2024 (11) TMI 237 - AT - Income Tax

Foreign exchange forward contracts with actual delivery not speculative transactions under Section 43(5) Income Tax Act

Assistant Commissioner of Income Tax, Central Circle -1 (1), Chennai Versus Coastal Energy Private Limited (under Official Liquidator), Chennai And Coastal Energy Private Limited (under Official Liquidator), Chennai Versus Deputy Commissioner of Income Tax, Corporate Circle -1 (2), Chennai. (Now assessed by Assistant Commissioner of Income, Central Circle -1 (1), Chennai.

ITAT Chennai held that foreign exchange forward contracts do not constitute speculative transactions under Section 43(5) of the Income Tax Act. The ... Disallowance of provision for foreign exchange fluctuations and loss on forward contract - Applicability of Section 43(5) regarding speculative transactions - HELD THAT:- The Forward Contracts (Regulation) Act, 1952 ('FCRA') defines 'goods' as 'every kind of movable property other than actionable claims, money and securities.' Since the provisions of section 43(5) of the Act apply only to transactions in 'commodity', it is respectfully submitted that the provisions of the said section are not at all applicable in the present case for the simple reason that foreign currency is not a trading commodity. We note that in order to be a 'speculative transaction', there should be a contract for purchase or sale of a commodity, including stocks and shares and such contract should be settled otherwise than by actual delivery or transfer of the commodity. In other words, the transaction must be settled on a net-net basis, whereby the difference between the price prevailing on the settlement date and the contracted price is paid/ received by the parties to the contract. In the instant case of the assessee the contracts are settled by actual delivery and not on a net-to-net basis and hence the same does not fall within the meaning of 'speculative transaction' as mentioned in section 43(5) of the Act. As respectfully following the decision of Woodward Governor India (P.) Ltd [2009 (4) TMI 4 - SUPREME COURT] we do not find fault in the order of the CIT(A) in deleting the disallowance made by the AO in the reassessment order. Therefore, we are of the considered view that both the provision for foreign exchange fluctuations and loss on forward contract are allowable as expenditure in the impugned year and hence we uphold the order of the CIT(A) and dismiss the appeal of the revenue. Issues Involved:1. Disallowance of provision for foreign exchange loss.2. Disallowance of loss on forward contracts.3. Applicability of Section 43(5) regarding speculative transactions.4. Consideration of materials found during search proceedings.Issue-wise Detailed Analysis:1. Disallowance of Provision for Foreign Exchange Loss:The primary issue was whether the provision for foreign exchange loss amounting to Rs. 4,09,91,273/- is allowable as an expenditure. The revenue contended that the provision was not computed on a scientific basis and was contingent in nature, relying on CBDT Instruction No.03/2010. However, the CIT(A) deleted the disallowance by applying the Supreme Court decision in CIT vs. Woodward Governor India (P) Ltd., which held that exchange differences arising on foreign currency transactions should be recognized as income or expenses in the period they arise. The assessee maintained that the provision was made in compliance with Accounting Standard AS11 and was consistent with the mercantile system of accounting. The Tribunal upheld the CIT(A)'s decision, emphasizing that the provision was made as per AS11 and the Supreme Court's guidelines, recognizing the exchange loss as an item of expenditure under Section 37(1).2. Disallowance of Loss on Forward Contracts:The second issue was the disallowance of Rs. 1,10,81,279/- as a loss on forward contracts. The AO considered these transactions speculative, as they involved premature cancellation of contracts. The CIT(A) disagreed, finding that the contracts were for hedging foreign exchange risks related to import payables, not for speculative purposes. The Tribunal supported this view, noting that the contracts were settled by actual delivery, not on a net-to-net basis, thus not falling under the definition of 'speculative transactions' per Section 43(5). The Tribunal referenced the Supreme Court's decision, which allows such losses as deductible expenses when they arise from genuine business transactions.3. Applicability of Section 43(5) Regarding Speculative Transactions:The Tribunal examined whether forward contracts could be classified as speculative under Section 43(5). It concluded that foreign exchange forward contracts are not 'commodities' as per the Act's definition, and thus, Section 43(5) does not apply. The Tribunal cited the Delhi Bench decision in Munjal Showa Ltd. v. DCIT, which clarified that foreign currency is neither a commodity nor shares, and thus not subject to speculative transaction provisions.4. Consideration of Materials Found During Search Proceedings:For assessment years 2011-12 to 2013-14, the CIT(A) relied on materials from a search conducted on 04.01.2017 to uphold disallowances. The Tribunal rejected this approach, stating that the CIT(A) cannot use search materials for adjudicating appeals from original assessments completed under sections 143(3) or 147. The Tribunal emphasized that separate procedures exist for handling issues arising from search operations, and the CIT(A) overstepped jurisdiction by considering such materials. Consequently, the Tribunal allowed the appeals for these years, applying the principles established for AY 2008-09.Conclusion:The Tribunal dismissed the revenue's appeal for AY 2008-09, upholding the CIT(A)'s deletion of disallowances for foreign exchange loss and forward contract loss. It allowed the assessee's appeals for AYs 2011-12 to 2013-14, rejecting the CIT(A)'s reliance on search materials and affirming that such losses are allowable as business expenditures.