S. 43(5): Loss on foreign currency forward contracts by a manufacturer/ exporter is a “speculation loss” and not a “hedging loss”

The assessee, a dealer in diamonds, entered into forward contracts in US dollars. Some of the contracts were cancelled during the year and some were outstanding at the end of the year. The assessee suffered a loss of Rs. 4.02 crores on account of the cancellation and “marked to market” of the said forward contracts and claimed that sum as a deduction. The AO & CIT(A), relied on Instruction No. 03/2010 dated 23-3-2010 and held that the said loss arose on account of a “speculative transaction” while the assessee claimed that it arose out of a “hedging transaction”. HELD by the Tribunal:

There is a difference between a “speculative transaction” and a “hedging transaction”. S. 43(5) defines a “speculative transaction” to mean a transaction in which a contract for the purchase or sale of any commodity, including stocks and shares, is periodically or ultimately settled otherwise than by the actual delivery or transfer of the commodity or scrips. Proviso (a) to s. 43(5) refers to a “hedging transaction” as a contract in respect of raw materials or merchandise entered into by a person in the course of his manufacturing or merchandising business to guard against loss through future price fluctuations in respect of his contracts for actual delivery of goods manufactured by him or merchandise sold by him. In order for a transaction to be a “hedging transaction”, the commodity dealt in should be the same. If the subject matter of the transaction is different, it cannot be termed a hedging transaction. Also, the merchandise in respect of which the forward transactions have been entered into by the assessee must have a direct connection with the goods sold by him. On facts, as the assessee was not dealing in Foreign Exchange, the forward transactions entered into by it cannot be held to be hedging transactions. As the assessee is dealing in diamonds, only the forward contracts entered into for diamonds would be covered by Proviso (a) to s. 43(5). Consequently, the loss suffered by the assessee is a speculative loss.