Holding

Clause (a) saves only contracts entered to hedge against loss on contracts for the actual delivery of goods sold, and the transactions in this case lack such correlation, so they are not saved.

Summary

Somasundram Chetir & Co., a cloth merchant, incurred losses of Rs.2,04,746 and Rs.17,000 in the assessment years 1960-61 and 1961-62 which the Assessing Officer treated as losses from speculative transactions, allowing set‑off only against speculative profits. The Tribunal held that the losses arose from hedging contracts and were saved from the speculative‑transaction rule by clause (a) of the third proviso to Section 24 of the Income‑Tax Act, 1922. The Madras High Court disagreed, interpreting clause (a) to require that the hedging contract be entered to guard against loss on contracts for the actual delivery of goods sold by the merchant, and found no such correlation in the facts. The Supreme Court affirmed the High Court, holding that without a link between the speculative contract and a sale contract for actual delivery, clause (a) does not apply, and the losses remain speculative. Consequently, the appeal was dismissed.

Issues considered

Whether the transactions that gave rise to the losses are saved from being treated as speculative transactions by clause (a) of the third proviso to Section 24 of the Income‑Tax Act, 1922.
Whether clause (a) requires a correlation between the speculative contract and a contract for actual delivery of goods sold by the merchant.

Legislation cited

Income Tax Act, 1922s. 24(1), s. 24(1) proviso clause (a)
Income Tax Act, 1961s. 28

Subjects

speculative transactionhedging contractloss set‑offIncome Tax ActSection 24clause (a)merchanttax assessment

Judgment

.
SK. AR. K. AR. SOMASUNDRAM CHETI'IAR AND CO.• MADURAI A
v.
COMMISSIONER OF INCOME TAX. MADRAS

JANUARY 15. 1992

[K. RAMASWAMY AND B. P. JEEVAN REDDY, JJ.] B

Income Tax Act, 1922-Section 24, third proviso, clause (a)-Require-
ments under-Contract--Constructi_o,._contract spoken in first part and in
second part--Co-relatio~When the clause applies to speculative transac-
tion, indicated.
c
Income Tax Act, 1922-Section 24, third proviso, clause (a}-Transac-
tions entered into by assessee whether saved under.

The appellant-assessee, was a registered firm. It was carrying on
business in cloth and yarn. Its cloth business consisted mainly in Gada
manufactured by certain Mills. D
The Income Tax Officer while making the assessment relating to
the assessment years of 1960-61 and 1961-62, held that the losses of Rs.
2,04,746 and Rs. 17,000 respectively sustained by the assessee in the two
assessment years constituted losses in speculative transactions in the
nature of business and, therefore, could not be set off except against E
profits from speculation. He carried forward the said loss to be set off
against speculation profits, if any, in subsequent assessment years.

The assessee's appeal was dismissed by the Appellate Tribunal,
though its further appeal to the Tribunal was upheld.
F
Before the Tribunal, the assessee, conceding that the transactions
in question are speculative transactions within the meaning of the
Explanation 2 to section 24, Income Tax Act, 1922, contended that the
transactions in question were saved under clause (a) of the proviso to
Section 24 of the Act. G

The Tribunal held that the transactions entered into by the assessee
were in the nature of the hedging contracts and, therefore, saved under
clause (a) of the proviso.

The Revenue obtained a reference to the High Court on the H

49
50 SUPREME COURT REPORTS (1992] 1 S. C.R.

A question, ''whether on the facts and in the circumstances or 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 or Rs. 17,000 in
the assessment year 1961~62 were saved from being treated as specula-
tive transactions by clause (a) or the third proviso to Section 24(1) of the
Income Tax Act, 1922." •
B
The assessee conceding that the transactions in question were
speculative transactions, contended before the High Court that the
.
transactions were saved by clause (a) of the third proviso to Section 24.

The High Court answered the reference in negative, i.e., in favour )..__
C of the Revenue, holding that the transactions in question were not saved
by clause (a) of the third proviso.

The assessee-appellant challenged the view taken by the High
Court in these appeals by special leave.

D On the question, whether the transactions in question were saved
by clause (a) of the third proviso to Section 24 of the Income Tax Act,
1922, dismissing the appeals, the Court,

HELD : 1.01. When the first part of clause (a) speaks of a contract
' in respect of merchandise, it refers to a contract falling within the
E definition of speculative transaction. But the further requirement of
clause (a) is that such a contract in respect of merchandise must have
been entered into by the merchant in the course of his business to guard
against loss through future fluctuations "in respect of his contracts for
actual delivery of goods sold by him." Clearly, the contracts referred to
in the latter part of clause (a) must be contracts for actual delivery of
F
goods sold by him. It necessarily means contracts of sale by him and such
contracts must be for actual delivery of goods. The words "for actual
delivery of goods" have evidently been put in designedly. [55D-E]

1.02. There need not be co-relation between contract to contract
G but there ought to be a co-relation between the contracts ~poken to in the
first part of clause (a) and the contracts spoken to in the latter part.
Unless such co-relation exists between two sets of contracts, the clause is
not attracted. [55E-F]

2. Tilt assessee entered into a contract of purchase with the mills
H and a contract of sale with another person. Then he entered into a
J.-
SOMASUNDRAM CHETII.\R & CO. v. C.I.T. [REDDY, J.] 51

contract of purchase with such person in respect of the same goods. He A
then obtained delivery of the cloth from the mills and sold them to the
third parties. So far as the first mentioned party is concerned he settled
the contract by paying the difference, resulting in loss. It is evident that
the course' of transactions do not attract and cannot be made to fall
within the four corners of clause (a). The contracts entered into by the
assessee do not fall within nor are they saved by clause (a) of the proviso. B
[55H-56B, SSG]

CIVIL APPELLATE JURISDICTION : Civil Appeal Nos. 1109-10 of
1976.

From the Judgment and Order dated 19 .4.1973 of the Madras High Coun C
J. in Tax Case No. 278 of 1967.

A.T.M. Sampath for the Appellant.

Dr. V. Gaurishankar, P. Parmeswaran, S. Rajappa and Ms. A.
Subhashini for the Respondents. D
The Judgment of the Court was delivered by

B.P. JEEVAN REDDY, J. These appeals by the assessee are preferred
against the judgment of the Madras High Court answering the question
referred to it in favour of the Revenue. The question stated for the opinion E
of the High Court under Section 66 (1) of the Indian Income Tax Act, 1922
was ..whether \)n the facts and in the circumstances of the case, the transac-
tions 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 F
(a) of the third proviso to Sectiop 24(1) of the Income Tax Act, 1922."

The assessee is a registered firm carrying on business in cloth and yarn.
Its Head-Office is at Madurai with branches at Vijayanagaram and Calcutta.
Its trade in cloth consisted mainly in Gada manufactured by certain mills
including Meenakshi Mills Ltd., Virudhnagar Textiles Ltd. and Loyal Tex- G
tiles Mills Ltd. The assessment years concerned herein are 1960-61 (previous
year ending on 12.4.1960) and 1961-62 (previous year ending on 12.4.1961).
In his assessment orders, relating to these two assesment years, the Income
Tax Officer held that the losses of Rs. 2,04,746 and Rs. 17,000 respectively
sustained by the assessee in the said two assessment years constituted losses
in speculative transactions in the nature of business and, therefore, could not H
52 SUPREME COURT REPORTS [1992] 1 S. C.R.

A be set off except against profits from speculation. He carried forward the said
Joss to be set off against speculation profits, if any, in subsequent assessment
years. The assessee's appeal to the Appellate Tribunal proved unsuccessful.
However, his further appeal to Tribunal was upheld. Before .the Tribunal, the
counsel for the assessee conceded that "the transactions in question are
speculative transactions within the meaning of the explanation." (The refer-
B ence is to Explanation - 2 to Section 24). His contention, however, was that
the transactions in question are saved under Clause (a) of the proviso to
Section 24. The Tribunal examined the said contention with reference to the
facts of the case and concluded that the transactions entered into by the
assessee were in the nature of the hedging contracts and, therefore, saved
under Clause (a) of the proviso. Dissatisfied with the order of the Tribunal,
C the Revenue asked for and obtained the above reference. Before the High )..,_
Court as weJJ, counsel for the assessee· conceded that the transactions in
question are speculative transactions but contended that they are saved by
Clause (a) of the third proviso to Section 28. This is what the High Court has
recorded:

D "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 cx:curred are speculative transactions as defined in Explana-
tion 2, and, therefore, it is not necessary for us to consider the
scope of the Explanation 2 to Section 24. The only question for
consideration is whether the transactions which are admittedly
E speculative coming within Explanation 2 to Section 24(1), will
fall within the scope of Clause (a) of the third proviso to that
section."

The High Court disagreed with the interpretation placed by the Tribu-
nal upon Clause (a) of the said proviso and held that on the material placed
F before it, it is not possible to hold that the transactions in question were saved
by clause (a) of the third proviso. Accordingly, it answered the question
referred in the negative-that is against the assessee and in favour of Revenue. -+
The correctness of the view taken by the High Court is challenged in this
appeal.
G
Section 24 of the 1929 Act insofar as it is relevant reads as foJJows :

''24. Set off of loss in computing aggregate income :- (1) where
any assessee sustains a loss of profits or gains in any year under
any of the heads mentioned in section 6, he shaJJ be entitled to
H have the amount of the loss set off against his income, profits or
gains under any other head in that years :
.. SOMASUNDRAM CHETI1AR & CO. v. CJ.T. [REDDY, J.] 53

i Provided that in computing the profits and gains chargeable A
under the head 'Profits and gains of business, profession or
vocation', any Joss 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 speculativ.e transactions.
B
Explanation 2 : A speculative transaction means a transaction in which
a contract for purchase and sale of any commodity including stocks and
shares is periodically or ultimately settled otherwise than by the actual
delivery or transfer of the commodity or scrips.
_/
Provided that for the purposes of this Section : c
(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; or D

(b) a contract in respect of stocks and shares entered into by a dealer
or investor therein to guard against loss in his holdings of stocks
and share through price fluctuations; or

(c) a contract entered into by a member of a forward market or a E
stock exchange in the course of any transactions in the nature of
jobbing or arbitrate to guard against loss which may arise in the
ordinary course of his business as such member;"

Explanation 2 to Section 24 defines what a speculative transaction is.
It corresponds to the definition contained in Clause 5 of Section 43 of the
F
~
-..,, Income Tax Act, 1961. The Madras High Court has taken the view that by
virtue of the definition contained in Explanation 2, "whenever there is no
actual delivery or transfer of the goods, the transaction should be taken to be
of a speculative nature .......... If the actual delivery of the goods is not given
under the settlement of the contract, then the intention of the parties at the G
time of contract is immaterial." It is not necessary for us to express any
opinion on this aspect since it was conceded by the assessee's counsel before
the High Court that the transactions in question were indeed speculative
transactions as defined by Explanation 2. The only question with which we
are concerned-and which alone has been considered by the High Court
too-is whether the transactions in question are saved by Clause (a) of the H
~ third proviso to Section 24.
S4 SUPREME COURT REPORTS (1992) 1 s. c. R.

A The Tribunal was of the opinion that Clause (a} of the third proviso is
intended to save hedging contracts among others. It dealt with the concept of
hedging contracts and held that for attracting Clause (a) of the proviso, the
..contracts for actual delivery of goods manufactured by him or merchandise
sold by him" need not necessarily be sale conttacts but can also be purchase
contracts. Applying the said interpretation it examined the transactions in
B question and held them saved by the said Clause. The High Court, however,
did not agree with the said interpretation. It took the view that "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". It, however, agreed with the Tribunal that there need not
be actual co-relation, contract to contract, between the purchase and sale
c contracts contemplated by the Clause and 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. It held ..for a transaction to
co~e 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 conttacts
. . . . . . . . . . . . there need not be actual co-relation, contract to contract, but that
D 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." It, however, added a note of caution which we may set out in its
own words...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 ~ view to guard
E against his future loss in general in that line of business. It is true, a co-
relation-contract .to contract-may not be necessary. But the contract or
contracts contemplated by Clause (a) has or have to guard against loss
through price fluctuations in respect of conttact or conttacts of sale entered
into by him of the same goods." Applying the said test me High Court
examined the transactions in question and came to the conclusion that they
F
were not saved under the said Clause. It noted that both with respect to cotton
bales and yam, the assessee had initially entered into conttacts of purchase
of certain goods from the mills. He then entered into a contract of sale of the
same goods to a party. Later, he entered into a conttact to re-purchase the
same goods from the same party. Subsequently, he took delivery of the goods
G from the mills and sold them to other parties. So far o>s contracts of purchase
and sale with the first mentioned party are concerned, he settled them by
paying the difference. In the circumstances, the High Court held that it is not
possible to say either that the sale contract entered into by the assessee with
the purchaser, or the purchase conttact entered into between them, would
come under Clau8e (a). The only question now before us is whether the High
H Court was right in its interpretation of Clause (a) of the third proviso of
SOMASUNDRAM CHETI1AR. a CO. v. CJ.T. [REDDY, J.] 55

Section 28 (which corresponds to Clause (a) of the proviso to the definition A
of speculative transactions contained in Clause 5 of Section 43 of the 1961
Act)? .

The proviso containing Clauses (a) to (c) is a proviso to Explanation 2
which defines what a speculative transaction is. Clause {a) of the proviso
contemplates and applies to a manufacturer as well as a merchant The B
assessee herein is not a manufacturer but only a merchant. The said Clause
insofar as it is relevant to the merchant would read thus :

• "a contract in respect of merchandise entered into by a person in
the course of his merchanting business to guard against loss
_j, through future price fluctuations in respect of his contracts for c
actual delivery of merchandise sold by him, shall not be deemed

-
to be a speculative transaction".

When the first part of Clause (a) speaks of a contract in respect of
merchandise, it refers uncloubredly to a contract falling within the definition
of speculative transaction. But the further requirement of Clause (a) is that D
such a contract in respect of merchandise must have been entered into by the
merchant in the course of his business to guard against loss through future
fluctuations "in respect of his contracts for actual delivery of goods sold by
him." Clearly, the contracts referred to in the latter part of Clause (a) must
be contracts for actual delivery of goodS sold by him. It necessarily means
contracts of sale by him and such contracts must be for actual delivery of E
goods. The words "for actual delivery of goods" have evidently been put in
designedly. We agree with the learned Judges of the High Court that there
need not be co-relation between contract to contract but there ought to be a
co-relation between the contracts spoken to in the first part of Clause (a) and
the contracts spoken to in the latter pan. Unless such co-relation exists
between two sets of contracts, the Cause is not attracted. The Tribunal was
F
t- not right in holding that the words "contracts for actual delivery of goods"
'('
occurring in the latter part of the definition do also take in contracts of
purchase. Such an undersranding is inconsistent with the scheme and spirit of
the Cause.
G
If we examine the contracts entered into by the assessee on the above
touch-stone, it would be evident that they do not fall within nor are they
saved by Clause {a) of the proviso. The nature of transactions entered into by
. the assessee, as found by the High Court, has already been set out by us
hereinbefore. The ~sessee entered into a contract of the purchase with the
mills and a contract of sale with another person. Then he entered into a H·
56 SUPREME COURT REPORTS £.1992) 1 S. C.R.

A contract of purchase with such person in respect of the same goods. He then
obtained delivery of the cloth from the miUs and sold them to the third
parties. So far as the first mentioned party is concerned he settled the contract
by paying the difference resulting in loss. It is evident that the said course of
transactions do net attract and cannot be made to fall within the four comers
of Clause (a).
B
We, accordingly, dismiss the appeal. No orders as to costs.
V.P.R. Appeals dismissed.

I
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I