By TIOL News Service

MUMBAI, JAN 03, 2019: THE ISSUE IS - Whether hedging contract entered into by a manufacturer solely for the purposes of making profit out of its manufacturing activity more predictable, is no basis to deny such profit arising out of hedging. YES IS THE VERDICT.

Facts of the case:

The assessee company is engaged in the business of manufacturing LMenthol. For said purposes, the assessee had a manufacturing unit at Jammu and the main raw material for the said product was an agrobased product called Crude Menthol Oil. Since this raw material was subject to high price fluctuation, the assessee entered into forward contracts to hedge itself against such price fluctuation. In the period relevant to the A.Ys 2006-07, the assessee earned profit out of such hedging contracts. The assessee's main business of production of LMenthol was eligible for deduction u/s 80IB. In the return the assessee filed for the said year, it claimed deduction of the profit received through the hedging contracts. The AO was however of the opinion that the same was not allowable, primary on the ground that the profit could not be stated to have been derived from the assessee's manufacturing activity. On appeal, both the CIT(A) as well as the ITAT reversed the order of AO.

High Court held,

++ the provision of Section 80IB uses expression "profit derived from" and this expression has been seen as restrictive in nature as compared to the expression "arising out of". However, in the present case what is found is that the assessee needed high quantity of steady supply of the raw material, which would go into manufacturing its final product. If the assessee did not enter into hedging contract, it would be exposed to wide fluctuation of costs in procuring such material. This would expose the assessee to possible losses since while undertaking contracts for production and sale of the final product, the assessee would have taken into account the procurement price of the raw material at the prevailing rate. In order to avoid such uncertainities, the assessee would enter into hedging contracts. Essentially, the entire exercise was for the purpose of making the profit out of its manufacturing activity more predictable. If the assessee had not entered into such contract and relied on the spot purchase of the product, surely the resultant loss or profit as a case may be, would be part of the assessee's manufacturing activity and thereby, in any case qualify for deduction u/s 80IB or eligible for carrying forward loss if otherwise permissible under the Act. We do not find any difference in the situation merely because such gain or loss were pursuant to hedging contract of the assessee.

(See 2019-TIOL-34-HC-MUM-IT)