2018 (1) TMI 133 - AT - Income Tax

Tribunal affirms forward contract loss as business loss, citing integral role in export business.

The Tribunal dismissed the revenue's appeal, affirming that the loss incurred by the assessee on account of cancellation of forward contracts is a ... Forward contracts loss on foreign exchange transactions assessed as speculation loss u/s 43(5) - Held that:- The assessee is exporter of tobacco and during the year under consideration the assessee entered into foreign exchange forward contract to mitigate the loss on fluctuation of foreign currency. There is no dispute with regard to the fact that the assessee is not trading in currency and the entire transactions were routed through bank. The total export turnover of the assessee was US$ 5,61,17,429 and the value of forward contracts booked by the assessee was US$ 4,22,92,364 which is less than the value of the exports. The facts of the issue are similar to that of the decision of Hon’ble ITAT, Visakhapatnam in the case of Sri Ramalingeswara Rice & Oil Mill [2016 (10) TMI 924 - ITAT VISAKHAPATNAM] and the issue is squarely covered by the order of this Tribunal. - Decided against revenue. Issues Involved:1. Classification of forward contracts loss on foreign exchange transactions as speculative loss under Section 43(5) of the Income Tax Act.2. Determination of whether the loss on cancellation of forward contracts should be considered as business loss or speculative loss.3. Applicability of judicial precedents and accounting standards to the treatment of forward contracts loss.Detailed Analysis:1. Classification of Forward Contracts Loss:The primary issue in the appeal was whether the forward contracts loss on foreign exchange transactions should be classified as speculative loss under Section 43(5) of the Income Tax Act. The assessee, an exporter of tobacco, incurred a loss of Rs. 62,20,829 due to the cancellation of foreign exchange forward contracts. The assessee argued that these contracts were entered to hedge against currency fluctuation risks and should be treated as business losses. The AO, however, classified the loss as speculative, stating that the transactions were settled otherwise than by actual delivery.2. Determination of Business Loss vs. Speculative Loss:The Commissioner of Income-Tax (Appeals) [CIT(A)] ruled in favor of the assessee, stating that forward contracts entered into with banks for hedging foreign exchange loss on outstanding receivables in foreign currency are integral or incidental to exports. Therefore, the loss on such forward contracts is a business loss and not a speculative loss. The CIT(A) relied on the decision of the ITAT Mumbai Bench in the case of London Star Diamond Company, which held that:- Forward contracts (FCs) are commodities.- FCs entered with banks for hedging foreign exchange fluctuations are integral to export activities and should be treated as business losses.- There is no requirement for a one-to-one correlation between FCs and export invoices.The CIT(A) observed that the forward contracts were entered to hedge against potential losses due to depreciation of the US dollar on realization of sale proceeds. The premature cancellation of these contracts was a business decision to avoid further losses, thus qualifying the loss as a business loss.3. Applicability of Judicial Precedents and Accounting Standards:The Tribunal upheld the CIT(A)'s decision, referencing similar cases where forward contracts for hedging purposes were treated as business losses. The Tribunal cited the case of Sri Ramalingeswara Rice & Oil Mill and Southern Rocks & Minerals (P) Ltd., which supported the view that hedging transactions are not speculative. The Tribunal also referred to Accounting Standard-11 (AS-11) issued by the Institute of Chartered Accountants of India, which states that forward exchange contracts entered to hedge foreign currency exposure should be regarded as business losses.The Tribunal emphasized that the assessee's transactions were not speculative as they were entered to mitigate losses from currency fluctuations in the course of export business. The Tribunal noted that the Reserve Bank of India permits forward contracts for hedging purposes, further supporting the classification of these transactions as business losses.Conclusion:The Tribunal dismissed the revenue's appeal, affirming that the loss incurred by the assessee on account of cancellation of forward contracts is a business loss. The Tribunal's decision was based on the facts that the forward contracts were integral to the assessee's export business, were entered to hedge against currency fluctuations, and were not speculative in nature. The Tribunal upheld the CIT(A)'s order, which relied on judicial precedents and accounting standards to classify the forward contracts loss as a business loss.