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Judgment
Ramanujam, J.—The following question has been referred to this court by the Income Tax Appellate Tribunal:
Whether, on the facts and in the circumstances of the case, the transactions resulting in the loss of Rs. 2,04,746 in the previous year, relevant for
the assessment year 1960-61 and in the loss of Rs. 17,000 in the assessment year 1961-62 were saved from being treated as speculative
transactions by Clause (a) of the third proviso to Section 24(1) of the Indian Income Tax Act, 1922?
The assessee in this case is a registered firm, carrying on business in cloth and yarn, and having its head office in Madurat and two branches, one
in Vijayanagaram and another in Calcutta. Its main business consisted of purchase and sale of gada, manufactured by the Meenaksbi Mills Ltd.,
Virudhunagar Textiles Ltd., Loyal Textiles Ltd., Kodandarama Mills, etc. In the previous year ending April 12, 1960, relevant to the assessment
year 1960-61, the assessee claimed a loss of Rs. 2,04,746 as against Rs. 41,785, the gross profit shown in the return, Similarly, in the previous
year ending April 12, 1961, relevant to the assessment year 1961-62, the assessee claimed a sum of Rs. 17,000 as business loss in its return.
The assessee''s claim was rejected by the Income Tax Officer on the ground that the said two sums represented losses in speculative
transactions within the meaning of Explanation 2 to Section 24(1) and that, therefore, it cannot be allowed as a normal business loss. There were
appeals to the Appellate Assistant Commissioner. The Appellate Assistant Commissioner, however, upheld the Income Tax Officer''s view. On
further appeals to the Income Tax Appellate Tribunal, the Tribunal, however, upheld the contention of the assessee that the impugned transactions
in respect of which the losses occurred had been entered into in the course of its merchanting business to guard against loss through future price
fluctuations in the cloth and yarn purchases made by the assessee from various mills and that, as such, the transactions in question cannot be
considered to be speculative in view of Sub-clause (a) to the third proviso to Section 24(1) of the Act. The assessee''s claim for deduction of the
two sums as business losses in the respective years was, therefore, allowed by the Tribunal. Aggrieved against the said view of the Tribunal, the
revenue has sought this reference.
The question referred relates to the scope and ambit of Sub-clause (a) to the third proviso to Section 24(1) of the Indian Income Tax Act, 1922
(hereinafter referred to as ""the Act ""). The said provision so far as it is relevant is set out below:
(1) Where any assessee sustains a loss of profits or gains in any year under any of the heads mentioned in Section 6, he shall be entitled to
have the amount of the loss set off against his income, profits or gains under any other head in that year :
Provided that in computing the profits and gains chargeable under the head ''Profits and gains of business, profession or vocation'', any loss
sustained in speculative transactions which are in the nature of a business shall not be taken into account except to the extent of the amount of
profits and gains, if any, in any other business consisting of speculative transactions:
Provided further that.....
Provided that for the purpose of this Section,--
a) 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 scope of Explanation 2 to Section 24(1) which defines a ""speculative transaction"" came to be considered by this court in T. C. No. 130 of
1967 R. Chinnaswami Chettiar Vs. Commissioner of Income Tax, and T. C. No. 134 of 1967 A. Muthukumara Pillai Vs. Commissioner of
Income Tax, . In T. C. No. 130 of 1967 it was held that the word ""actual"" in Explanation 2 to Section 24(1) means ""real"" as opposed to the words
theoretical or probable"" and that whenever there is no actual delivery or transfer of the goods the transaction should be taken to be of a
speculative nature. In T. C. No. 134 of 1967 (A. Muthukumara Pillai Son v. Commissioner of income tax) this court had considered the scope of
Section 43(5) of the Income Tax Act of 1961 which corresponds to Explanation 2 to Section 24(1) of the Indian Income Tax Act of 1922. In that
case the court took the view that the definition of ""speculative transaction"" in Section 43(5) gives a simple test in deciding for the purpose of
Income Tax what a speculative transaction means, and expressed :
If a contract for sale or purchase is ultimately settled and no actual delivery of the goods was effected under the settlement, then it is a specu lative
transaction. The requirement u/s 30 of the Contract Act of the existence of the intention of the parties even at the time of original contract not to
give or take delivery of the goods to make it speculative or wagering transaction is dispensed with for the purpose of Income Tax. If the actual
delivery of the goods is not given under the settlement of the contract, then the intention of the parties at the time of the contract is immaterial.
In this case it has been conceded at all stages by the assessee that the transactions in respect of which the losses in question have occurred are
speculative transactions as defined in Explanation 2 and, therefore, it is not necessary for us to consider the scope of Explanation 2 to Section 24.
The only question for consideration is whether the transactions which are admittedly speculative coming within Explanation 2 to Section 24(1), will
fall within the scope of Clause (a) of the third proviso to that section.
Before we proceed to consider the scope and ambit of Clause (a) of the third proviso to Section 24(1), it is necessary to find out the exact
nature of the transactions in question in respect of both the assessment years 1960-61 and 1961-62. As already stated, the loss claimed in the year
1960-61 is Rs. 2,04,742 consisting of Rs. 6,492, being the loss in the cloth business and Rs. 1,98,254 in yarn business. The sum of Rs. 6,492
representing the loss in the cloth business arose out of transactions entered into by the assessee with two parties, (1) R. S. Krishnamachari, and (2)
Durga Textiles. But the nature of the transactions with the said two parties is substantially the same. The sum of Rs. 1,98,254 represents Rs.
45,754 debited in the accounts as losses due to price difference (vilaivasi) and Rs. 1,52,500 shown as losses in transactions or purchases and
sales involving no delivery of yarn. The amount of Rs. 17,000 debited as loss in the accounts for the year 1961-62 is purely the difference in price
(vilaivasi). As regards the said sum of Rs. 45,754 shown as loss in the year 1960-61 and Rs. 17,000 in the year 1961-62 towards vilaivasi, the
details of the transactions are not given and it is not known whether they related to purchase transactions or sale transactions in yarn. The modus
operandi adopted by the assessee in those transactions is not clear from the accounts maintained. It has been conceded before us by the assessee
that all the transactions in respect of which the above losses have been incurred are speculative transactions and, therefore, it is for the assessee to
establish that, by virtue of Clause (a) of the third proviso to Section 24(1), the transactions out of which the losses have occurred should not be
deemed to be speculative transations. In respect of the above two sums of Rs. 45,754 and Rs. 17,000, the assessee is not in a position to give the
details of the transactions and, therefore, it is not possible to find out whether the transactions out of which the above sums have been incurred as
losses were such as to come under Clause (a) of the third proviso. Once the assessee is not in a position to show that these transactions are
covered by Clause (a) of the third proviso to Section 24(1), then the transactions cannot be taken out of the category of speculative transactions.
We are, therefore, of the view that, in any event, the above two sums have to be treated as speculative losses.
Taking the rest of the amounts, that is, the loss of Rs. 6,492 in cloth business and Rs. 1,52,500 in yarn business, it is seen that though the
transactions in relation to these amounts are clearly numerous, the nature of all the transactions is substantially the same. Therefore, we propose to
consider the nature of only one transaction in cloth business and another in yarn business.
On 12th November, 1959, the assesses entered into a contract with Virudhunagar Textiles Ltd. for the purchase of 100 bales of gada cloth for
delivery in December, 1959, at Rs. 0-14-0 per yard. On November 14, 1959, it entered into a contract for the sale of of 100 bales of gada cloth
manufactured by Virudhunagar Textiles Ltd. to one R. S. Krishnamachari of Madurai for December delivery at Rs. 0-14-1 per yard and on that
day it held a stock of 8 bales and there was an outstanding contract for the purchase of 188 bales from the said mills. On 25th November, 1959, it
entered into a contract for the purchase of 100 bales of gada cloth from R. S. Krishnamachari at Rs. 0-14-5 per yard. It ultimately took delivery of
the 100 bales of gada from Virudhunagar Textiles Ltd. on 12th December, 1959, at the agreed price of Rs. 0-14-0 per yard and sold the same to
other parties in due course. On 31st December, 1959, the assessee settled his sale and purchase contracts with R. S. Krishnamachari by paying
the difference at 4 paise per yard for 100 bales and this amounted to Rs. 3,156.66
On 22nd September, 1959, the assessee entered into a contract with the Loyal Mills for purchase of 25 bales of yarn of 26''s at Rs. 19 per
bundle to be delivered in October, 1959. On 1st October, 1959, it had entered into a contract of sale with one P. R. S. Srinivasan for 25 bundles
of 26''s (Loyal) at Rs. 19-14-0 per bale to be delivered in December, 1959. On December 5, 1959, it entered into a contract for the purchase of
the same quantity with the same party at Rs. 21-6-0 per bundle to be delivered in December, 1959. It took delivery of the bales from the mills
later in various instalments and sold the same to various parties, the average sale price being Rs. 21 per bundle. It settled its purchase and sale
contracts on January 27, 1960, with the said Srinivasan by paying the difference of 8 annas per bundle for 25 bales without actual delivery, which
amounted to Rs. 1,500.
The question is whether the above purchase and sale contracts entered into by the assessee with those parties which were settled otherwise
than by actual delivery would come within Clause (a) of the third proviso to Section 24(1). Clause (a) deals with 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 in respect of his
contracts for actual delivery of the goods manufactured by him or merchandise sold by him. Clause (a), so far as it deals with a trader, may be
extracted thus:
A contract in respect of...merchandise entered into by a person in the course of his...merchanting business to guard against loss through future
price fluctuations in respect of his contracts for actual delivery of goods... sold by him...shall not be deemed to be a speculative transaction.
This makes it clear that it is only those contracts of purchase entered into by an assessee to guard against loss through future price fluctuations
in respect of his contracts of sale for actual delivery of the goods can be taken to be covered by Clause (a). On the wording of Clause (a) it is not
possible to accept the view of the Tribunal that it covers both purchase and sale transactions. For a transaction to come under Clause (a) it should
be one entered into by an assessee to guard against loss through future price fluctuations in respect of his sale contracts and, therefore, Clause (a)
cannot at all take in a sale contract, even though it is intended to guard against loss through price fluctuations in respect of the contract for the
purchase of the goods. The Tribunal has also expressed the view that there need not be actual correlation--contract to contract--but that it is
sufficient if a transaction either by way of purchase or sale is entered into with a view to guard against any future loss in that particular line of
business. The Tribunal also took the view that the words ""in respect of his contracts for actual delivery....."" occurring in Clause (a) ought to be
given a wider interpretation, that what the proviso intended was not a specific correlation--contract to contract--but a general correlation, that
what it required was that the speculation should not be a general and wide one but one consistent with and incidental to the assessee''s transaction
in ready goods as a trader and that the transactions entered into by the assessee fell within the scope of Clause (a) of the third proviso to Section
24(1). But we are inclined to think that we will be doing considerable violence to the language used in Clause (a) if it is understood to cover all
cases of purchases and sales entered into by an assessee with a view to guard against his future loss in general in that line of business. It is true, a
correlation--contract to contract--may not be necessary. But the contract or contracts contemplated by Clause (a) has or have to be proved to
have been entered into with a view to guard against loss through future price fluctuations in respect of contract or contracts of sale entered into by
him of the same goods.
On this construction of Clause (a), let us consider the nature of the transactions entered into by the assessee. Both in relation to cotton and
yarn, initially he entered into contracts of purchase of certain goods from the mills. Then he entered into a contract of sale of the same goods to a
party. But later he entered into a contract to repurchase from the same party of the same goods. Later he took delivery of the goods from the mills
and sold them to other parties and settled the contracts of purchase and sale with the said parties by paying the difference. It is not possible to say
that either the sale contract entered into by the assessee with the purchaser or the purchase contract entered into between them would come under
Clause (a). For one thing the sale contract would not be covered by Clause (a) as, in our opinion, it is intended to cover only purchase contracts.
Secondly, the purchase contract entered into by the assessee will not also come under Clause (a) for the reason that it is not intended to guard
against future loss in respect of any contract of sale of goods entered into by him with another party. As a matter of fact the evidence in this case
disclosed, and the Tribunal has also found, that the price of cotton and yarn was rising and the object of the assessee in purchasing the goods from
the dealer to whom it has agreed to sell the goods is to secure a larger price for the goods and consequently a higher .profit, and not with a view to
guard against losses. In this view it has to be taken that the assessee has not established its case that the transactions in respect of which the losses
in question have occurred are covered by Clause (a) of the third proviso to Section 24(1).
The reference is therefore, answered in the negative and against the assesseee. The revenue will have its costs from the assessee. Counsel''s fee
Rs. 250.