivative transactions shall be allowed to be set off from the business income of the assessee by treating the same as business loss and not loss due to speculation as held by the Revenue. - Decided in favour of assessee. - I.T.A.No.1327/Mds. /2014 - Dated:- 17-4-2015 - SHRI A.MOHAN ALANKAMONY, ACCOUNTANT MEMBER AND SHRI CHALLA .....

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CIT (A) had erred in upholding the order of the Ld.A.O wherein the loss incurred by the assessee on account of forex derivative contracts was treated as speculative loss and thereby not allowing the assessee to set off the same against its business income. 3. The brief facts of the case are that the assessee is a limited company, engaged in the business of manufacturing garments, filed its return of income for the assessment year 2008-09 on 30.9.2008 admitting Nil income under the normal computa .....

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erved that apart from manufacturing and export of hosiery garments to various countries, the assessee had also entered into forex derivative contracts with Axis Bank, Yes Bank & IDBI Bank. The Forex Derivative Contracts were in the nature of options and swap contract. The assessee had contended before the Ld. Assessing Officer that these transactions are hedging transactions for minimization of risk relating to foreign currency fluctuat ions, which arises from the export business of the asse .....

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I Bank, Axis Bank and Yes Bank. The Ld. Assessing Officer further held that as per sect ion 43(5) the cont racts for purchase and sale of any commodity including stock and shares also includes derivat ives which can be infer red from the proviso(d) to the above sect ion where it is mentioned that the trading in der ivat ives refer red in clause (ac) of sect ion-2 of Secur it ies Cont racts Regulat ion Act , 1956 done in a recognized stock exchange are deemed to be excluded from the def init ion .....

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f the commodi ty does not include Derivat ives the same would not have been excluded in the proviso (d) to sect ion 43(5). So the claim made by the assessee that Foreign Cur rencies are not commodit ies as per sect ion 43(5) is not val id. The assessee also claimed that derivat ives are excluded under proviso (d) to sect ion 43(5) is also not acceptable as the proviso does not give blanket exclusion to al l the der ivat ive contracts but only to such cont racts that are traded in the recognized .....

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vative transactions are having an underlying hedge against export bills of the assessee , is akin to saying that an exporter visiting Hong Kong and having a loss from his gambling in a Casino in Macau is to be treated as a business loss. The exporter may have receivables in Hong Kong dollars. However his gambling in Macau casino, if resulted in a loss is a separate speculative activity even though the loss in gambling is paid in Hong Kong dollars. Similar is the situation here with the assessee. .....

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This resulted in a huge speculation loss. Therefore, the derivative transactions undertaken by the assessee have no relations whatsoever with the assessee s export business either as underlying or a hedge. 6.13 Considering the facts and circumstances contained in the above discussion it is evident that the derivative transaction entered into by the assessee are short time speculative transactions without any hedge or underlying on the regular export business of the assessee. This has resulted in .....

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s incurred due to forex derivative transaction by the assessee has to be treated as business loss and not speculative transaction as held by the Revenue. He further relied in the following decisions to drive his point:- a) CIT V Vishindas Holaram [2014] 50 taxmann.com 337(Bom.) b) CIT V Badridas Gauridu (P) Ltd [2003] 261 ITR 256(Bom.) c) CIT V Sooraj Mull Nagarmull [1981] 121 ITR 169(Cal.) d) CIT V Panchmahal Steel [2013] 215 taxmann 140(Guj.) e) CIT V Friends & Friends Shipping Pvt Ltd in .....

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2015. 4.1. The Ld. D.R on the other, hand argued in support of the order of the Revenue and pleaded that the additions sustained by the Ld. CIT (A) may be upheld. 5. At the outset we find this issue to be identical to the issue heard by the Chennai Bench of the Tribunal in the case of M/s.SCM Garments Pvt Ltd., I.T.A.No.1645/Mds./2013 & 2275/Mds./2014 for the assessment years 2009-10 & 2010-11. Both the Ld.A.R and Ld.D.R agreed that the decision of that case may be fol lowed in the insta .....

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the assessee. Therefore, it is obvious that the assessee would be having huge sundry debtors resulting from export of garments which are receivable in the foreign currency. These sundry debtors are exposed to currency fluctuation risk. One of the methods to protect loss against foreign currency fluctuation is by way of hedging . Hedging transactions are entered in order to protect against the loss due to compensatory price movement. It protects an asset or liability against fluctuation in foreig .....

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se currency movements. In the present case before us, the assessee has selected to book Options Contract as per the advice of its bankers in order to hedge its foreign exchange risk. Options contract is a right to exercise the option of buying or selling of a foreign currency at a particular price. However, the assessee is not compelled to buy or sell, if the spot market prices are favorable or not favorable. The cost of this option is called Option Premium . Upon the payment of the same, the ex .....

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ee s account has crystallized and is a realistic loss suffered by the assessee. In these circumstances, the issue under consideration before us is that, whether loss on account forex derivates are to be considered as a business loss in parlance with Section 28 of the Act. Further, in the case of the assessee before us, the following facts emerge and the legal issues involved are discussed and summarized herein below:- (i) The assessee has entered into forex derivative transactions only in order .....

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currency fluctuation risk by entering into forex derivative contract. (vi) The Special Bench of the ITAT, Kolkata Bench in the case of Shri Capital services Ltd Vs. ACIT in 121 ITD 498(Kol.)(SB) has held that foreign currency is neither commodity nor shares as defined U/s. 43(5) of the Act. (vii) The Instructions issued by CBDT Instruction No.03/2010 dated 23.03.2010 has recognized the loss out of forex derivatives on actual settlement/conclusion of contracts as allowable business loss, however .....

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hrough recognized stock exchange. (viii) It is pertinent to note here that the bankers act as an advisory agent to the assessee in order to protect them from foreign exchange exposure by using their expertise and these services cannot be obtained by the assessee in the stock exchange where their scope of service is very limited. (ix) In the present case the assessee has taken a hedging position to the extent of ₹ 1.05 crores and USD ₹ 3 crores during the period 2007-2009 based on the .....

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g exposure both in respect of Euro and USD is more than adequate to cover the hedging positions taken in respect of cross currency derivative contracts entered into by the assessee. The Revenue has not brought out any material on record to controvert to this claim of the assessee. (xi) Since the assessee has entered into foreign currency derivative contract adequate enough to cover the overall exposures of foreign currency, the contention of the Revenue that the proportion of the loss in derivat .....

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ss. (xiii) Section 73(1) of the Act restricts the set off of speculation loss against the other business income in only those cases were speculative transactions carried on by the assessee are of such nature so as to constitute a business by itself. It is pertinent to mention here that RBI does not permit any bank under its umbrella to entertain its client in any separate business of forex derivative transactions. Permission is granted only for the clients of the bank to hedge on foreign exchang .....

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eculative transactions or wages because pricing of the deal follows a scientific pattern on the basis of financial mathematics. Just as actuaries scientifically determined the value of insurance risk and the premium payable, Financial Mathematician/Portfolio Managers evaluate the price of these derivatives. (Para 81 of the Order) 8. Further, it is pertinent to note that the foreign currency is neither commodity nor stock or shares. Foreign currency is nothing but currency printed in a different .....

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ance on the economic factors prevalent in that country and Stock/Shares is placing reliance in the economic strength and business policies of the company. Section 43(5) of the Act defines speculative transactions as under:- Section 43 (Relevant provisions are highlighted herein below) (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 delive .....

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inst loss in his holdings of stocks and shares through price fluctuations; or (c) a contract entered into by a member of a forward market or a stock exchange in the course of any transaction in the nature of actual delivery , see Taxman s Direct Taxes Manual, Vol. 3. Jobbing or arbitrage to guard against loss which may arise in the ordinary course of his business as such member; [or] (d) an eligible transaction in respect of trading in derivatives referred to in clause 35[(ac)] of section 236 of .....

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e 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 byelaws 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 .....

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in foreign currency derivatives either through recognized stock exchange or through RBI. When the banks facilitates its clients to deal in foreign exchange derivatives through RBI, more stringent regulations are complied and therefore these transactions cannot be denied the benefits provided under the Act when traded through recognized stock exchange. 9. Now the question is whether to treat the foreign currency derivatives as commodities, or stocks and shares. If it is treated as commodities, S .....

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ized stock exchange. The argument of the Revenue is that, if the transactions are made though banking sectors, then the same will fall within the scope of speculative transactions. This argument appears to be absurd and illogical because both Recognized Stock Exchange and Nationalized Banks are either Government regulatory body or extended arm of the Government. Further the characteristic of the currency and stock/shares are not the same and therefore, currency cannot be held as stock or shares. .....

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to this effect in its order. The Assessing Officer has not considered these facts. Under s.43(5) of the IT Act, Speculative transaction has been defined to mean a transaction in which a contract for the purchase or sale of a commodity is settled otherwise than by the actual delivery or transfer of such commodity. However, as stated above, the assessee was not a dealer in foreign exchange. The assessee was an exporter of cotton. In order to hedge against losses, the assessee had booked foreign e .....

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l Nagarmull, reported in (1981) 129 ITR 169(Cal.) wherein it was held that the assessee used to carry on export and import of jute business. In the course of normal business it used to enter into foreign exchange contracts in order to cover up loss and difference in foreign exchange valuation. The assessee utilized part of the amount of the foreign exchange covered. This finding of fact has not been challenged, If in the course of normal carrying on of business certain loss or obligation or inte .....

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foreign exchange contracts, if any loss occurred then such loss was a loss referable to and related to the business carried on and arising out of the business of the assessee. Here there is no finding that entering into foreign exchange contract was the nature of the business operation for the export and import of the goods by the assessee. The assessee was not a dealer in foreign exchange contract as such. Here in this case, the contract was for a full amount and what the assessee paid in fulfi .....

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as not a loss from a speculative transaction as defined in Expln.2 of s.24(1) of IT Act, 1922. C. In the case of Cotton Blossoms (India) Pvt. Ltd. V ACIT, in ITA No.2032/Chny/2012 vide order dated 21.02.2013, also the Chennai Bench of the Tribunal held that, in respect of forex contracts entered into by the assessee in similar circumstances will not fall under the definition of speculative transaction. D. In the case of Sutlej Cotton Mills Ltd Vs. CIT, reported in 116 ITR 1(SC) wherein it was he .....

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nd not speculative profit. F. In the case of CIT Mumbai Vs. Vishindas Holaram, reported in (2014) taxmann.com 37(Bombay) it was held that once main business of assessee is identified, if some incidental activities or transactions or dealing in foreign exchange is undertaken but that is also related to some extent to main business activity, then, it could not be said that assessee is in speculative business. G. In the case of CIT Vs. Climate System Pvt. Ltd., reported in 2014 (8) TMI 901 - Delhi .....

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