COMMISSIONER OF INCOME-TAX VS SRI RAMALINGA CHOODAMBIGAI MILLS LTD.
2001 P T D 495
[239 I T R 120]
[Madras High Court (India)]
Before R. Jayasimha Babu and N. V. Balasubramanian, JJ
COMMISSIONER OF INCOME‑TAX
versus
SRI RAMALINGA CHOODAMBIGAI MILLS LTD.
Tax Case No.162 of 1985 (Reference No.70 of 1985), decided on 19/02/1998.
Income‑tax‑‑‑
‑‑Business expenditure‑‑‑Damages paid for cancellation of contracts for purchase of cotton as assessee decided to produce yarn of higher count‑‑ Hedging contracts and not speculative transaction‑‑‑Deductible as revenue expenditure‑‑‑Indian Income Tax Act, 1961, Ss.28, Expln. 2 & 43(5)(a).
The assessee had entered into contracts during the previous year relevant to the assessment year 1976‑77 for the purchase of cotton required for the manufacture of yarn. Two of those contracts had to be cancelled because the assessee decided to produce yarn of higher counts and the variety of cotton ordered under those contracts was no longer required. The assessee, therefore, cancelled those contracts and had to pay a sum of Rs.40,687 as damages. The amounts so paid was claimed as deduction as revenue expenditure in computing the income from the business. The Income‑tax Officer disallowed the claim on the ground that the amounts claimed had been paid by the assessee voluntarily after having unilaterally cancelled the Contract and was, therefore, to be treated as speculation loss. The Commissioner of Income‑tax (Appeals), to whom the assessee appealed, held that the contracts were in the nature of hedging contracts and could not be regarded as speculative transactions. The Tribunal affirmed that view of the Commissioner (Appeals). On a reference:
Held, that the contracts were entered into in the ordinary course of business of running a textile mill and had been entered into bona fide to secure the supply of the raw materials required by it. The contracts were later cancelled only because that raw material was no longer fit for the assessee's use, having regard to the fact that a different variety of cotton was required for the manufacture of higher count of yarn. Entering into such contracts and settling the same by paying damages does not amount to carrying on speculative business.
CIT v. Kamani Tubes Ltd. (1994) 207 ITR 298 (Bom.) fol
CIT v. Shantilal (P.) Ltd. (1983) 144 ITR 57 (SC) ref.
C.V. Rajan for the Commissioner.
Nemo for the Assessee.
JUDGMENT
R. JAYASIMHA BABU, J.‑‑‑The questions referred for our decision at the instance of the Revenue and which' arose from the assessment proceedings in respect of the assessment year 1976‑77 of a textile mill, Sri Ramalinga Choodambigai Mills Ltd., Tirupur, are:
(1) Whether, on the facts and in the circumstances of the case, the Appellate Tribunal is justified in law in holding that a sum of Rs.40,687 claimed to have been paid by the assessee for cancelling the contracts for purchase of cotton is not in the nature of a speculation loss?
(2) Whether, on the facts and in the circumstances of the case, the Appellate Tribunal is justified in holding that the assessee was not carrying on a speculation business and that the contracts entered into for purchase of cotton and the subsequent settlement of the contracts otherwise than by actual delivery of goods, will not constitute a speculation business?"
The assessee had entered into contracts during the previous year relevant to the assessment year in question for the purchase of cotton required for the manufacture of yarn. Two of those contracts had to be cancelled because the assessee decided to produce yarn of higher counts and the variety of cotton ordered under those contracts was no longer required. The assessee, therefore, cancelled those contracts and had to pay a sum of Rs.40,687 as damages. The amounts so paid was claimed as deduction as revenue expenditure in computing the income from the business. The Income‑tax Officer disallowed the claim on the ground that the amounts claimed had been paid by the assessee voluntarily after having unilaterally cancelled the contract and was, therefore, to be treated as speculation loss. The Commissioner to whom the assessee appealed, held that the contracts were in the nature of hedging contracts and could not be regarded as speculative transactions. The Tribunal has affirmed that view of the Commissioner, and in our opinion rightly.
The contracts had been entered into for securing supplies of cotton which is the raw material for the manufacture of the yarn the assessee's business being the manufacture of yarn. The assessee was not carrying on a separate and distinct business of speculating on trading in cotton. The decision of the assessee to cancel, these contracts was not with a view to suffer a loss or make profit, but to minimise the loss that it was likely to suffer as the purchase of that variety cotton would not have been of utility to the assessee after the assessee had changed the plan of manufacture. which required a different variety of cotton.
Learned counsel for the Revenue submitted that these transactions must be regarded as speculative transactions, in view of the definition of speculative transaction set out in section 43(5) of the Act. That provision defines speculative transaction as one for the purchase or sale of any commodity, including stocks and shares, which is periodically or ultimately settled otherwise than by the actual delivery of the commodity or scups. The proviso to section 43(5)(a) provides that a contract in respect of raw materials or merchandise 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, shall not be deemed to be a speculative transaction. The assessee here had entered into the contracts for the purchase of cotton which was required for the manufacture of the yarn. As those contracts were in the nature of hedging contracts; those contracts are excluded by the very definition from the category of speculative transactions.
Learned counsel for the Revenue also submitted that in view of the Explanation 2 to section 28 of the Act, where speculative transactions carried on by an assessee are of such a nature as to constitute a business, the business shall be deemed to be distinct and separate from any other business. That Explanation is not attracted here as the assessee was not carrying on a speculative business in the purchase or sale of cotton. Even assuming that the contract in question can be regarded as constituting speculative transactions, that by itself would not be the sufficient to hold that the assessee was carrying on a speculative business. The contracts were entered into in the ordinary course of business of running a textile mill and had been entered into bona fide to secure the supply of the raw materials required by it. The contracts were later cancelled only because that raw material was no longer fit for the assessee's use, having regard to the fact that a different variety of cotton was required for the manufacture of higher count of yarn. If all such contracts are excluded from the definition of speculative transaction entering into such contracts, and settling the same by paying damages does not amount to carrying on speculative business for the purpose of Explanation 2 to section 28 of the Act.
Counsel for the Revenue invited our attention to the decision of the Supreme Court in the case of CIT v. Shantilal (Private) Limited (1983) 144 ITR 57, wherein the Court dealt with a case of an award made pursuant to a claim for damages on account of breach of contract, and held that such arbitration award does not amount to settlement of contract for the purpose of section 43(5) of the Act. That judgment is not of any assistance to the Revenue in this case.
Counsel also referred to a decision of the Bombay High Court in the case of CIT v. Kamani Tubes Ltd. (1994) 207 ITR 298, wherein the Court observed that in deciding the character of the transaction, what is important to consider is the distinctive character of such transactions. In each case it is the total effect of all the relevant facts and circumstances that determines the character of the transactions. We are entirely in agreement with that view.
The questions referred for our decision are, therefore, answered in the affirmative, against the Revenue and in favour of the assessee. The assessee is entitled to costs in the sum of Rs.1,000.
M.B.A./200/FC
Reference answered