By TIOL News Service

MUMBAI, SEPT 12, 2017: THE ISSUE BEFORE THE TRIBUNAL IS - Whether loss resulted due to cancellation of the forward contracts, which was entered into by a trader with the banks to mitigate the losses on forex fluctuation, cannot be treated as speculative loss. YES is the answer.

Facts of the case:

The Assessee is engaged in the business of manufacturing and export of diamonds. It entered into forward contract with the Banker, which minimised the risk/loss in the Forex market. Due to various commercial considerations and exigencies and also change in the forex market, assessee had to cancel all forward contracts which were booked during the accounting year relevant to the A.Y.2008-09 under consideration. Such cancellation of forward contracts in US dollars resulted into net loss. According to the AO, the transactions in future contracts lack transaction in stock and share of foreign exchange when settled otherwise by then actual delivery, would be speculated transactions u/s 43(5). On appeal, the CIT(A) held that the future contracts were settled otherwise by then actual delivery could not be bound to held that future contracts were not speculative contracts u/s 43(5) of the Act.

Tribunal held that,

++ in terms of nature of business, assessee imports rough diamonds mainly from Diamond Trading Company and exports finished diamonds to various parties on credit. Credit term for the sales ranges between 90 to 150 days. Most of the customers have long term relationship with the assessee. As assessee imports rough diamonds and export finished diamonds, it receives and pay foreign currency. These foreign currency transactions are incidental to the assessee’s diamond business. Thus, foreign currency transactions were entered by the assessee for the purpose of meeting the requirement and for nothing else or for no other purpose. Thus, assessee’s business and sources of borrowings are effectively in foreign currency and thus the assessee is exposed to adverse movements in foreign exchange which it receives and pays as part of its business. All these transactions entered by the assessee are incidental to its business activity of import and export and to protect against adverse movements in foreign exchange in a highly volatile global market. Thus, foreign exchange fluctuation is a risk which assessee has to face and therefore, it is prudent for it to mitigate it;

++ the issue under consideration is squarely covered by the decision of co-ordinate Bench in case of Mahendra Brothers Exports Pvt. Ltd., wherein the Tribunal observed that: "....It is evident that, due to large import and export of diamonds, which is the main business activity of the assessee, it is exposed to high risk of foreign exchange gain or loss which is arising only because of the said business only. To mitigate the foreign currency loss, RBI introduced the regulations so that exporters and importers can hedge the same through authorized dealers, mostly Banks. The assessee had entered into hedging transaction through banks and the amount for which the hedging transactions are entered are within the amount of the underlying transactions of imports and exports. There is no independent transaction of foreign exchange on standalone basis. Such a loss cannot be in any manner equated with hedging of foreign currency alone, but ceases to fall within the realm of ‘speculation’ albeit it is inextricable linked with the business of the assessee. Accordingly, foreign exchange loss in the course of the business occurred due to hedging transactions through advance is nothing but business gain or loss....";

++ a similar view has been taken by ITAT Mumbai Bench in case of Hiraco India Pvt. Ltd., ITA No.2300/Mum/2015 - 2016-TIOL-526-ITAT-MUM wherein it was held that the Forward contracts 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. The Coordinate Bench further held that the forward contracts entered by the assessee, an exporter and not the dealer in foreign exchange, with the Banks as incidental to the export business, are business transactions and loss or gains is not of speculation nature. Respectfully following the judicial pronouncements, we do not find any merit for not allowing the setting off loss arising out of cancellation of foreign exchange / forward contract.

(See 2017-TIOL-1243-ITAT-MUM)