2009 (8) TMI 1249 - AT - Income Tax

Forward contract profits deemed speculative, not deductible under Income-tax Act.

The tribunal determined that profits from forward contracts were classified as speculative income and not eligible for deductions under section 10B of the ... Deduction u/s 10B - Gain on forward contracts - Whether proceeds from hedging foreign currency risk does not constitute income derived from exports and is also not received in convertible foreign exchange ? - HELD THAT:- As in the instant case, there are a number of transactions and the forward contracts have been taken in respect of 46 per cent of the export turnover. Thus, it is not an isolated transaction. Hence, in view of Explanation 2 to section 28, the profit from the forward contract will have to be assessed as profit from speculation business. It is true that section 10B(1) says that a deduction of such profit and gains as are derived by 100 per cent export oriented undertaking is to be allowed as deduction. For the purposes of sub-section (1), the quantum of deduction is to be computed as per section 10B(4). The deduction permissible is in the same proportion to the profit of the business of the undertaking as it bears to the export turnover to the total turnover. The words uses are 'profit of the business of the undertaking'. The business of the undertaking is to manufacture and export readymade garments. As held profit from forward contract is profit to be assessed under the head ‘Speculation business’ and speculation business is not the business of the undertaking. Hence, for the purpose of computing deduction u/s 10B, speculation business cannot be considered as the business of the undertaking. Thus we hold that the CIT(A) was not justified in holding that profit from forward contract is to be included in the profit of the business of the undertaking for the purposes of computing deduction u/s 10B. Issues Involved:1. Eligibility of gains on forward contracts for deduction under section 10B of the Income-tax Act, 1961.2. Classification of income from forward contracts as speculative transactions.Detailed Analysis:Issue 1: Eligibility of Gains on Forward Contracts for Deduction Under Section 10BThe revenue appealed against the CIT(A)'s order, which held that gains from forward contracts are eligible for deduction under section 10B of the Income-tax Act, 1961. The Assessing Officer (AO) had observed that the assessee netted off profits from forward contracts against finance expenses and claimed a deduction under section 10B. The AO argued that deductions under section 10B are allowed only on profits derived from the export of articles or things, and not from forward contracts, which he considered financial transactions. The AO thus classified the profits from forward contracts as income from other sources, not eligible for section 10B deduction.The CIT(A) countered, noting that the forward contracts were booked to hedge against foreign exchange fluctuations related to export sales. The CIT(A) referenced the Mumbai Bench's decision in D. Kishorekumar & Co. v. Dy. CIT, which treated income from forward contract cancellations as part of business profits eligible for deduction under section 80HHC. The CIT(A) concluded that profits from forward contracts constituted part of the export turnover and were thus eligible for section 10B deduction.During the tribunal proceedings, the revenue's representative argued that profits from forward contract cancellations were not derived from exports and thus not eligible for section 10B deduction. The representative cited the Supreme Court's decisions in CIT v. Sterling Foods and Cambay Electric Supply Industrial Co. Ltd. v. CIT, which emphasized that profits must have a direct nexus with the industrial undertaking to qualify for deductions. Conversely, the assessee's representative relied on the Mumbai Bench's decision in D. Kishorekumar & Co., asserting that profits from forward contracts were integral to the business and should be included in section 10B deductions.Issue 2: Classification of Income from Forward Contracts as Speculative TransactionsThe tribunal examined whether the income from forward contracts should be classified as speculative transactions. Section 43(5) defines a speculative transaction as one settled otherwise than by actual delivery. The assessee admitted that profits from forward contracts were from those settled without actual delivery. The tribunal referenced several High Court decisions, including V.N. Sarsetty v. CIT and Hoosen Kasam Dada (India) Ltd. v. CIT, which held that contracts settled without actual delivery are speculative.The tribunal also noted that the proviso to section 43(5) excludes certain transactions from being deemed speculative, but this exclusion did not apply to the assessee's forward contracts, which were not for goods manufactured or sold by the assessee. Additionally, Explanation 2 to section 28 deems speculative transactions as distinct from other business activities. The tribunal found that the assessee's forward contracts, representing 46% of the export turnover, constituted a significant number of transactions, qualifying as speculative business under Explanation 2 to section 28.The tribunal concluded that profits from forward contracts should be assessed as profits from speculative business, separate from the business of manufacturing and exporting readymade garments. Consequently, these speculative profits could not be included in the business profits for computing deductions under section 10B.Conclusion:The tribunal held that the CIT(A) erred in including profits from forward contracts in the business profits for section 10B deductions. The tribunal upheld the AO's decision, classifying the profits from forward contracts as speculative income, not eligible for section 10B deductions. The revenue's appeal was allowed, and the CIT(A)'s order was revised accordingly.