M G BROTHERS Vs. COMMISSIONER OF INCOME TAX

JUDGEMENT

(1.) The Income-tax Appellate Tribunal referred the following two question of law for the opinion of this court under s. 256(1) of the I.T. Act, 1961 :

(2.) The assessee, a partnership firm, carries on business in the manufacturer and sale of groundnut oil and its bye-products. For the income-tax assessment year 1973-74, the assessee filed its return declaring income of Rs. 2,90,807. While declaring the income as above, the assessee claimed that it suffered a loss of Rs. 1,60,946 in respect of certain transaction which it entered into in cotton seed oil and neem oil. It is not disputed there this loss was suffered by passing paying difference pursuant to settlement to the contracts otherwise than by delivery of goods. The assessee did not dispute that these transaction fell within the meaning of the expression "speculative transactions" under s. 43(5) of the I.T. Act, 1961 (for short "the Act"), but claimed that the transactions in question fell within the scope of clause (a) of the proviso to sub-s.(5) of s.43 and should not, therefore, but treated as "speculative transactions". The assessee accordingly claimed that the loss of Rs. 1,60,946 should be held to have been incurred during the course of its business and set off accordingly against the income under the head "Business". In other words, the assessees claim was that the loss in transaction relating to cotton seed oil and neem oil pertained to contracts in respect of raw material or merchandise entered into by it in the course of its manufacturing or merchanting business to guard against loss through future price fluctuations in respect of its contracts for actual a delivery of goods manufactured by it or merchandise sold by it. The contracts relating to cotton-seed oil and neem oil, which resulted in the above loss, are not in respect of the assessees manufacturing operation in groundnut oil and, in that sense, the commodities of cotton seed oil and neem oil are unconnected with the manufacturing business. The assessees case, however, is that the contracts were entered into by it in the course of its merchanting business and, therefore clause (a) of the proviso to sub-s.(5) of s.43 is clearly applicable. It may be mentioned that the contracts excluded from the purview of "speculative transactions" under s. 43(5) are what are popularly called "hedge contracts". The modus operandi of a hedging transaction is succinctly explained by a well-known economist, W. R. Natu, in his book "Regulation of Forward Markets" at page 19 as under :

(3.) If a forward contract satisfies the requirement of clause (a) of the proviso to sub-s.(5) of s.43 of the Act, then the transactions covered by that contract shall not be deemed to be speculative transactions. The consequence would be that any profit or loss arising on such hedge contract will be held to be profit or loss arising in the normal cause of the assessees business and will be dealt with as such. In the present case, if the contracts entered into by the assessee in relation to cotton seed oil and seem oil could be held to be hedging transaction satisfying the requirement of clause (a) of the proviso to sub-s. (5) of s. 43 above referred to, the assessees claim for setting off that loss against its income from business is perfectly tenable. The ITO declined to accept the assessees claim that the contracts entered into by the assessee relating to cotton seed oil and neem oil were hedge contracts. The ITO held that the assessee does not manufacture and sell either cotton seed oil or neem oil. The ITO also held that the contracts in question are not in respect of merchandise entered into or dealt with by the assessee in the course of its merchanting business. The ITO categorically found that the assessee never carried on any business in the commodities of cotton seed oil and neem oil, whether as a manufacturer or as a merchant. In those circumstances, the ITO held that the ingredients of clause (a) of the proviso to sub-s. (5) of s. 43 were not satisfied. In that view, the ITO held that the loss arose in respect of transaction which are clearly "speculative transactions" within the meaning of s. 43(5) of the Act are not saved by clause (a) of the proviso to sub-s. (5) of s. 43; consequently, the ITO rejected the assessees claim for setting off the above referred loss against the assessee income from business.