D. KISHORE KUMAR & CO. v. DEPUTY COMMISSIONER OF INCOME TAX
[Citation -2005-LL-0331-4]

Citation 2005-LL-0331-4
Appellant Name D. KISHORE KUMAR & CO.
Respondent Name DEPUTY COMMISSIONER OF INCOME TAX
Court ITAT
Relevant Act Income-tax
Date of Order 31/03/2005
Assessment Year 1993-94
Judgment View Judgment
Keyword Tags convertible foreign exchange • forward exchange contract • speculation business • business transaction • business expediency • computing deduction • business activity • separate business • foreign currency • forward contract • export business • special bench • interest paid • market price • market value
Bot Summary: These contracts ensured that the assessee has availability of the foreign exchange at a fixed rate o n the date on which foreign exchange payments fall due. In the prevailing market conditions in the foreign exchange market, the assessee considered it appropriate to cancel the forward contracts and book the profits, i.e., realize the difference between agreed forward contract price and prevailing market price. Of Explanation to s. 80HHC. The AO also observed that the criterion for reducing 90 per cent of certain receipts in not whether the receipt is business or non business but whether the particular receipt has any turnover element... The AO also noted that the gain on cancellation of foreign exchange contract is not derived from the business activity of the assessee as the same is not springing from, or arising from, or flowing from, an activity of the business carried out by the assessee, and are not transactions of the business within the meanings of profits or gains of business. As learned Departmental Representative has very rightly pointed out, in case we come to t h e conclusion that these forward exchange contracts, and their settlement without delivery, is a separate business by itself, the profits on these transactions will have to be treated as profits of speculation business distinct and separate from that of export business. The purpose of these transactions was clearly to minimise assessee s risk on account of fall in value of rupee, but the quantum of foreign exchange covered by these forward contracts was limited to the extent of assessee s actual exposure in respect of import value commitments. As a matter of fact, this profit on cancellation of forward contracts is generally revenue neutral because the question of profit on cancellation of forward contracts can only arise in a situation when the value of foreign currency is increasing vis-a-vis domestic currency, and when the foreign exchange value is so increasing the ultimate payment made in foreign exchange by the assessee also increases. There is one more aspect of the matter, and that is the reason as to why the forward contracts were cancelled midway and the profits were booked on the same instead of using these contracts to actually meet the foreign exchange requirements at the time of paying the import bills.


This is appeal filed by assessee, and is directed against CIT(A) s order dt. 31st March, 1997, in matter of assessment under s. 143(3) of IT Act, 1961, for asst. yr. 1993-94. assessee s grievance, as raised in this appeal before us, is two-fold first that CIT(A) erred in confirming adjustment made by AO of reducing 90 per cent of premium received on cancellation of forward contracts of foreign exchange, for purpose of computing deduction allowable under s. 80HHC of Act; and second, against CIT(A) s holding 90 per cent of interest on fixed deposits is to be reduced for purpose of computing s. 80HHC deduction. We will take up second grievance first. As far as second grievance of assessee is concerned, learned representatives have fairly agreed that this issue is now covered by Special Bench decision of Tribunal in case of Lalsons Enterprises vs. Dy. CIT (2004) 82 TTJ (Del)(SB) 1048: (2004) 89 ITD 25 (Del)(SB). Learned Departmental Representative, however, dutifully relies upon orders of authorities below. Special Bench decision being binding judicial precedent for us, we respectfully follow same, and, accordingly, we direct AO to recompute deduction under s. 80HHC in light of principles laid down by aforesaid Special Bench decision. In effect, AO shall, while computing deduction under s. 80HHC, exclude 90 per cent of only take net amount i.e., interest received as reduced by interest paid on invested funds on which interest is so received. matter is hereby restored to file of AO with these directions. Ground No. II, which sets out above grievance, is thus allowed for statistical purposes. We now come back to first grievance. So far as this grievance of assessee is concerned, material facts of case are as follows. assessee is diamond exporter. In course of this business, assessee imports rough diamonds, cuts and polishes same and exports cut and polished diamonds. payments for imports of diamonds is required to be made, on due dates, in US Dollars. With view to minimise risk of increased cost of imports, due to fall in value of rupee vis-a-vis US Dollars, assessee entered into forward contracts for foreign exchange. These contracts ensured that assessee has availability of foreign exchange at fixed rate o n date on which foreign exchange payments fall due. However, in prevailing market conditions in foreign exchange market, assessee considered it appropriate to cancel forward contracts and book profits, i.e., realize difference between agreed forward contract price and prevailing market price. On this cancellation of forward exchange contracts, or, put it differently, realization of difference between contracted price of dollars vis-a- vis prevailing market price of foreign exchange, assessee received sum of Rs. 10,30,305. assessee s claim was that this receipt of Rs. 10,30,305 was integral part of its export business profits. AO, however, was of view that 90 per cent of aforesaid receipt is liable to be excluded from profits of business under cl. (baa) of Explanation to s. 80HHC. AO also observed that "the criterion for reducing 90 per cent of certain receipts in not whether receipt is business or non business but whether particular receipt has any turnover element..." AO also noted that gain on cancellation of foreign exchange contract is "not derived from business activity of assessee as same is not springing from, or arising from, or flowing from, activity of business carried out by assessee, and are not transactions of business within meanings of profits or gains of business ." AO went on to add said income "could not be brought within ambit of as derived from business activity of assessee . Hence, contention of assessee is rejected". Aggrieved by action of AO, assessee carried matter in appeal before CIT(A) but without any success. CIT(A) confirmed action of AO and also observed as follows: Moreover, both these receipts do not qualify for allowance of deduction as per provisions of s. 80HHC(1) as well as 80HHC(2) for following reasons, viz.: (i) Neither these receipts are earned out of trading of commodity in international market, in other words by export of commodity; (ii) Both these receipts are received in India and these are not received outside India in any convertible foreign exchange as required under sub-s. (2) of s. 80HHC. assessee is not satisfied by order of CIT(A) also and is in second appeal before us. We have heard Shri Shivaram, learned counsel for assessee, and Shri Sarangal, learned Departmental Representative. We have also carefully perused orders of authorities below, as also paper book filed before us, and duly considered factual matrix of case as also applicable legal position. We must first of all address ourselves to nature of these forward exchange contracts, and question whether or not these transactions can be considered to be integral part of export business or whether or not these transactions are to be considered as business by itself. As learned Departmental Representative has very rightly pointed out, in case we come to t h e conclusion that these forward exchange contracts, and their settlement without delivery, is separate business by itself, profits on these transactions will have to be treated as profits of speculation business distinct and separate from that of export business. But then, authorities below have only excluded 90 per cent of these profits, in computing deduction under s. 80HHC, whereas learned Departmental Representative s contention being accepted will mean that entire profits are required to be excluded. That will mean that assessee will be worse off as result of having come up in this appeal before. While such result is certainly not permissible under law, this aspect of matter, for reasons we shall now state, is entirely academic in present context. details of forward exchange contract were filed before us at p. 31 of t h e paper book. These details clearly show that all forward exchange contracts were in respect of each specific import order placed by assessee. purpose of these transactions was clearly to minimise assessee s risk on account of fall in value of rupee, but quantum of foreign exchange covered by these forward contracts was limited to extent of assessee s actual exposure in respect of import value commitments. That aspect is not disputed. O n these facts, even though transactions having been settled without delivery, conditions of s. 43(5), describing speculative transactions, are clearly fulfilled, requirement of Expln. 2 to s. 28 is not fulfilled inasmuch as it cannot be concluded that transactions are such nature as to constitute business by itself. In our understanding of situation, these transactions are genuine business transaction to hedge against increased cost of purchases of rough diamond imports. It is commonly accepted part of financial management practices today that risk element, due rise in value of foreign currency in respect of import transactions entered, is minimised by entering into forward contracts for purchase of that currency. This is particularly necessary in market in which value of domestic currency is falling, which is evident from fact that assessee realized profits on cancellation of those contracts. These transactions are integral part of export business and cannot be considered in isolation of export business in course of which transactions have been entered into. As matter of fact, this profit on cancellation of forward contracts is generally revenue neutral because question of profit on cancellation of forward contracts can only arise in situation when value of foreign currency is increasing vis-a-vis domestic currency, and when foreign exchange value is so increasing ultimate payment made in foreign exchange by assessee also increases. In case, value of foreign currency was not to go up, there would not have been gains on cancellation of contracts but then actual costs, in terms of domestic currency, that assessee pays when he has to pay for imports in foreign currency does not also go up. Since it is undisputed position that imports, in connection with which assessee had entered into forward contracts, actually took place, this profit on cancellation of forward foreign exchange contracts effectively only reduces costs of purchases in respect of those imports, and cannot be, by any logic, construed as transactions independent of assessee s business of importing rough diamonds and exporting cut and polished diamonds. There is one more aspect of matter, and that is reason as to why forward contracts were cancelled midway and profits were booked on same instead of using these contracts to actually meet foreign exchange requirements at time of paying import bills. We have noted that all these contracts were cancelled on 13th April, 1992, when prevailing market price was INR 100 = US$ 3.235, as against forward contract rate of INR 100 = US $ 3,840 and rates of INR 100 = US $ 3.68 to 3.7325 prevailing on date of imports. due dates of payment at that point of time were only 16 days to 77 days away, as evident from chart showing due dates-which was also contained in p. 31 of paper-book. decision as to whether further hedging against increase in foreign currency is warranted or not is essentially commercial decision which depends on number of factors, most important factor being trend of currency markets at that point of time and businessman s perception about future trends of currency market. For example, when businessman perceives that market value of foreign currency vis-a-vis domestic currency will not go any higher or when market starts declining trend, he may see business expediency in cancellation of contract. fact of premature cancellation, therefore, cannot alter nature of transaction. For all these reasons, we are of considered view that credit shown in P&L a/c as profit on cancellation of forward contracts is as integral part of export business, as purchases or imports. As it effectively controls and reduces cost of imports, and is integral part of export business profits, and as, in our considered view, exclusion clause under cl. (baa) of Explanation to s. 80HHC cannot apply to these profits, authorities below were indeed not justified in holding that 90 per cent of these profits is required to be excluded from profits of export business. This amount is not covered by any of categories which are covered by aforesaid clause in Explanation to s. 80HHC. We, therefore, uphold contention of assessee, and direct AO to recompute deduction under s. 80HHC by, inter alia, not excluding 90 per cent of profit realized on cancellation of forward foreign exchange contracts, from profits of export business. assessee succeeds on this issue. Ground No. 11 is thus allowed. In result, appeal is allowed in terms indicated above. *** D. KISHORE KUMAR & CO. v. DEPUTY COMMISSIONER OF INCOME TAX
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