Hedge sale contracts and speculative loss: forward sales against purchase contracts are not protected and cannot be set off.

Forward contracts of sale entered into by a merchant as hedges against future price fluctuations in respect of forward purchase contracts do not fall within proviso (a) to the second Explanation to section 24(1) of the Income-tax Act, 1922. The proviso protects only hedge contracts of purchase connected with contracts for actual delivery of goods manufactured or merchandise sold, and does not extend to sale contracts entered as hedges against purchase contracts. As a result, the loss arising from such forward sale transactions remains speculative and is not admissible for set-off against other business income.

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Issues: Whether forward contracts of sale entered into by a merchant as hedge contracts against future price fluctuations in respect of his forward contracts of purchase fall within proviso (a) to the second Explanation to section 24(1) of the Income-tax Act, 1922, and whether the resultant loss is eligible for set-off against other business income.

Analysis: Proviso (a) excludes from the definition of speculative transaction only a contract in respect of raw materials or merchandise entered into in the course of manufacturing or merchanting business to guard against loss through future price fluctuations in respect of contracts for actual delivery of goods manufactured or merchandise sold. Read in context, the proviso contemplates hedge contracts of purchase where the underlying exposure is a forward contract of sale for actual delivery. The language does not extend to forward contracts of sale entered into as a hedge against forward contracts of purchase. Such sale contracts remain within the definition of speculative transaction.

Conclusion: The assessee's forward contracts of sale were not covered by proviso (a) and the loss arising from them was speculative and not admissible for set-off against other business income.

Final Conclusion: The reference was answered against the assessee, and the disputed loss was held not to be deductible against non-speculative business profits.

Ratio Decidendi: Proviso (a) to the second Explanation to section 24(1) of the Income-tax Act, 1922 protects only hedge contracts of purchase against forward sales, and does not exempt forward contracts of sale entered into as hedges against forward purchases.

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