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Addl. Commissioner of Income-tax Vs. M.P. Sugar Mills (P.) Ltd. - Court Judgment

LegalCrystal Citation
SubjectDirect Taxation
CourtAllahabad High Court
Decided On
Case NumberIncome-tax Reference No. 83 of 1975
Judge
Reported in(1984)38CTR(All)112; [1984]148ITR203(All); [1983]15TAXMAN247(All)
ActsIncome Tax Act, 1961 - Sections 43 and 43(5)
AppellantAddl. Commissioner of Income-tax
RespondentM.P. Sugar Mills (P.) Ltd.
Appellant AdvocateM. Katju, Adv.
Respondent AdvocateRajaram and ;Rajesh Kumar, Advs.
Excerpt:
.....qualify the term 'goods 'about which there is a contract for actual delivery. act, 1922, was available also in respect of hedging contracts which are contracts of sale as..........the loss that is likely to be occasioned to a manufacturer in respect of price fluctuation of the goodscontracted to be delivered can be safeguarded by entering into hedging contract by way of sale of the raw materials. in our opinion, there exists no valid reason for, in the case of a manufacturer, excluding from the ambit of hedging contracts contemplated by section 43(5)(a), hedging contracts in respect of raw materials that are entered into by way of sale and confining the same to hedging contracts by way of purchases of such raw materials alone. it will depend upon the facts of each case whether a particular transaction by way of forward sale, which is mutually settled otherwise than by actual delivery of the said goods, has been entered into with a view to safeguard against loss.....
Judgment:

H.N. Seth, J.

1. The assessed, M/s. M.P. Sugar Mills Private Ltd., Kanpur, is a private limited company and runs amongst other units, a sugar mill at Majhaulia and an oil mill at Kanpur. It claimed that during the accounting period relevant to the assessment year 1963-64, it incurred a liability for payment of Rs. 10,92,364 for deferred payment of cane price under price-linking formula and as such it was entitled to an allowance of this amount while computing its income. The ITO disallowed the claim made by the assessee. In appeal, the order passed by the ITO in this regard was upheld by the AAC. However, in second appeal, the Income-tax Appellate Tribunal accepted the claim made by the assessee and held that it was entitled to the allowance claimed by it.

2. The assessee's trading account showed that in connection with its oil mill business it had incurred the following losses which, according to the assessee, partook the nature of hedging losses, and the assessee claimed that it was entitled to deduct the same from its business profits :

Rs.

A.

Lahi sarson vaida-net loss

2,35,882

B.

Moongphali vaida-loss

13,605

Total

2,49,487

3. The ITO disallowed the claim of the assessee. In appeal, the AAC agreed with the reasons given by the ITO. He observed : 'Whatever may be the position in the commercial world, it seems to me from a reading of Section 43(5)(a) that in the case of a manufacturer only forward purchase contracts in raw material against contracts to make actual supply of manufactured goods are hedging transactions.' The appellant's attempt to extend the definition to forward sale contracts in raw materials is not justified by the wordings in the section and upheld the order passed by the ITO. In second appeal, the Income-tax Appellate Tribunal came to the conclusion that the assessee had suffered the loss in question as a result of certain forward transactions of sale of raw materials used by it in manufacturing oil and that such contracts had been entered into with a view to safeguard loss on account of fluctuation in price and were as such contracts of hedging nature which fell outside the ambit of speculative transactions described in Section 43 of the I.T. Act, 1961 (hereinafter referred to as 'the Act'). The assessee was accordingly entitled to adjust the same against its business profits. On the request made by the Commissioner of Income-tax, the Income-tax Appellate Tribunal has stated the case request-ing us to express our opinion on the following two questions of law which, according to it, arose out of its appellate order :

'Whether, on the facts and in the circumstances of the case, the Appellate Tribunal was legally correct in holding that the sum of Rs. 10,92,346 on account of additional price of sugarcane represented a liability of the assessee-company for the assessment year 1963-64 and could be allowed as a deduction in computing its total income ?

Whether, on the facts and in the circumstances of the case, the Appellate Tribunal is legally justified in holding that the loss of Rs. 2,49,487 is a hedging loss within the meaning of Section 43(5)(a) of the Income-tax Act, 1961, and could accordingly be set off against the business income of the assessee '

4. So far as the first question referred by the Tribunal is concerned, the parties are agreed that the same question, which arose in similar circumstance in the case of the assessment of the assessee for the years 1961-62 and 1962-63, was referred by the Tribunal to this court and this court, vide its decision reported in the case of Motilal Padampat Sugar Mills v. CIT : [1977]106ITR988(All) , and in ITR No. 665 of 1974 (CIT v. M. P. Sugar Mills (P.) Ltd.) decided on 5th of April, 1978, held that in law the liability to pay additional price did accrue in the year in which the sugarcane was purchased and within which the minimum price was fixed and hence the assessee was entitled to claim deduction of a reasonable estimated amount or, in the alternative, if during the course of the assessment proceedings, the actual amount is quantified, the quantified amount. In view of the said decisions, which are inter parties, the first question referred to us must be answered in the affirmative and in favour of the assessee.

5. A perusal of the appellate order of the Tribunal indicates that so far as the second question is concerned, the main difference between the assessee and the Department was in respect of the interpretation of the provisions contained in Section 43(5) of the Act. Whereas according to the assessee, in the case of manufacture, contracts both for sale and purchase of raw materials if entered into with a view to safeguard the future price fluctuation in respect of contracts for actual delivery of goods manufactured by it are taken out of the ambit of speculative transaction as defined by Section 43(5) of the Act, the case of the Department is that it is only such contracts for purchase made by the assessee that qualify for not being treated as speculative transactions.

6. Section 43(5) provides that speculative transaction means a transaction in which a contract for the purchase or sale of any commodity including stocks and shares, is periodically and ultimately settled otherwise than by the actual delivery or transfer of the commodity or scrips. Clause (a),however, provides that the transaction of the nature mentioned above will not be deemed to be speculative transaction if the contract in respect of raw materials or merchandise had been entered into by a person in the course of his manufacturing or merchanting 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. Such contracts entered into by a merchant or manufacturer to safeguard against loss through future price fluctuation are in the commercial world known as hedging contracts. This clause contemplates contracts entered into by two classes of persons, namely, (1) a person who manufactures goods from raw materials, and (2) a merchant who carries on merchanting business. Whereas in the case of a manufacturer it is the contract entered into by him in respect of raw materials used in the course of his manufacturing business to guard against loss through future price fluctuations in respect of his contracts for actual delivery of goods manufactured by him, that are taken out of the ambit of speculative transactions, the contracts taken out of the scope of such transactions in the case of merchants are those which he enters into in respect of his merchandise with a view to safeguard loss through future price fluctuation in respect of contracts for actual delivery of merchandise sold by him. It is significant to note that Section 43 nowhere provides that such hedging contracts must necessarily be purchase contracts. Of course, in cases where loss through future price fluctuation in respect of contracts for actual delivery of goods manufactured or merchandise sold, can in fact not be safeguarded by entering into contract for sale of raw materials or merchandise, there would be no reason to exclude such transaction from the ambit of Section 43(5)(a) of the Act. It may be that in the case of merchandise one may urge that when one enters into a hedging contract in respect of merchandise to guard against loss through future price fluctuation in respect of the merchandise sold, such contract has necessarily to be that of a contract for purchase (we are not concerned with this question in this reference), but then the same thing cannot be said about hedging contracts entered into by a manufacturer in respect of raw material.

7. Even though in the commercial world the cost of raw material plays an important role in determining the price at which a manufacturer agrees to sell or deliver the manufactured goods, yet it does not necessarily mean that future price fluctuation in respect of the manufactured product must correspond to price fluctuation in respect of the raw material. There can be cases where even while the price of raw materials falls, the price of the manufactured goods contracted to be delivered may go up resulting in a loss to the manufacturer. In such a case, the loss that is likely to be occasioned to a manufacturer in respect of price fluctuation of the goodscontracted to be delivered can be safeguarded by entering into hedging contract by way of sale of the raw materials. In our opinion, there exists no valid reason for, in the case of a manufacturer, excluding from the ambit of hedging contracts contemplated by Section 43(5)(a), hedging contracts in respect of raw materials that are entered into by way of sale and confining the same to hedging contracts by way of purchases of such raw materials alone. It will depend upon the facts of each case whether a particular transaction by way of forward sale, which is mutually settled otherwise than by actual delivery of the said goods, has been entered into with a view to safeguard against loss through price fluctuation in respect of the contract for actual delivery of the goods manufactured.

8. In support of his submission that hedging contracts to guard against loss on account of future price fluctuation of the manufactured commodity, have necessarily to be those by way of purchase and not by way of sale, learned counsel for the Revenue relied upon the cases of Chimanlal Chhotalal v. CIT : [1968]69ITR129(Guj) , CIT v. SK. AR. K. AR. Somasundaram Chettiar & Co. : [1975]101ITR832(Mad) and CIT v. Agrawal Brothers : [1980]123ITR231(MP) .

9. In the case of Chimanlal Chhotalal v. CIT : [1968]69ITR129(Guj) , a dealer in cotton and cotton seeds had entered into forward contract for sale of kapas and cotton bales which were eventually settled between them otherwise than by actual delivery of goods. The assessee claimed that those transactions had been entered into as hedging contracts, and that they fell within the ambit of prov. (a) to Expln. 2 of Section 24 of the Indian I.T. Act, 1922 (which corresponds to prov. (a) to Section 43(5) of the I.T. Act, 1961), and could not be regarded as speculative transactions. A Division Bench of the Gujarat High Court had pointed out that the said clause contemplated taking out of the scope and ambit of Expln. 2 'a contract in respect of raw materials or merchandise entered into by a person in the course of his manufacturing or merchanting business' and, prima facie, these words would include not only a contract for purchase of raw materials or merchandise but also a contract for sale of raw materials or merchandise. But then, as such hedging contracts are to be entered into for purposes of guarding against loss through future price fluctuations in respect of contracts for actual delivery of goods manufactured or merchandise sold which in the context had to be contracts for sale of the merchandise or manufactured goods, the hedging contracts in respect of such transactions must necessarily be a forward contract of purchase. In coming to this conclusion, the Bench seems to proceed on the assumption that having regard to the nature of commercial transactions, loss suffered because of price fluctuations in respect of a contract for sale of manufactured goods can never besafeguarded by entering into a forward contract for sale of raw materials, the underlying assumption being that fluctuation in price of raw materials necessarily results in similar fluctuation in the price of manufactured goods. In our opinion, such an assumption is not justified. As already indicated by us, there can be cases where while the price fluctuation of manufactured goods may be having an upward trend, the price of raw materials may have a downward trend and in such cases one can enter into forward contracts for sale of raw materials to cover up a possible loss that the manufacturer may suffer in respect of his contract for actual delivery of manufactured goods by reason of the price of such goods going up in the meantime.

10. In CIT v. SK. AR. K. AR. Somasundaram Chettiar & Co. : [1975]101ITR832(Mad) , the Madras High Court was required to consider the question as to whether in the case of a trader, a loss on account of price fluctuation in respect of a contract for actual delivery of merchandise could be safeguarded by entering into a hedging contract by way of sale of merchandise. It came to the conclusion that since contracts for delivery of merchandise are necessarily contracts for sale, the corresponding hedging contracts in respect of such merchandise must necessarily be by way of purchases. Again, the underlying assumption being that loss suffered on account of fluctuation in the price of goods contracted to be delivered can in fact never be safeguarded by entering into a contract for sale of similar goods. In this case, the learned judges did not concern themselves with the question in relation to a manufacturer in whose case a hedging contract in respect of raw materials used in the manufacture of goods contracted to be delivered is taken out of the ambit of speculative transaction. It may be that in the case of hedging contracts in respect of goods similar to those covered by a contract for delivery entered into by a trader or merchant, the objective can be achieved only by entering into forward contracts by way of purchase of such goods. But then, that position does not enure in relation to hedging contracts in respect of raw materials entered into with a view to safeguard the loss on account of fluctuation in price of manufactured goods contracted to be delivered or sold.

11. The case of CIT v. Agrawal Brothers : [1980]123ITR231(MP) , also does not support the stand of the Revenue. In that case after considering the scope and ambit of prov. (a) to Section 43(5), Mr. Justice Oza came to the conclusion that in the case of a merchant it was open to him to enter into hedging contracts not only for purposes of safeguarding loss due to future price fluctuation in respect of the merchandise contracted to be delivered by him but also for safeguarding such loss in respect of the merchandise which he purchases and of which he takes actual delivery as well. In thisconnection, the learned judge referred to a number of decisions of the various High Courts wherein it had been held that hedging contracts covered by proviso (a) to Section 43(5) could only be entered into with a view to safeguard losses due to future price fluctuation in respect of contract for sale of goods sold and observed thus (p. 242):

'Unfortunately, none of the decisions referred to above have considered the proviso to indicate as to whether the phrase ' merchandise sold by him ' was a clause qualifying the term 'goods'. It is also clear that so far as the first part of the proviso is concerned, in none of these decisions it has been held that when the proviso talks of a contract in the beginning of the proviso, it is limited to one kind of contract. In fact, the decision of the Gujarat High Court clearly rules that this contract could be both ways so far as the interpretation of the first part of the proviso is concerned. The ultimate conclusion that the hedging contract could only be for purchase and not for sale, it appears, has been derived from the last part of this clause where it is stated ' merchandise sold by him '. And because the phrase uses the words ' sold by him' it is understood to mean that the contract for actual delivery of goods which could be protected could only be a contract of sale and not of purchase. In fact, it appears that because the manufacturer and merchant both have been put together, what ordinarily happens with a manufacturer has been considered and the sale has been made applicable to the case of a merchant although, with respect to the decisions quoted above, in our opinion, it does not appear to be the true interpretation of this clause of the proviso. In fact the term 'goods' has been qualified by two phrases. In the case of a manufacturer the phrase used is 'manufactured by him' and in the case of a merchant the phrase used is 'merchandise sold by him'. And this clearly goes to show that these two phrases qualify the term ' goods ' about which there is a contract for actual delivery. And if this contract for actual delivery is for sale, naturally a hedging contract could be for purchase, But if this contract for actual delivery happens to be one for purchase, then the hedging contract is bound to be for sale, as in the present case.'

12. Sohani J. did not agree with Oza J. The learned judge posed the question which required consideration by him thus (p. 246):

'The short question for consideration in this case is whether the forward contracts of sale entered into by the assessee for the purpose of guarding against loss through future price fluctuations in respect of the forward contracts of purchase are covered by prov. (a) to Section 43(5) of the Act.'

and held that the said proviso was attracted only if the following circumstances existed (p. 246):

' (i) There are contracts for actual delivery of goods manufactured by the assessee or of merchandise sold by the assessee ;

(ii) The assessee has by a subsequent transaction intended to guard against losses through price fluctuations in respect of contracts for actual delivery entered into by him ; and

(iii) the transaction in question must be a contract entered into in respect of raw materials or merchandise in the course of the assessee's manufacturing business or merchanting business and it should have been settled otherwise than by actual delivery of goods.'

13. In view of the fact that Sohani J. eventually came to the conclusion that in the case before him the Tribunal had found that the transactions in question had not been entered into by the assessee to guard against future loss in respect of any existing contract for actual delivery of merchandise sold by the assessee, he declined to go into the question as to whether or not the hedging contracts contemplated by the proviso could also be by way of forward contracts of sale of raw material or merchandise, as the case may be. In view of the difference of opinion between the two learned judges, the matter was referred to G. P. Singh, the Chief Justice, who agreed with Sohani J., that under prov. (a) to Section 43(5) ot the Act, it is only hedging contracts entered into to safeguard loss due to future price fluctuation in respect of merchandise or goods sold by the merchant or the manufacturer that could alone be taken out of the definition of speculative transactions. He also did not go into the question as to whether such hedging contracts could be entered into also by way of forward contracts for sale of goods or of raw materials.

14. We are accordingly of opinion that none of the aforementioned three cases, cited by the learned counsel appearing for the Revenue, are helpful to him.

15. In the case of Kirtilal Jaisinglal & Co. v. CIT : [1980]121ITR279(Bom) , while dealing with a similar question a Bench of the Bombay High Court referred to Circular No. 23 (XXXIX-4)-D of 1960, issued by the CBR which stated that the intention of Clause (a) of the proviso to Expln. 2 to Section 24(1) of the Indian I.T. Act, 1922, has always been that where bona fide forward sales are entered into with a view to guarding against the risk of raw materials or merchandise in stock falling in value, the loss arising as a result of such forward sale should not be treated as a speculation loss. Further, that hedging sales can be taken to be genuine only to the extent the total of such transactions does not exceed the total stocks of raw materials or merchandise in hand. If the forward sales exceed the ready stock, the loss arising from the excess transactions should be treated as loss arising from speculative transactions and not from genuine hedgingtransactions. It held that that the circular was binding on the I.T. authorities and that under it the benefit of Clause (a) of the proviso to Expln. 2 to Section 24(1) of the Indian I.T. Act, 1922, was available also in respect of hedging contracts which are contracts of sale as well. In the circumstances, the learned judges declined to interpret the provisions contained in Expln. 2 to Section 24(1) or prov. (a) thereof. The decision in this case, if at all, supports the eventual view which we are taking in this case.

16. In the case of Pankaj Oil Mills v. CIT : [1978]115ITR824(Guj) , a Full Bench of the Gujarat High Court did not agree with a Division Bench decision of the same court in the case of Chimanlal Chhotalal v. CIT : [1968]69ITR129(Guj) . After discussing the nature of hedging contracts entered into in the commercial world, it came to the conclusion that hedging contracts, in order to be out of speculative transaction, must be in respect of only raw materials so far as a manufacturer is concerned and that these contracts may be both with regard to sales and purchases.

17. In view of the aforesaid discussion, we are of the opinion that the Tribunal did not make any mistake in holding that the vaida transactions of sale of lahi, sarson and moongphali could be regarded as hedging contracts falling within Clause (a) of prov. (5) to Section 43 of the Act.

18. Learned counsel appearing for the Revenue next contended that in the instant case there is no finding by the Income-tax Appellate Tribunal to the effect that the transactions claimed to be hedging contracts by the assessee had been entered into to guard against loss through future fluctuation in the price of manufactured goods. Instead, the indications are that the said transactions had been entered into, if at all, with a view to guard against the price fluctuation of raw materials which the assessee used in the manufacture of goods and with a view to safeguard the loss through price fluctuation in respect of contracts for actual delivery of the goods manufactured by it. We are unable to accept this submission. After quoting the provisions of P. 43(5) in para. 13 (p. 62 of the paper book) of its appellate order, the Tribunal made the following observation :

' It is, therefore, clear that they were transactions of sale on which the assessee earned profits and the losses were mitigated. The reason was only to guard against the fluctuation in market prices...... In theassessee's case the contracts were for delivery of raw materials or goods produced. There is bound to be some time lag in the production of the goods and during that period prices may fall and in order to safeguard against the same, the assessee deals in forward sale of raw materials... '

19. Again in para. 16 (p. 66 of the paper book) of its order, the Tribunal went on to observe thus :

' The proviso provides for certain exceptions and one of them, with which we are concerned in this appeal is a contract in respect of raw materials entered into by a person in the course of his manufacturing business to guard against loss through future price fluctuations in respect of its contract for actual delivery of goods manufactured by him...... '

20. These observations go to indicate that the Tribunal accepted the assessee's case that the concerned contracts claimed to be hedging contracts in respect of raw materials had been entered into with a view to guard against future price fluctuation of the manufactured goods contracted to be sold by him. The Commissioner, in the statement of case in respect of the two questions of law for the opinion of this court, stated thus:

' ...the Tribunal has allowed the assessee's appeal by holding that in the case of a manufacturer, if in respect of contract for delivery of goods manufactured by him at a future date, in order to safeguard against loss through future price fluctuations, he enters into some contract for the purchase and sale of any material, such contracts would be hedging contracts. '

21. This shows that even the Commissioner, while requesting the Tribunal to make a reference to the court, took it that the finding of the Tribunal was that the contracts in respect of raw materials had been entered into by the assessee in order to safeguard against loss through future price fluctuation in respect of the contracts for purchase and sale of manufactured goods and it is too late in the day for him to contend before us that this was not so. While calling upon the Income-tax Appellate Tribunal to state the case before this court, the Department did not make any attempt to question the correctness of the said finding.

22. We are accordingly of opinion that even the second question has also to be answered in the affirmative and in favour of the assessee.

23. In the result, we answer both the questions referred to us in the affirmative and in favour of the assessee. The assessee will be entitled to costs which are assessed at Rs. 200.


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