2025 (10) TMI 847 - AT - Income Tax

Hedge losses on JPY forward contracts for export receivables held normal business losses, allowed to offset business income.

ITAT held that losses on settlement of target redemption forward contracts, entered to hedge export receivables in JPY, are normal business losses ... Claim of expense on account of “loss on settlement of target redemption forward contracts - Addition of Exchange Difference Derivatives -revenue had sought to dispute the export exposure of the assessee in Japanese Yen alone in the instant case - HELD THAT:- We find that the argument of the revenue that automobile business transactions of the assessee are in lakhs whereas the hedging contract of export receivables are in crores is to be dismissed as devoid of merit as it is not supported by the facts and figures depicted in the financial statements of the assessee company. Assessee had declared exchange gains from these hedging contracts in the earlier year which has been taxed as business income by the revenue. Merely because there is a loss arising on hedging contracts during the year under consideration, the same cannot be treated as speculative in nature by taking a divergent stand. Assessee is not engaged in trading of foreign currency in the instant case. The forward contracts are entered into in the instant case by the assessee only for hedging its risk on account of exchange fluctuations, which had to be construed as being incidental to the main core business of the assessee of export of automative lightings and mirror plates. The same cannot be construed as speculative in nature. It is to be noted that the underlying asset is confirmed export orders available with the assessee. We find further that the issue in dispute is settled by the decision of Simon India Ltd [2022 (12) TMI 358 - DELHI HIGH COURT] wherein it was held that where assessee claimed loss against forward contracts, entered into so as to hedge risk against foreign exchange fluctuations to cover its exports and imports, since assessee was reinstating its debtors and creditors in connection with execution of contracts and had submitted necessary details in regards to same, disallowance made by treating loss as speculative was erred. We hold that the loss are to be construed as normal business loss arising on hedging contracts which are integral and incidental to the core business of the assessee of export of automative lightings and mirror plates and accordingly the same is eligible to be set off against the business income. The said loss cannot be construed as speculative in nature in view of the proviso to clause (a) of section 43(5) of the Act. Accordingly, we do not find any infirmity in the order of the Learned CITA granting relief to the assessee. The grounds raised by the revenue are dismissed. ISSUES PRESENTED AND CONSIDERED 1. Whether losses on settlement of target-redemption forward contracts (USD-JPY structured OTC derivatives) entered to hedge anticipated JPY export receivables are speculative transactions within the meaning of section 43(5) of the Income-tax Act, and therefore not allowable as business loss. 2. Whether losses on settlement of forward contracts entered to hedge USD-denominated export receivables (exchange difference - derivatives) are speculative under section 43(5) and disallowable, or are deductible as business loss incidental to export operations. ISSUE-WISE DETAILED ANALYSIS Issue 1 - Speculativeness of losses on target-redemption USD-JPY forward contracts (JPY exposure hedging) Legal framework: - Section 43(5) defines 'speculative transaction' and disallows speculative losses; proviso (a) provides that certain transactions incidental to business and with proximate nexus to business are not to be treated as speculative. - Regulatory framework and market practice: OTC derivatives governed by ISDA master agreements and subject to Reserve Bank of India (RBI) eligibility criteria and master circulars for exporters; USD often functions as the major traded currency base in FX markets, making USD-JPY the traded pair while JPY-INR is a derived cross-rate. Precedent treatment (followed/distinguished/overruled): - Followed and applied: High Court and Tribunal authorities holding forward contracts entered by exporters to hedge export receivables are incidental to business and not speculative (extracts from Soorajmal Nagarmull; Badridas Gauridu; Vishindas Holaram; decisions of various ITAT benches cited; and the jurisdictional High Court decision in PCIT v. Simon India Ltd.). Interpretation and reasoning: - Factual matrix accepted by the Tribunal: exporter had technical collaboration and buy-back agreements with foreign buyer, letters of intent, capital investment in machinery for manufacture of goods for export, and demonstrated historic export activity and confirmed orders. - Contract structure and operation: the target-redemption contracts were multi-monthly instruments with mechanisms (any-time knock-out and accumulated intrinsic value trigger) that prevented crystallisation of notional monthly losses until final maturity; losses became crystallised only on fulfilment/non-occurrence of specified future events. Hence the claimed loss was crystallised on maturity and not a mere notional accrual. - Nexus and incidental nature: the contracts were entered to hedge JPY export receivables; banks offered these contracts after due diligence on underlying export orders; the contracts conform to ISDA terms and RBI eligibility norms, and therefore were instruments offered to exporters, not instruments for foreign-exchange trading. - Market realities: the AO's objection that contracts used USD-JPY rather than JPY-INR misunderstands FX market practice where USD is the major traded currency and many cross-rates (including JPY-INR) are derived mathematically; lack of direct JPY-INR traded contracts does not sever the commercial nexus between hedging instrument and JPY receivables. - Commercial causation: global economic collapse (post-September 2008) materially reduced anticipated exports; the shortfall in actual exports versus targeted quantity resulted from external market events, not speculative intent; the assessee had earlier crystallised and declared gains under the same arrangements in an earlier year, evidencing bona fide hedging. Ratio vs. Obiter: - Ratio: Where forward contracts are entered as hedges for export receivables, are governed by market/ regulatory standards, are backed by underlying contracts/LOIs and infrastructure, and contain contractual features that delay crystallisation until maturity, losses on such instruments are business losses incidental to export operations and not speculative within s.43(5). The Tribunal applies precedents to hold such losses allowable. - Obiter: Observations about the detailed historical FX ranges and bank notes explaining USD as currency major are explanatory to reasoning but not new legal propositions overruling precedent. Conclusions: - The loss of Rs. 17,70,51,673 on target-redemption USD-JPY forward contracts is a normal business loss incidental to the export business, not a speculative loss under section 43(5), and is allowable to be set off against business profits. Issue 2 - Speculativeness of losses on USD-INR forward contracts (USD exposure hedging) Legal framework: - Same statutory provision: section 43(5) and the proviso excluding incidental hedging/transactions with direct nexus to business from characterization as speculative. - RBI risk-management and eligibility criteria for forward contracts; requirement that forward facilities be granted on the strength of underlying or anticipated exports consistent with regulatory norms. Precedent treatment (followed/distinguished/overruled): - Followed the same line of authority as Issue 1 (Soorajmal, Badridas, Vishindas, various ITAT decisions, and PCIT v. Simon India Ltd.), treating hedging contracts entered by exporters as incidental and deductible. Interpretation and reasoning: - Factual findings: assessee entered USD-denominated forward contracts with reputable banks (Citi Bank, Standard Chartered) on the basis of confirmed orders/underlying exports; contract amounts were within bank-calculated exposure limits derived from past export/import averages; monthly and year-wise export data were produced showing USD receipts consistent with hedging commitments. - Contract mechanics: these USD contracts settled monthly on expiry (no delayed final maturity structure like target-redemption), but were nonetheless offered on the strength of underlying export transactions and in compliance with RBI norms; losses/gains are part of commercial management of FX risk and directly affect profit computation when actual receipts are reinstated at due-date exchange values. - Nexus and purpose: contracts were not for trading in foreign exchange and the assessee was not a dealer in forex; the hedges were integral to business risk management and intended to protect against exchange fluctuations, not to speculate. Ratio vs. Obiter: - Ratio: Losses on forward contracts in USD entered to hedge USD-denominated export receivables, supported by underlying export orders and regulatory/commercial compliance, are business losses and not speculative under s.43(5); the same principles as applied to USD-JPY target-redemption contracts govern USD-INR hedges. - Obiter: Comments on the mandatory role of banks and regulatory checks are contextual supports rather than new legal ratios. Conclusions: - The loss of Rs. 88,83,314 arising from settlement of USD hedging contracts is allowable as business loss incidental to export operations and is not a speculative loss under section 43(5). Cross-references and overall disposition - The Tribunal consistently relies on factual link (underlying contracts/LOIs, capital investments, past export record), contractual mechanics (crystallisation at maturity, knock-out/accumulation features), regulatory compliance (ISDA terms, RBI eligibility), and judicial precedents (Soorajmal; Badridas; Vishindas; PCIT v. Simon India Ltd.; cited ITAT authorities) to conclude that the hedging transactions in issue are incidental to the business and not speculative. - Net conclusion: both contested additions disallowing hedging losses under the head of speculative transactions were correctly deleted by the appellate authority; the revenue's grounds challenging those deletions are dismissed and losses are allowed to be set off against business income. (Order dismissing revenue appeal upheld.)