L o n d o n S t a r D i a m o n d C o m p a n y ( I ) P . L t d . vs. D C I T In the Income Tax Appellate Tribunal “D” Bench, Mumbai Before Vijay Pal Rao, (J. M.) and D. Karunakara Rao, (A. M.) I.T.A. No.6169/M/2012 Assessment Year: 2009-2010. Date of Order: 11.10.2013 Counsel for Assessee/Revenue: Soli Dastur and Nikhil Ranjan/Dipak Ripote

Facts:
The assessee is engaged in the business of trading and manufacturing of rough and polished diamonds. It had entered into forward contracts with the banker to safeguard against the exchange fluctuations of export considerations/sale profits as per RBI guidelines. Total of forward contracts entered into during the was Rs. 135.99 crore and the cancellation thereof aggregated to Rs. 126.3 crore. The total exports during the year was Rs. 107.57 crore. Total outstanding receivable in foreign exchange was much higher than any of these figures. It filed its return of income declaring the total income of Rs. 35.29 lakh. The AO examined the applicability of the provisions of section 43(5) of the Act in general and clause (c) of the proviso to section 43(5) in particular and held that the foreign exchange contracts constituted speculative transactions under the said provisions and treated the loss on cancellation thereof of Rs. 4.69 crore as the speculation loss and assessed the income of the assessee at Rs. 5.04 crore. On appeal, the CIT(A) upheld the order of the AO.

Before the tribunal, the revenue relied on the orders of the AO and the CIT(A) and contended that the certain data showed that the total of Forward exchange Contracts on certain dates were more than the exports receivable and also questioned the asssessee‘s failure to demonstrate the paisa to paisa and date-wise correlation between the Forward Contracts and the Export Invoices.

Held:
The tribunal laid down the following principles:

• Considering the judgment of the Calcutta High court in the case of CIT vs. Sooraj Muill Magarmull (129 ITR 169) which was followed by the Bombay High Court in the case of CIT vs. Badridas Gauridu Pvt. Ltd. (261  ITR 256), it held that the Forward Contracts are commodities falling in the definition of speculative transactions governed u/s. 43(5);

• Forward exchange contracts when entered into with the banks for hedging the losses due to foreign exchange fluctuations on the export proceeds, are to be considered integral or incidental to the export activity of the assessee and therefore, the losses or gains constituted the business loss or gains and not the speculation activities. For the purpose it relied on the decisions of the Mumbai tribunal in the case of D. Kishorekumar and Co. (2 SOT 769), the Bombay High Court in the case of CIT vs. Badridas Gauridu (P) Ltd. (supra) and the Calcutta High Court in the case of CIT vs. Sooraj Muill Magarmull (supra).

The tribunal then noted that the loss suffered by the assessee on account of the cancellation of forward exchange contract was broadly of two types viz., loss suffered on cancellation of matured contracts (Rs. 4.15 crore) and loss suffered on cancellation of pre-matured contracts (Rs. 64 lakh). According to the tribunal, the former being related to the Forward exchange contracts which are integral or incidental to the exports of the diamonds, should be allowed as business loss in view of the binding High Court or Tribunal decisions/ judgments in the case of D. Kishore kumar and Co (supra), Badridas Gauridu Pvt. Ltd. (supra), Sooraj Muill Magarmull, (supra). In the case of loss suffered on cancellation of pre-matured contracts, the tribunal observed that the onus is on the assessee to explain satisfactorily why the assessee resorted to premature cancellation of some FCs. Further, it observed that it is not required that there must be 1:1 precise correlation between Forward exchange Contacts and the corresponding export invoice. So long as the total Contracts does not exceed the exports of the year plus outstanding export receivable, the Forward exchange Contracts can constitute hedging transaction‘. In the case of loss suffered on cancellation of pre-matured contracts, the tribunal allowed the loss of Rs. 42 lakh accepting the explanation of the assessee that the maturity date of those contracts fell during the weekend days and therefore, the assessee cancelled the contracts three days prior to the due date. As regards the other contracts cancelled prior to longer than three days it held that losses therefrom should also be allowed as business loss so long as the same are integral part of the exports. However, according to it, the assessee needs to answer as to why it went for premature termination and the onus was on the assessee as per the ratio of the Apex Court in the case of CIT vs. Josef John (67 ITR 74). Accordingly, to examine this part of the loss, the matter was remanded to the AO.