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(i) These contracts were booked as permitted by RBI Regulations.

(ii) The transactions were covered by the exception provided in section 43(5)(a) on the Income Tax Act, 1961."

3. Briefly stated relevant facts of the case are that the assessee is engaged in the business of trading and manufacturing of rough and polished diamonds and filed the return of income declaring the total income of Rs. 35,29,042/-. Assessment was completed u/s 143(3) of the act determining the total income of Rs. 5,04,71,720/-. Assessing Officer made addition of Rs. 4,69,42,680/-. Relevant facts leading to the said addition include that the assessee being an exporter, made export of diamonds and outstanding receivable in foreign currency and entered into forward contracts with the Banks to hedge the exchange loss if any. Further, in accordance with the statutes, he also revalued the outstanding export receivable too. The total gain on account exchange difference on exports is Rs. 679.75 lacs on account of both actual realization and revaluation of outstanding receivables. The loss incurred on account of forward contracts to safeguard the outstanding receivables is Rs. 469.43 lacs. Accordingly, assessee set off the loss against the said gain and credited the net amount/ profit of Rs. 210.14 lacs to the profit and loss account. During the assessment proceedings, AO made various enquiries with regard to this credit entry and in response, assessee filed letters dated 29th and 30th November, 2011 which formed part of the assessment order. In these letters, the assessee provided numerous statistical data to justify its stand. In brief, total forward contracts entered into during the year works out to Rs. 135.99 Crs and the total cancellation is Rs. 126.3 Crs, the net forward contract is Rs. 9.95 Crs. The total exports in the year works out to Rs. 107.57 Crs. Total outstanding receivable in foreign exchange is much higher than any of these figures. Briefly, the stand of the assessee is that it entered into forward contracts with the banker to safeguard against the exchange fluctuations of export considerations/sale profits. It is the stated reasoning of the assessee, being an exporter, he has outstanding receivables whose value in US dollar is always subjected to market fluctuations internationally. Therefore, he needs to hedge the receivable against the exchange loss if any. Accordingly, he entered into the forward contracts with the Banks as per the RBI guidelines. Thus, the gains as well as the loss constitute business gains and loss and entitled for set off before the net gains is credited to the P and L Account. In this regard and before the AO, the assessee relied on the exemptions provided in clause (c) of the proviso to section 43(5) of the Act which provides for the definition of "speculation transaction". Clauses (a) to (e) of the said section provides for exemption of certain facts from the definition of "speculation transaction‟. Thus, the assessee contended that the impugned loss is outside the scope of the "speculation transaction" and the loss being integral part of the export 7 ITA 1359/Mum/2014 business constitutes 'business loss'. Consequently, the same is eligible for set off against the foreign exchange gains earned by the assessee both on account of actual realizations and revaluation of the outstanding receivables. Eventually, AO considered the above submissions of the assessee and also examined the applicability of the provisions of section 43(5) of the Act in general and clause (c) of the proviso to section 43(5) in particular and held that the impugned transactions do not satisfy in all the conditions specified in the said provisions. Relevant discussion is given in para 9 of the assessment order. AO dismissed the applicability of clause (a) of the proviso to section 43(5) stating that the assessee failed to demonstrate that the impugned transactions were incurred for hedging the risk against the raw material or merchandize. Similarly he rejected the applicability of clause (b) of section 43(5) of the Act too. AO opined that the same applies to the stocks and shares. On the applicability of clause (c) to section 43(5), AO dismissed the submissions of the assessee stating that the said provisions apply only to a case of contract entered into by a member of a forward market or an exchange which is not the case here. Finally, on the applicability of clause (d) of the proviso to section 43(5), AO ruled out the same considering the unfulfilment of the conditions specified therein. Thus, the AO concluded that the foreign exchange contracts constitute speculative transactions u/s 43(5) of the Act. AO also discussed the provisions of Explanation 2 to section 28 of the Act which provides for the explaining the deemed 'speculation business' and held that the profit and loss arising from such transactions have to be computed separately and treat the same as per the provisions relating to the 'speculation business'. In this context he also referred to the provisions of Explanation to section 73 relating to 'speculation loss'. Relying on the principles relating to the onus AO held that the assessee failed to demonstrate that the transactions in question relates to hedging transactions. AO analyzed the principles laid down by the AAR-New Delhi, in the case of Sopropha S.A., In re [2004] 268 ITR 37/138 Taxman 75 and held that the said principles are found unfulfilled for calling the impugned transactions as hedging transactions. On the burden of proof issues, AO relied on the judgment of the Hon'ble Supreme Court in the case of CIT v. Joseph John [1968] 67 ITR 74. Referring to the Delhi High Court judgment in the case of Delhi Flour Mills Co. Ltd. v. CIT [1974] 95 ITR 151 (Delhi), AO opined that the foreign exchange transactions cannot have any nexus with the export of diamonds. In this regard, AO is of the opinion that the person selling cotton cannot enter into forward contract, say for gold. He also discussed the judgment of Bombay High Court in the case of CIT v. Arjan Khimji & Co. [1980] 121 ITR 421/[1979] 1 Taxman 550. Thus, AO concluded by stating that the foreign exchange/currency derivative transactions are not covered by the exclusions provided in the proviso to section 43(5) of the Act. Further, he held that assessee failed to the establish that the transactions in question have the nature of hedging transactions and he treated the loss of Rs. 4,69,42,680/- as the speculation loss and made the addition. So far as the profit earned on actual realization of export proceeds and the profits on revaluation of the outstanding receivable is concerned, the AO taxed the as the business income of the assessee and accordingly, denied the set off of the loss of 8 ITA 1359/Mum/2014 Rs. 4,69,42,680/- against the gains of Rs. 679.75 lacs. Aggrieved with the same, assessee filed the present appeal before the CIT (A).

Before the CIT (A)

4. During the proceedings before the first appellate proceedings, assessee made written submissions and mentioned that the impugned forward contracts (FCs) are linked or incidental to the export invoices of the year and the outstanding receivables related to the exports and therefore, these are hedging transactions and constitutes business contracts. Assessee mentioned that, leaving 50% of the contracts which are settled by delivery, rest of the transactions are either terminated by the Bank on due / maturity dates due to commercial reasons because of non-realization of exports from the debtors. Further, the assessee mentioned that out of the forward contracts cancelled prior to the due dates, some of these contracts are cancelled three days prior in view of the week end holidays. Referring to the terminated and cancelled Forward contracts on the due date or later, the assessee reasoned that it directly imply the integral part of the export business and therefore, the related loss constitutes business loss'. Referring to the rest of the loss-yielded FCs, which are cancelled prior to the due date, assessee mentioned that they are cancelled to reduce the loss and it is a business decision of the assessee. Further, assessee argued that the provisions of section 43(5) are not applicable to this case as it applied only to the commodity including stocks and shares and relied on the decision of the ITAT, Delhi in the case of Munjul Showa Ltd. v. Dy.CIT. 94 TTJ 227 [2005]. As per the assessee the forward contracts do no constitutes 'commodity', which is precondition for invoking the said sub-section (5) of section 43 of the Act. Even if it is applied, the impugned FCs being hedging in nature are covered by clause (a) to the proviso to section 43(5) of the Act. The outstanding receivables are always higher than the forward contracts cumulatively. In large number of transactions, the cancellation of contracts was done only on the maturity and therefore, there are no speculative contracts. Assessee relied on the Bombay High Court judgment in the case of CIT v. Badridas Gauridu (P.) Ltd. [2003] 261 ITR 256 and Ors and mentioned that the said judgment applied to the case of the assessee. Regarding the AO's reliance on AAR Ruling in the case of Sopropha S.A. (supra), assessee submitted that considering the fact that the assessee fulfills couple of conditions and the impugned transactions must be treated as hedging transactions. Further, assessee relied on RBI Circular dated 13.12.2006 and the CBDT Circular No.23D dated 12.9.1960 and mentioned that RBI has no problem with the impugned contracts as they are undergone to guard the risk of underlying receivables and the claim of the assessee needs to be accepted. Assessee also relied on the Dollar rate fluctuations from April 2008 to March 2009, which registering per dollar appreciation from Rs. 39.9668 to Rs. 51.2062 during the year. Eventually. CIT (A) considered and rejected above arguments of the assessee. Eventually, assessee's appeal was dismissed upholding the conclusions of the AO. Aggrieved with the decision of CIT (A), assessee filed the present appeal before the Tribunal vide ground imported above.

6. Elaborating the disputes and the issues, Ld Counsel submitted that the assessee entered into the Forward Contracts (FCs) with the Banks as integral part of the export business with the aim to safeguard against the foreign exchange fluctuation of the US dollar vis a-vis the Indian currency and therefore, the FCs are not speculative transactions or speculation business. To substantiate the same, he mentioned that the total worth of the FCs entered during the year are Rs. 135.99 Crs and same constitute merely around 3% of the 'Outstanding Receivable of export proceeds in foreign currency' in the beginning of the year. At no point of time, the same exceeded the said trade receivables in currency.

"It is true that the CIT (A) has made some observations which would prima facie suggest that there was no direct co-relation between the exchange document and the precise contract. However, such observations cannot be seen in isolation................

.............We find that the decisions of the Bombay High Court and the Calcutta High Court noted above would cover the situation.

34. From the above analysis and summary of judgments, it is safely concluded that the impugned FCs are "commodities". However, considering the fact that these FCs are integral part or incidental to the core business of export of diamonds or the outstanding receivables of export proceeds, in principle, the impugned FCs constitute 'hedging transaction' and not the 'speculative contracts'. As such, the banks do not entertain FCs of speculative nature with the customers like the assessee, the exporter. As such, the extension of FCs, in case of non-receipt of export proceeds on the due dates, is not allowed without cancelling the existing FCs. However, the onus is on the assessee to explain satisfactorily why the assessee resorted to premature cancellation of some FCs. Further, it is not the requirement that there must be 1:1 precise correlation between FC and the corresponding export invoice. So long as the total FCs does not exceed the exports of the year plus outstanding export receivable, the FCs can constitute 'hedging transaction'. Further also, the 'premature cancellation of FCs may not alter the above conclusions so long as the assessee has valid and acceptable explanation for such cancellations. It should not be the case, to start with, FC can be a 'hedging transaction' but the ending of such FC is 'speculation'. In the light of this synopsis of our views in the matter, we shall not deliberate on the impugned losses.