A transaction in which a contract for purchase and sale of any commodity is periodically or ultimately settled otherwise than by the actual delivery or transfer of the commodity is a speculative transaction, unless it is a contract 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.

( 1 ) THIS reference arises out of the income-tax assessment of Nuddea Mills Co. Ltd. , the assessee, for the assessment years 1961-62, 1965-66 and 1966-67, the relevant accounting years ending on the 31st March of the calendar years 1961, 1965 and 1966.

( 2 ) THE facts as found and on record are, inter alia, that the assessee is a manufacturer of jute goods. In the assessment years involved, the assessee entered into forward contracts for sale of standard jute goods of its manufacture. Subsequently, the assessee received overseas offers for supply of special quality jute goods where the margin of profit was expected to be high. The capacity of the looms available to the assessee for production was limited and the assessee was not in a position to manufacture the special quality jute goods for the overseas purchasers and also standard jute goods to fulfil the assessee's forward contracts of sale. To earn higher profits, the assessee decided to manufacture the special quality jute goods and reduced the manufacture of standard jute goods correspondingly. The assessee covered its forward contracts of sale by entering into forward contracts of purchases of standard jute goods or purchased back some of its forward contracts of sales.

( 3 ) IN covering its forward contracts of sale as aforesaid, the assessee suffered losses in the relevant assessment years, respectively, of Rs. 3,95,929, Rs. 1,18,065 and Rs. 3,14,540. In its assessments to income-tax, the assessee contended that such losses were incurred on hedging transactions and not on speculation.

( 4 ) THE Income-tax Officer held that as the contracts for forward sales had been settled otherwise than by actual delivery of goods, the transactions conformed to the definition of a speculative transaction under Explanation 2 to Section 24 (1) of the Indian Income-tax Act, 1922 ("the 1922 Act"), and Clause (5) of Section 43 of the Income-tax Act, 1961 ("the Act" ). He held further that the transactions were not hedging transactions within the meaning of the said section as they were not entered into to guard against losses through future price fluctuations. The losses claimed were added back to the income of the assessee.

( 5 ) THE assessee preferred appeals against the said assessments before the Appellate Assistant Commissioner who found that the assessee carried on business of manufacture of jute products and also sold the products manufactured by forward contracts. The contentions of the assessee that the purchase back of the forward contracts was a part of the business of the assessee of supply of special quality jute goods to overseas buyers by switching production of standard jute goods and that the transactions were only hedging transactions were rejected by the Appellate Assistant Commissioner. It was held that the said transactions were not entered into to guard against loss on account of future price fluctuations of basic raw materials. The decisions of the Income-tax Officer were upheld.

( 6 ) THE assessee preferred further appeals against the orders of the Appellate Assistant Commissioner before the Tribunal. The assessee contended before the Tribunal, inter alia, that the transactions which had resulted in losses to the assessee were not speculative in nature within the meaning of the relevant provisions of the 1922 Act and the 1961 Act. At the inception of the forward contracts of sale, the assessee did not intend to settle the same otherwise than by actual delivery of goods. In the circumstances and on account of commercial considerations, it became necessary ultimately to determine the contracts by purchasing back the same.

( 7 ) IT was contended in the alternative that the transactions were of the nature of hedging contracts within the meaning of proviso (a) to Explanation 2 to Section 24 (1) of the 1922 Act or proviso (a) to Section 43 (5) of the 1961 Act.

( 8 ) CONTENTIONS to the contrary were made on behalf of the Revenue.

( 9 ) IT w