Loss on foreign exchange forward contracts is incidental to the exports business and not a “speculation loss“. However, if the contract is prematurely cancelled, the assessee has to justify the loss

London Star Diamond Company (I) P. Ltd vs. DCIT (ITAT Mumbai)

The assessee, an exporter of diamonds, entered into forward contracts with Banks to hedge the exchange loss, if any, in respect of the outstanding receivable in foreign currency. The assessee suffered a loss of Rs. 4.69 crore on account of the maturity & premature cancellation of the said forward contracts. The AO & CIT(A) held that the forward contracts constituted a “speculative transaction” u/s 43(5) and that the loss suffered thereon was a “speculation loss” which could not be set-off against the other income. On appeal by the assessee to the Tribunal HELD:

 

(i) Though a forward contract for purchase or sale of foreign currency falls in the definition of “speculation transaction” u/s 43(5) as it is settled otherwise than by the actual delivery or transfer of the commodity, it cannot be regarded as constituting a “speculation business” under Explanation 2 to s. 28. A forward contract, entered into with banks for hedging losses due to foreign exchange fluctuations on the export proceeds, is in the nature of a “hedging contract” and is integral or incidental to the export activity of the assessee and cannot be considered as an independent business activity. Therefore, the losses or gains constitute business loss or gains and do not arise from speculation activities. The fact that there is a premature cancellation of the forward contract does not alter the nature of the transaction. There is also no requirement in the law that there should be a 1:1 correlation between the forward contracts and the export invoices. So long as the total value of the forward contracts does not exceed the value of the invoices, the loss has to be treated as a business loss (Sooraj Mull Magarmull 129 ITR 169 (Cal), Badridas Gauridu 261 ITR 256 (Bom), Panchamahal Steel 215 Taxman 140 (Guj) and Friends and Friends Shipping (Guj) followed; contrary view in S. Vinodkumar Diamonds (ITAT Mum) referred);

 

(ii) On facts, the loss arising on cancellation of matured forward contracts is allowable as it is attributable to the genuine failure of the trade debtors to comply with the credit terms and conditions. As regards the loss arising on account of premature cancellation of the forward contracts, the assessee requires to explain the reason for the premature cancellation. The explanation that the maturity of date of some of such premature cancelled forward contracts fell during the week-end and therefore they were cancelled three days prior to the due date is acceptable and the loss is allowable. The explanation that some other forward contracts were prematurely cancelled due to business reasons and to avoid higher loss requires to be examined by the AO. The correspondence with the banks and the RBI guidelines on the issue as well as the accounting treatment by the banks also requires to be examined. The assessee’s alternative argument that the said loss is “damages” payable to the banks for breach of contracts or settlement of the contracts also requires examination by the AO.

Growth in China's services activity accelerates.

China's official non-manufacturing PMI grew at the quickest rate in 13 months in October, rising to 56.3 from 55.4 in September. The increase adds to an improving manufacturing sector and provides further evidence that China's economy has stabilized. At a meeting this coming weekend, China's leaders are expected to unveil reforms to strengthen the services sector and open it up to foreign competition.

Eurozone manufacturing recovery broad-based.

Eurozone manufacturing PMI edged up to 51.3 in October from 51.1 in September. The "modest and fragile recovery continues and remains broad-based, with growth seen in all nations bar France and Greece," says Markit. Increasingly "robust gains" in production in countries such as Spain, Italy and Ireland "suggest that structural reforms to boost competitiveness are starting to pay off." The euro was +0.1% at $1.3508 at the time of writing.

Is the fiscal deficit under control?

In the first half of the last year, India's fiscal deficit had reached about 66% of the full year target. This time around (in FY14), it's at a much higher figure of 76%. While this is definitely an area of concern, the silver lining is that the month on month (MoM) increase has been declining. In other words, the deficit has been increasing at a slower pace. As can be seen from the chart below, the MoM increase in the fiscal deficit number (as a percentage of the estimated budget) has been slowing at a gradual pace. 

India's FM has been seemingly confident on meeting the fiscal deficit target of 4.8% of GDP, with the argument that the revenues are usually back ended. These hopes hinge on the improving tax collections as the economy picks up coupled with revenues from divestments. What must however be kept in mind is that that the fiscal deficit was targeted on expectation of a higher GDP growth rate. With the latter coming down as compared to what was anticipated at the start of the year, it is possible that the actual figure may be higher than anticipated (in percentage terms). Is this why the FM is forced to use his accounting gimmickry skills to make the situation seem better than it is? 

Chinese factory activity edges up.

China's official manufacturing PMI increased to an 18-month high of 51.4 in October from 51.1 in September and surpassed consensus. However, the reading for big companies rose, while that for smaller ones dropped into contraction territory, highlighting the unbalanced nature of China's economy. HSBC's PMI data edged up to 50.9 from 50.2. Readings for South Korea, Indonesia, Vietnam and Taiwan indicated that manufacturing grew in those countries, although India remained in contraction.

AT&T exploring Vodafone acquisition.

AT&T (T) is reportedly preparing the groundwork for a takeover of Vodafone (VOD) next year in a deal that would create a company with a market cap in excess of $250B and over 500M wireless subscribers. Executives at the U.S. carrier are trying to identify which assets it would retain and who would buy businesses that would be spun off. Any deal, of course, would have to wait until Vodafone closes the sale of its Verizon Wireless stake.

BOJ maintains policy as is; ups GDP outlook.

As expected, the Bank of Japan has maintained its program of expanding the monetary base at an annual rate of ¥60-70T ($611-713B) a year. The BOJ said it is making steady progress in achieving its target of 2% inflation, and reiterated that it expects CPI of 1.3% in 2014-15 and 1.9% a year later. The central bank slightly increased its 2014-15 GDP growth outlook to 1.5% from a prior prediction of 1.3% but maintained its 2015-16 forecast at 1.5%.