Foreign exchange loss incurred at the time of implementing export contract to be considered as a business loss Instead of Speculative loss
What does speculative transaction means under Income Tax Act?
As per section 43 (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 scripts:
Provided that for the purposes of this clause –
(a) 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; or
(b) A contract in respect of stocks and shares entered into by a dealer or investor therein to guard against 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 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 (ac) of section 2 of the Securities Contracts (Regulation) Act, 1956 (42 of 1956) carried out in a recognised stock exchange; [or]
(e) an eligible transaction in respect of trading in commodity derivatives carried out in a recognised association, which is chargeable to commodities transaction tax under Chapter VII of the Finance Act, 2013 (17 of 2013), shall not be deemed to be a speculative transaction.
Fact and Issue of the case
The assessee is a company engaged in the business of providing computer aided engineering analysis and software services. The assessee filed its return of income for the Assessment Year 2009-10 declaring a total income of Rs.28,48,96,860/- and deduction of Rs.75,000/- was claimed under Chapter VI-A of the Act. The return was processed under Section 143(1) of the Act and was subsequently taken up for scrutiny. The Assessing Officer by an order dated 22.2.2013, inter alia, made the addition on account of disallowance of provision of loss of derivative contracts to the extent of Rs.16,35,54,352/- out of total provision made during the year of Rs.19,96,59,000/-. Out of the aforesaid amount, the Assessing Officer allowed a sum of Rs.3,61,04,648/- pertaining to Assessment Year 2008-09. The Assessing Officer also rejected the claim for disallowance under Section 14A of the Act and added a sum of Rs.7,34,975/- by applying Rule 8D(iii).
The assessee thereupon filed an appeal before the Commissioner of Income Tax (Appeals), who by an order dated 18.11.2013, inter alia upheld the decision of the Assessing Officer in disallowing the provision for loss in derivative contracts. The Commissioner of Income Tax (Appeals), however, allowed the entire actual loss incurred in respect of derivative contracts for the Assessment Year 2009-10 on the ground that the loss had been actually incurred and there is no logic in restricting the loss to the extent of provision created in the earlier year. However, on the issue of disallowance under Section 14A of the Act, the Commissioner of Income Tax (Appeals) upheld the order of the Assessing Officer. In the result, the appeal preferred by the assessee was partly allowed. The assessee as well as the revenue filed appeals before the Income Tax Appellate Tribunal against the order of Commissioner of Income Tax (Appeals). The Tribunal, by a common order dated 14.11.20 14 allowed the appeal preferred by the assessee and dismissed the appeal preferred by the revenue. Being aggrieved, the revenue has filed this appeal.
Observation of the Court
After having noticed the relevant statutory provisions, court may advert to the facts of the case in hand. The assessee has entered into forward contract with the bank to buy or sell foreign exchange at an agreed price at a specified future date in order to hedge against possible future financial loss due to fluctuation in the rate of foreign currency. The Tribunal, inter alia, has held that foreign exchange forward contract means an agreement to exchange different currencies at a forward rate. It has further been held that the aforesaid contract created a continuing binding obligation on the date of contract against the assessee to fulfil the same on the date of maturity and it is in the nature of a hedging contract because it is a contract entered into against possible future financial losses. The assessee would come to know of the actual profit/loss only on the date of maturity only unless there is any premature cancellation of the contract.
Thereafter, the Tribunal has noted the well settled principles regarding the accounting principles and in Paragraph 4.5.5 has held that the contention of the assessee that, forward contract was to be revalued in accordance with Accounting standards 11 and therefore, the assessee had no option but to determine the profits / loss with regard to unmatured foreign exchange forward contracts in accordance with currency rates as on the date of the valuation i.e., 31st March has not been disputed by the revenue. Thereafter, in Paragraph 4.5.8, the Tribunal has held that it is not in dispute that the forward contracts have been entered into by the assessee in order to protect its interest against fluctuation in foreign currency, in respect of consideration for export proceeds which is a revenue item and has concluded as follows:
(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 contingent liability.
(iv) The accounting treatment is as per Accounting Standards and the ICAI Guidelines.
(v) The principles enunciated by the Hon ‘ble Apex Court in the case of Woodward Governor India Pvt. Ltd. (supra) are applicable to the facts of the case on hand.
It is pertinent to mention here that the revenue has not questioned doubted the genuineness and reasonableness of the transaction. Similarly, the revenue has not disputed the fact that the estimation was made on reasonable basis and not on adhoc basis which is evident from Paragraph 6.1 of the order of Commissioner of Income Tax (Appeals). The loss which is claimed by the assessee, is claimed as deductible business expenditure and therefore, provision for loss has to be allowed at the close of the year in accordance with Paragraphs 3 to 39 of the Accounting Standard 11, which deals with foreign exchange contract. It is not disputed by the revenue that forward contracts were entered to protect the assessee from foreign exchange fluctuation in respect of consideration for export proceeds. The tribunal, therefore, rightly relied on the decision in WOOD WARD GOVERNOR INDIA supra while allowing the market to market loss as relating to forward exchange contract as deduction. It is pertinent to mention here that Instruction No.3 of 2010 was issued on 23.03.2010 and same is not applicable for the Assessment Years 2008-09 and 2009-10 in view of well settled legal position that a circular which is beneficial in nature applies retrospectively but a circular which is oppressive has to be applied prospectively (SEE: CCE VS. MYSORE ELECTRICAL INDUSTRIES LTD (2006) 12 SCC 448). It is pertinent to note that the aforesaid has not been given effect o by several high courts namely in MUNJAL SHOVA LTD VS DCIT (2016) 382 ITR 555 (DELHI) and in CIT VS. VINERGY INTERNATIONAL PVT LTD ITA NO.376/2014 (BOMBAY HIGH COURT).
The loss sustained by the assessee due to fluctuation in foreign exchange while implementing export contract is incidental to assessee’s course of business, therefore, such a loss is not a speculative loss but a business loss. The aforesaid findings have not been demonstrated to be perverse. For the aforementioned reasons, the substantial questions of law No.1 and 3 are answered against the revenue and in favour of the assessee.
Now court may advert to the second substantial question of law. It is pertinent to note that for Assessment Year 2009-10 the assessee has not earned dividend income. The aforesaid fact has not been disputed by the revenue. It is also relevant to mention that Circular No.5/2014 dated 11.02.2014 is not applicable in the instant case as the instant case pertains to Assessment Year 2009-10. The aforesaid Circular has no retrospective operation. It is noteworthy that aforesaid Circular was not even relied by the parties. This court in COMMISSIONER OF INCOME TAX VS. KINGFISHER INVESTMENT INDIA LTD. vide judgment dated 29.09.2020 inter alia held that disallowance under Section 14A read with Rule 8D has to be made even when taxpayer in a particular year has not earned any exempt income. This court relied on the decision of the Supreme Court in MAXOPP INVESTMENT LTD supra which was reproduced in Paragraph 5 of the decision and reliance was also placed on Circular dated 11.02.2014 issued by Central Board of Direct Taxes (CBDT). However, the aforesaid decision was subsequently considered by this court in judgment dated 16.01.2021 passed in I.T.A.No.271/2017 (PRINCIPAL COMMISSIONER OF INCOME TAX VS. NOVEL SOFTWARE DEVELOPMENT) in which it was held that decision of this court in KINGFISHER FIN VEST LTD. was distinguishable as the basis of the aforesaid decision of this court was the decision of the Supreme Court in MAXOPP INVESTMENTS LTD. supra and it was held that the aforesaid decision does not deal with applicability of Section 14A of the Act. However, eventually this court agreed with the view taken by High Court of Madras in CIT VS. CHETTINAD LOGISTICS P LTD., (2017) 80 TAXMANN.COM 221 (MAD.) AND KEM INVEST LTD. VS. CIT, (2015) 16 TAXMANN.COM 118 (DELHI) and held that since no exempt income has accrued to the assessee therefore, the provisions of Section 14A of the Act do not apply to the fact situation of the case. Therefore, it has become necessary for us to clarify the view taken in the two decisions viz., KINGFISHER FINVEST INDIA LTD. AND MIS NOVEL SOFTWARE INDIA (P) LTD. supra. At this stage, court may refer to Paragraph 40 of the decision of the Supreme Court in MAXOPP supra, the relevant extract of which reads as under:
It is to be kept in mind that in those cases where shares are held as ‘stock-in-trade’, it becomes a business activity of the assessee to the deal in those shares as a business proposition. Whether dividend is earned or not becomes immaterial. In fact, it would be a quirk of fate that when the investee company declared dividend, those shares are held by the assessee, though the assessee has to ultimately trade those shares by selling them to earn profits. The situation here is therefore, different from the case like Maxopp Investment Ltd. where the assessee would continue to hold those shares as it wants to retain control over the investee company. In that case, whenever dividend is declared by the investee company that would necessarily be earned by the assessee and the assessee alone. Therefore, even that the time of investing into those shares, the assessee knows that it may generate dividend income as well and as and when such dividend income is generated that would be earned by the assessee. In contrast, where the shares are held as stock-in-trade, this may not be necessarily a situation. The main purpose is to liquidate those shares whenever the share price goes upon order to earn profits. In the result, the appeals filed by the revenue challenging the judgment of the Punjab and Haryana High Court in State Bank of Patiala also fail, though law in this respect has been clarified hereinabove.
From perusal of the relevant extract of the Supreme Court, it is evident that the decision in MAXOPP IN VESTMENT LTD. supra deals with applicability of Section 14A of the Act. Therefore, the observations made with regard to applicability of Section 14A in MIS NOVEL SOFTWARE INDIA (P) LTD. are factually incorrect and it hasten to clarify the same. However, from relevant extract of Paragraph 40, it is evident that only expenses proportionate to earning of exempt income could be disallowed under Section 14A of the Act and the decision of MAXOPP INVESTMENT LTD is an authority for the aforesaid proposition that the provision is relatable to earning of actual income. The object of Section 14A is to curb the practice to claim deduction of expenses incurred in relation to exempt income against taxable income and at the same time avail of the tax incentive by way of exemption of exempt income without making any apportionment of expenses incurred in relation to exempt income. The High Court of Madras has relied on the decision of the Supreme Court in COMMISSIONER OF INCOME TAX VS. WALFORT SHARE AND STOCK BROKERS (2010) 326 ITR 1 wherein it has been held that Section 14A is relatable to income of actual income or not notional or anticipated income. Therefore, the conclusion arrived at by us in MIS NOVEL SOFTWARE INDIA (P) LTD. is affirmed but for different reasons. It is also clarified by us that while recording the conclusion in KINGFISHER FIN VEST LTD. that disallowance under Section 14A has to be made even taxpayer has not earned any exempt income, this court has misread the ratio of the decision of the Supreme Court in MAXOPP INVESTMENT LTD supra and therefore, the aforesaid view being contrary to the law laid down by the Supreme Court is not a binding precedent.
Hence the court concluded that loss sustained by assessee due to fluctuation in foreign exchange while implementing export contract was incidental to assessee’s course of business, therefore, such a loss was not a speculative loss but a business loss
Read the full order from belowForeign-exchange-loss-incurred-at-the-time-of-implementing-export-contract-to-be-considered-as-a-business-loss-Instead-of-Speculative-loss-1