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Issues: Whether gain arising from cancellation or early settlement of forward foreign exchange contracts entered into to hedge foreign exchange exposure on underlying debt investments is assessable as capital gains or as income from other sources.
Analysis: The forward contracts were inextricably linked to the underlying debt securities held as investments. The applicable foreign-exchange hedging framework restricted the contracts to the value and tenor of the underlying exposure, and required their cancellation or unwinding when the underlying securities were sold. No material established independent foreign-exchange trading. As hedging instruments, the contracts took the character of the underlying capital investments. They constituted capital assets, and their cancellation or early settlement extinguished contractual rights and obligations, amounting to a transfer. Consistent earlier decisions on identical facts remained binding in the absence of reversal or stay by a superior forum.
Conclusion: The gain from cancellation or early settlement of the hedging forward foreign exchange contracts is taxable under the head Capital Gains and not under the head Income from Other Sources, in favour of the assessee.
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