Foreign exchange hedging loss and disputed liability deduction depend on business character and accrual on settlement.

Foreign exchange contracts entered into in the ordinary course of export-import business to hedge exchange fluctuations were treated as business transactions, not speculative dealings, because the assessee was not trading in foreign exchange as such; the resulting loss was therefore incidental to business and not a speculative loss under the 1922 Income-tax Act. A disputed liability under the mercantile system became deductible only when it was settled and thereby ascertained, since a genuinely contested claim does not accrue until settlement or adjudication; the amount was accordingly allowable in the year of settlement.

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Issues: (i) Whether the loss arising from the foreign exchange contracts was a speculative loss or a business loss incidental to the assessee's export-import business; (ii) Whether the liability for the amount of Rs. 80,491 accrued and became ascertained in the year of settlement so as to be deductible in the relevant assessment year.

Issue (i): Whether the loss arising from the foreign exchange contracts was a speculative loss or a business loss incidental to the assessee's export-import business.

Analysis: The foreign exchange contracts were entered into in the ordinary course of the assessee's export and import business to cover exchange fluctuations. The assessee was not carrying on a business of dealing in foreign exchange as such. The loss arose from the conduct of the assessee's regular business operations and was found by the fact-finding authorities to be incidental to that business. On that footing, the case did not fall within speculative transactions under Explanation 2 to Section 24(1) of the Indian Income-tax Act, 1922.

Conclusion: The loss was a business loss incidental to the assessee's business and not a speculative loss.

Issue (ii): Whether the liability for the amount of Rs. 80,491 accrued and became ascertained in the year of settlement so as to be deductible in the relevant assessment year.

Analysis: Although the claim originated earlier, the liability was disputed and remained unascertained until it was settled in the relevant accounting year. Under the mercantile system, a liability becomes deductible when it accrues and is ascertained; where the claim is genuinely disputed, accrual occurs on settlement or adjudication. The settlement in the accounting year fixed the liability, making the amount deductible in that year.

Conclusion: The liability accrued and became ascertained in the year of settlement and was deductible in the relevant assessment year.

Final Conclusion: The reference was answered in favour of the assessee on both questions, and the disputed amount was held allowable as a business deduction in the relevant year.

Ratio Decidendi: A loss arising from foreign exchange contracts entered into in the ordinary course of business for hedging business exposure is not a speculative loss where the assessee is not a dealer in such contracts, and a disputed liability under the mercantile system is deductible only when it is settled or otherwise ascertained.

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