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M/s. Comstar Automotive Technologies (P) Ltd. Versus The Deputy Commissioner of Income Tax And Vice-Versa

2016 (7) TMI 1051 - ITAT CHENNAI

Disallowance u/s 14A r.w.r.8d - plea of the assessee is that Rule-8D(ii) & (iii) is not applicable to the assessee’s case as the assessee is having own funds - Held that:- The assessee is not able to demonstrate what is the own funds available to the assessee to make investments which yielded exempt income. The fund flow filed by the assessee does not show date on which the assessee made investments out of own funds. Being so, the argument of assessee cannot be the good explanation to hold that .....

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Straight Line method while applying the formula in Rule -8D(ii). -Decided partly in favour of revenue - Treatment of unabsorbed depreciation - priority for deduction u/s.10B of the Act over set off of brought forward unabsorbed depreciation allowance - Held that:- It is held by the Hon’ble Karnataka High Court in the case of CIT Vs. Himatsingka Seide reported in [2006 (8) TMI 125 - KARNATAKA High Court] held that unabsorbed depreciation has to be adjusted against the income for the purpose o .....

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orrect view of the facts of the case - Decided against assessee - MTM losses on forward contracts - whether are contingent in nature and a provision created on such notional loss cannot be allowed? - Held that:- The MTM loss on forward contracts is not contingent loss and it is a business loss to set off against the business income of assessee. However, the AO has to consider the transaction equivalent to the export turnover to determine the MTM loss and also if there is any premature cancel .....

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a Poojari, Accountant Member These cross appeals are directed against the order of the Commissioner of Income-tax (Appeals)-I, Chennai dated 30.12.2014 pertaining to assessment year 2009-10. 2. In assessee s appeal, the first ground is with regard to disallowance u/s.14A of the Act. This ground is common in both the appeals. 2.1 The Revenue is also in appeal before us with regard to direction of the CIT(A) that AO shall not eliminate the current liabilities in arriving at the total assets for th .....

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first ground relates to disallowance u/s.14A of the Act to the tune of ₹ 15,23,543/-. During the course of assessment proceedings, the AO had found that the assessee had investment in tax free territory amounting to ₹ 2,09,41,000/- as on 31.3.2008. The investment in mutual fund had been redeemed and the value as at 31.3.2009 is Rs: Nil. The assessee had got dividend income of ₹ 1.25 crores during the year which is exempt u/s 10(35). The AR submitted before the AO that the disal .....

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was not satisfied with the arguments of the AR and invoked the provisions of s.14A r.w. Rule 8D and disallowed ₹ 15,23,543/-. Aggrieved, the assessee carried the appeal before the Ld.CIT(A). Before CIT(A), the assessee took a plea that assessee has not incurred any expenditure in earning exempt income. The CIT(A) observed that the assessee has not discharged that the assessee has not incurred expenditure towards exempt income. Since the assessee has not not furnished details of expenditure .....

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rest expenditure in relation to investments which yield exempt income, which does not form part of the total income, the average total assets had to be taken, before the current liabilities are reduced as per balance sheet prepared in Straight Line Method. Against this, the Revenue is in appeal before us. 3.3 According to ld.A.R, Rule 8D(ii) is not applicable to the assessee s case since the assessee is having its own funds to make investments which yield exempt income. The ld.A.R submitted that .....

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pt income. 3.4 On the other hand, ld.D.R submitted that assessee has incurred total interest expenditure at ₹ 2,14,50,000/- and average total assets was ₹ 1,72,37,95,000/-. The average investments was worked out at ₹ 10,47,05,000/- and according to him, when applied formula in Rule 8D(ii), the total disallowance should be ₹ 13,02,894/- and disallowance under Rule 8D(iii) i.e. 0.5% of the average investments of ₹ 10,47,05,000/- worked out ₹ 5,23,525/-. Then tot .....

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of the assessee is that Rule-8D(ii) & (iii) is not applicable to the assessee s case as the assessee is having own funds. However, the assessee is not able to demonstrate what is the own funds available to the assessee to make investments which yielded exempt income. The fund flow filed by the assessee does not show date on which the assessee made investments out of own funds. Being so, the argument of assessee cannot be the good explanation to hold that the assessee is not incurred interest .....

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ing the formula in Rule -8D(ii). 3.7 Accordingly, the ground raised by the assessee is dismissed and the ground raised by the Revenue is partly allowed. 4. The next ground in assessee s appeal is with regard to treatment of unabsorbed depreciation. 4.1 The facts of the issue are related to priority for deduction u/s.10B of the Act over set off of brought forward unabsorbed depreciation allowance of ₹ 52,18,23,725/-. In the assessment proceedings for earlier assessment years, the AO had not .....

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of unabsorbed depreciation losses carried forward to future assessment years. 4.2 We have heard both the parties and perused the material on record. This issue is squarely covered by the judgement of Supreme Court in the case of Himatsingka Seide. It is held by the Hon ble Karnataka High Court in the case of CIT Vs. Himatsingka Seide reported in 286 ITR 255 held that unabsorbed depreciation has to be adjusted against the income for the purpose of exemption u/s.10B of the Act; exemption u/s.10B .....

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of assessee is rejected. 5. The next ground in revenue s appeal is with regard to MTM losses on forward contracts are contingent in nature and a provision created on such notional loss cannot be allowed. 5.1 The facts of the issue are that the assessee has failed to add back provision for MTM losses of ₹ 18.51 crorés. During the assessment proceedings, the ld.A.R submitted that the removal of MTM losses from the profits of business is incorrect since it is irretrievably linked to t .....

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ose its identity as business transaction. Further, AO observed that losses on forward contracts when the same is squared up by delivery of export proceeds received (actual receipt) is also allowable. But, MTM losses as at restatement at the end of the Financial Year are not a business transaction but only a speculative transaction. It is because as on 31st March of the Financial Year actual delivery of foreign currency does not happen. It is based on this rationale that the Central Board of Dire .....

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MTM of forward contracts. Hence, AO came to a conclusion that the MTM losses which are speculative in nature of ₹ 18,50,96,905/- is reduced from the claim of expenditure in arriving at the losses for the year. Aggrieved by the action of AO, the assessee carried the appeal before the Ld.CIT(A). On appeal, the Ld.CIT(A) observed that the issue is to decide whether he forex losses on account of Marked to Market (MTM) are to be allowed as a business losses or denied as speculative losses. The .....

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in held as follows:- We have heard the rival contentions and perused and carefully considered the material on record, the submissions made and the judicial decisions placed reliance upon. It would be relevant to briefly examine the concept of derivatives and the underlying nature of these transactions before deciding whether they are speculative transactions or not; whether they represent notional loss or real loss and whether or not they are allowable as deduction. Simply put, a derivative is a .....

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change rate in respect of contracts that have not matured (i.e. open contracts). As per the prescribed Accounting Standards, companies are required to account for the MTM losses in their books of account despite the fact that the contract has not yet matured as on the Balance Sheet date. 4.5.3 Foreign exchange Forward Contract means an agreement to exchange different currencies at a forward rate. Forward rate is the specified rate for exchange of currency at a specified future date. The assessee .....

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because it is a contract entered into against possible future financial losses. It follows from the above that while it is true that the assessee would come to know of the actual profit I loss only on the date of maturity, unless there is any premature cancellation of the contract, it is equally true that the assessee could anticipate the loss on the valuation date, say 3l March, with reasonable accuracy. Prudent accounting and commercial principles require that all accrued losses have to be tak .....

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ereby creating a realisable debt in its favour; i.e. a legally enforceable right; (ii) All anticipated losses, which accrued on the date of balance sheet have to be accounted for as per prudent accounting policies; (iii) Stock-in-trade is valued at the end of the previous year in accordance with the matching principle in order to find out the true profit I/loss. (iv) The method of accounting consistently followed by the assessee should not be discarded casually without having good and sound reas .....

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ot give the assessee the right to claim the loss under the Income Tax Act. It is this contention of the Assessing Officer that requires to be examined, having regard to the fundamental commercial principles which have received judicial recognition. It is a settled principle, upheld in several decisions of the Courts, that deduction is allowable under the Act in respect of liabilities that have crystallised during the year. If an anticipated future liability is coupled with a present obligation, .....

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It is to be borne in mind that the issues relating to the accrual of income cannot be decided on the same footing and considerations on which issues relating to losses are to be decided. In the case of loss! expenditure, the concept of reasonable certainty to meet an existing obligation comes into play; which in legal terminology is referred to as crystallisation of liability . This is in keeping and consonance with the principle of prudence as considered by the Hon1ble Apex Court in the case o .....

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(1) in the year of fluctuation in the rate of exchange or whether the same could only be allowed in the year of repayment of such loans? (ii) Whether the assessee is entitled to adjust the actual cost of imported assets acquired in foreign currency on account of fluctuation in the rate of exchange at each balance sheet date, pending actual payment of the varied liability?1 The above questions of law were elaborated by their Lordships at para 4 of the order which is extracted as under:- 4. At the .....

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c concerned with exchange differences arising on repayment of liabilities incurred for the purpose of acquiring fixed assets. In other words, in the second category of cases, we are concerned with the assessee(s) incurring liabilities on capital account. In such cases, we are required to consider the provisions of s. 43(1), 43A (both, before and after amendments vide Finance Act, 2002). 4.5.6 The Hon ble Apex Court after it considered and examined the issue, decided as at paras 13 to 21 of its o .....

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prior to the date of payment cannot be said to have gone irretrievably as it can always come back. According to the learned counsel, in the case of increase in liability due to foreign exchange fluctuations, if there is a revaluation of the rupee vis-a-vis foreign exchange at or prior to the point of payment, then there would be no question of money having gone irretrievably and consequently, the requirement of expenditure is not met. Consequently, the additional liability arising on account of .....

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which it is used. Sec. 37 enjoins that any expenditure not being expenditure of the nature described in ss. 30 to 36 laid out or expended wholly and exclusively for the purposes of the business should be allowed in computing the income chargeable under the head Profits and gains of business . In ss. 30 to 36, the expressions expenses incurred as well as allowances and depreciation has also been used. For example, depreciation and allowances are dealt with in s. 32. Therefore, Parliament has used .....

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icular case, cover an amount which is a loss even though the said amount has not gone out from the pocket of the assessee. This view of the Madhya Pradesh High Court has been approved by this Court in the case of Madras Industrial Investment Corporation Ltd. vs. CIT (1997) 139 CTR (SC) 555 (1997) 225 ITR 802 (SC). According to the Law and Practice of Income-tax by Kanga and Palkhivala, s. 37(1) is a residuary section extending the allowance to items of business expenditure not covered by ss. 30 .....

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and gains of a business would differ according to the system adopted. This is made clear by defining the word paid in s. 43(2), which is used in several ss. 30 to 43C, as meaning actually paid or incurred according to the method of accounting upon the basis on which profits or gains are computed under s. 28/29. That is why in deciding the question as to whether the word expenditure in s. 37(1) includes the word loss11 one has to read s. 37(1) with S. 28, s. 29 and s. 145(1). One more principle .....

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to valuation of stock. But the ordinary principle of commercial accounting requires that in the P&L a/c the value of the stock-in-trade at the beginning and at the end of the year should be entered at cost or market price, whichever is the lower. This is how business profits arising during the year needs to be computed. This is one more reason for reading s. 37(1) with s.145. For valuing the closing stock at the end of a particular year, the value prevailing on the last date is relevant. Thi .....

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inciples of commercial accounting, unless, such principles stand superseded or modified by legislative enactments, unrealized profits in the shape of appreciated value of goods remaining unsold at the end of the accounting year and carried over to the followirg years account in a continuing business are not brought to the charge as a matter of practice, though, as stated above, loss due to fall in the price below cost is allowed even though such loss has not been realized actually. At this stage .....

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nting Standard which is continuously adopted by an assessee can be superseded or modified by legislative intervention. However, but for such intervention or in cases falling under s. 145(3), the method of accounting undertaken by the assessee continuously is supreme. In the present batch of cases, there is no finding given by the AO on the correctness or completeness of the accounts of the assessee. Equally, there is no finding given by the AO stating that the assessee has not complied with the .....

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ch stock-in-trade is valued is part of the method of accounting. It is well established, that, on general principles of commercial accounting, in the P&L account, the values of the stock-in-trade at the beginning and at the end of the accounting year should be entered at cost or market value, whichever is lowerthe market value being ascertained as on the last date of the accounting year and not as on any intermediate date between the commencement and the closing of the year, failing which it .....

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assets of the business at two different dates is taken into account. Sec. 145(1) enacts that for the purpose of s. 28 and s. 56 alone, income, profits and gains must be computed in accordance with the method of accounting regularly employed by the assessee. In this case, we are concerned with s. 28. Therefore, s. 145(1) is attracted to the facts of the present case. Under the mercantile system of accounting, what is due is brought into credit before it is actually received; it brings into debit .....

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ven by the AO on the correctness of the Accounting Standard followed by the assessee(s) in this batch of civil appeals. 17. Having come to the conclusion that valuation is a part of the accounting system and having come to the conclusion that business losses are deductible under s. 37(1) on the basis of ordinary principles of commercial accounting and having come to the conclusion that the Central Government has made Accounting Standard-Il mandatory, we are now required to examine the said Accou .....

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). This has been discussed earlier. Similarly, it is important to note that foreign currency notes, balance in bank accounts denominated in a foreign currency, and receivables/payables and loans denominated in a foreign currency as well as sundry creditors are all monetary items which have to be valued at the closing rate under AS-il. Under para 5, a transaction in a foreign currency has to be recorded in the reporting currency by applying to the foreign currency amount the exchange rate between .....

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ich deals with recognition of exchange differences, needs to be considered. Under that para, exchange differences arising on foreign currency transactions have to be recognized as income or as expense in the period in which they arise, except as stated in para 10 and para 11 which deals with exchange differences arising on repayment of liabilities incurred for the purpose of acquiring fixed assets, which topic falls under s. 43A of the 1961 Act. At this stage, we are concerned only with para 9 w .....

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nding liability relating to import of raw materials using closing rate of exchange. Any difference, loss or gain, arising on conversion of the said liability at the closing rate, should be recognized in the P&L account for the reporting period. 19. A company imports raw material worth US $ 250000 on 15th Jan., 2002 when the exchange rate was ₹ 46 per US $. The company records the transaction at that rate. The payment for the imports is made on 15th April, 2002 when the exchange rate is .....

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exchange loss in the P&L account and is not to be adjusted against the cost of raw materials. 20. In the case of Sutlej Cotton Mills Ltd. vs. CIT 1978 CTR (SC) 155 (1979) 116 ITR 1 (SC) this Court has observed as under: The law may, therefore, now be taken to be well settled that where profit or loss arises to an assessee on account of appreciation or depreciation in the value àf foreign currency held by it, on conversion into another currency, such profit or loss would ordinarily be .....

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by the assessee is mercantile system, which brings into debit the expenditure amount for which a legal liability has been incurred before it is actually disbursed and brings into credit what is due, immediately it becomes due and before it is actually received; (ii) whether the same system is followed by the assessee from the very beginning and if there was a change in the system, whether the change was bona fide; (iii) whether the assessee has given the same treatment to losses claimed to have .....

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e seen from the extractions reproduced above, the decision in the case of Woodward Governor India Pvt. Ltd. (supra) has been rendered in respect of monetary items , denominated in foreign currency which include to mean money held and assets and liabilities to be received or paid in fixed amounts, e.g. cash, foreign currency notes, balance in bank accounts denominated in a foreign currency, receivables / payables and loans denominated in a foreign currency, sundry creditors, etc. are all monetary .....

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een that the decision in the case of Woodward Governor India Pvt. Ltd. (as extracted above) has been rendered with regard to items in the revenue account and capital account. Therefore, the view of the learned CIT (Appeals) that this decision of the Honble Apex Court relates to only restatement of existing currency liabilities and assets is not correct. 4.5.8 In the case on hand, it is not in dispute that the forward contracts have been entered into by the assessee in order to protect its intere .....

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bove, we are of the considered view that the appeal of the assessee on this issue, succeeds for the following reasons :- i) A binding obligation accrued against the assessee when it entered into foreign exchange forward contracts; ii) The forward contracts are in respect of consideration for export proceeds, which are revenue items; iii) The liability is determinable with reasonable certainty when an obligation is pending on the balance sheet date and such a liability cannot be said to be a cont .....

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India have witnessed a substantial growth in recent years. This combined with extreme volatility in the foreign exchange market in the last financial year is reported to have resulted in substantial losses to an assessee on account of trading in forex-derivatives. A large number of assesses are said to be reporting such losses on marked to market basis either suo motu or in compliance of the Accounting Standard or advisory circular issued by the Institute of Chartered Accountants. The issue whe .....

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will arise as to whether such a loss is on account of a speculative transaction as contemplated in Section 43(5) of the Income tax Act. For determining whether loss from a transaction in respect of a forexderivative is a speculation loss or not, the Assessing Officers may refer to Proviso (d) below sub-section (5) of Section 43 inserted by the Finance Act, 2005, with effect from 1.4.2006. It lays down that any eligible transaction in respect of trading in derivatives referred to in clause (ac) .....

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ty has crystallized. In this factual matrix, from the wordings of the Instruction, it follows that the loss arising out of the forward contract is not notional. In such a case, the CBDT Instruction requires the Assessing Officer to examine whether such a loss is on account of a speculative transaction as contemplated in section 43(5) of the Act. 4.5.10 The issue of speculative transactions and hedging transactions has been examined and analysed in detail in the decision of the ITAT, Mumbai in th .....

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peculative transaction. The requirement of section 30 of the Indian Contract Act of the existence of the intention of the parties even at the time of the original contract not to give or take delivery of the goods in order to make it a speculative/wagering transaction is dispensed with for the purpose of the Act and if actual delivery is not given/taken under the settlement of contract, then the intention of the parties at the time of the contract becomes im-material. Thus, the true test is deli .....

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ps. 5.2.2. Here, it would be useful to appreciate in proper perspective how hedge transactions are commercially understood before determining the true scope, width and nature of proviso (a) to sectiori43(5). Hedge contracts are those contracts which hedge against prejudicial price fluctuations. In speculative transactions the modus operandi of persons indulging in them is that when one enters into a contract of purchase, he also simultaneously enters into one or more contracts of sale against th .....

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technique of hedge trading can be understood in simple terms. It is said that the hedge contract is so called because it enables the persons dealing with the actual commodity to hedge themselves, i.e., to insure themselves against adverse price fluctuations. A dealer or a merchant enters into a hedge contract when he sells or purchases a commodity in the forward market for delivery at a future date. His transaction in the forward market may correspond to a previous purchase or sale in the ready .....

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materials or the merchandise on hand which would include existing stocks as well as the stocks acquired under the firm contracts of purchase. As per the accepted commercial norms object of a hedging contract is to secure oneself against loss in a future delivery contract, but such transactions cannot be regarded as inter-connected. Each one is independent of the other. So far as the profit or loss arising from a future delivery contract is concerned, it is determined on the date of actual delive .....

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al course and the hedger might at times gain and at times lose but such a gain or loss would be marginal and far less than what it would be if the person had not hedged at all. While, however, the hedging operation protects the hedger against loss arising from adverse fluctuations in prices, it also prevents him from making windfall profit owing to favourable fluctuations in prices as well. The forgoing of such a possible windfall profit is the price which he pays for the insurance against loss. .....

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se, a manufacturer or merchant has necessarily to enter into forward transactions of sale and purchase both, and without these contracts of sale and purchase constituting hedge transactions, there would be no effective insurance against the risk of loss in the price fluctuations of the commodity, manufactured or the merchandise sold. 5.3. Hedging contracts are dealt in Clause (a) of the proviso to section 43(5) of the Act. From the above discussion it can safely stated that the said clause appli .....

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actual deliiery of goods, (4) Hedging contracts may be both with regard to sales and purchases, (5) Hedging contracts need not succeeed the contracts for sale and actual delivery of goods manufactured, but the latter may be subsequently entered into, provided they are within the reasonable time not exceeding generally the assessment year, (6) In order to be genuine and valid hedging contracts of sales, the total of such transactions should not exceed the total stocks of the raw materials or the .....

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uard against such loss that he entered into the forward contracts of sale, he could not claim the benefit of clause (a) of the proviso to section 43(5). With regard to speculative I hedging transactions we had benefit of perusing the judgments of M.G. Bros. V CIT (1985) 1564 itr 695/20 Taxman 90 (AP), Nuddea Mills Co. Ltd. V. CIT (1988) 171 ITR 169 (1987) 35 Taxman 3 (Cal), Delhi Flour Mills Co. Ltd. V CIT (1974) 95 ITR 151 (Del) and Pankaj Oil Mills V CIT (1978) 115 ITR 824 (Guj) delivered by t .....

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stion will not qualify to be called as speculative transaction. In view of the facts and circumstances of the case on hand, as discussed above, we hold that the provision for losses on derivative contracts is allowable as expenditure. We, accordingly allow the Grounds at S.Nos.1 to 9 raised by the assessee. 5.3 Further, the Co-ordinate Bench of this Tribunal in the case of M/s.Cotton Blossom (I) Pvt. Ltd.,in ITA No.583/Mds./2014 & 1531/Mds./2015 vide order dated 31.1.22015 after considering .....

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