Balasubrahmanyan, J.
1. This group of reference under s. 256(1) of the I. T. Act, 1961, relate to the case of Sri Ranga Vilas Ginning and Oil Mills, Coimbatore, for the assessment years 1965-66 to 1971-72. The questions of law set out in T. C. Nos. 734 to 739 of 1976 are as follows :
'1. Whether, on the facts and in the circumstances of the case, the Tribunal was right in holding that the amounts of Rs. 39,940, Rs. 23,345, Rs. 23,074, Rs. 21,642, Rs. 24,246 and Rs. 24,603 received consequent to entering into contract with the President of India on May 1, 1963, for the supply of water did not represent agricultural income and was, therefore, not exempt from taxation under the Income-tax Act, for the assessment years 1965-66, 1966-67, 1967-68, 1968-69, 1969-70 and 1970-71, respectively
2. Whether, on the facts and in the circumstances of the case, the Tribunal was right in holding that the losses claimed of Rs. 7,301, Rs. 16,130, Rs. 9,975, Rs. 18,891, Rs. 3,583 and Rs. 16,500 were losses from speculation business within the meaning of section 73 of the Income-tax Act, 1961, and had to be considered as such for the assessment years 1965-66, 1966-67, 1067-68, 1968-69, 1969-70 and 1970-71, respectively ?'
2. The assessee is a firm of five partners carrying on business in ginning cotton and in the manufacture and sale of groundnut oil and cotton seed oil. Their previous year is the calendar year. The assessee owned extensive agricultural lands on which they grow cotton. The lands were supplied with water from a huge well. On May 1, 1963, the assessee-firm entered into a contract with the Ministry of Defence, Government of India, under which the assessee agreed to supply water for the use of the residents of a housing colony situate nearby, belonging to and occupied by the personnel of the Defence dept. Under the terms of the agreement, the assessee agreed to supply water from its open tank to the Defence dept. employees at a sliding scale of rates of Rs. 2.50 per 1,000 gallons up to 50,000 gallons in any one day and at the rate of Rs. 2 per 1,000 gallons where the supply exceeded 50,000 gallons and up to 1,00,000 gallons. The supply was to be registered by a meter to be fixed by the defence dept. at the supply point. The supply point was noted in a sketch attached to the agreement, which showed that it was at a distance away from the water tank to which the assessee had laid the main supply pipe lines. The agreement was to be in force for three years unless terminated earlier.
3. On the basis of the agreement aforesaid, the assessee was supplying water to the Defence dept. They received the following amounts as consideration for the supply of water in the relevant assessment years in question :
Rs.1965-66 39,9401966-67 23,3451967-68 23,0741968-69 21,6421969-70 24,2461970-71 24,603
4. The assessee claimed that the receipts from the Defence dept. constituted agricultural income, which was exempt under the Act. The ITO rejected this claim holding that the income in question arose from the contract with the Defence authorities and must be regarded as fees for services rendered by the assessee in supplying water. On appeal by the assessee, the AAC disagreed with the view of the ITO. The Appellate Assistant Commissioner held that the receipts from supply of water must be regarded as rent or revenue derived from land used for agricultural purposes. He held that it may also be brought under the latter part of the definition of 'agricultural income' and regarded as a by-product of the assessee's agricultural operations in growing cotton. He, accordingly, deleted from the assessment made by the ITO the receipts from sale of water for all the assessment years. The department took the matter in appeal before the Tribunal and urged that the AAC was in error in holding that the receipts from the defence dept. for the sale of water was agricultural income. The Tribunal accepted this contention. They held that the receipts in question arose as a result of the contract entered into between the assessee and the Govt. of India, by which the assessee undertook to supply specified quantities of water in return for payment of money under a sliding scale. The Tribunal further held that this contract had no direct nexus with the agricultural lands held by the assessee. That the water supplied by the assessee came out of a well situated in the agricultural lands of the assessee was, according to the Tribunal, an accidental factor and the sale of water by the assessee must, in the circumstances, be regarded as being de hors the assessee's agricultural activities. On the basis of these considerations, the Tribunal held that the receipts from sale of water were assessable in the hands of the assessee as non-agricultural income. In this reference, at the instance of the assessee, this conclusion of the Tribunal is canvassed in the first of the questions we have set out earlier.
5. Mr. S. V. Subramaniam, learned counsel for the assessee, relied on the definition of 'agricultural income' in s. 2(1) of the Act, and stressed the following words occurring in that definition;
'In this Act, unless there is anything repugnant in the subject or context, -
(1) 'agricultural income' means -
(a) any rent or revenue derived from land which is situated in India and which is used for agricultural purposes.'
6. Learned counsel submitted that receipts obtained by the assessee from sale of water amounted to revenue which must be held to be derived from land which was used for agricultural purposes. Learned counsel pointed out that it was common ground that the assessee was growing cotton in the land and the well was situated in the land wherein the cotton wa grown. Hence, according to learned counsel, the land must be regarded as one which was used for agricultural purposes and when the well, it must be regarded as revenue derived from land which was used for agricultural purpose.
7. The question was debated during arguments, whether (receipts from sale of) subterranean water found from a well, situate in an agricultural land used for agricultural purposes can be regarded as revenue derived from land in the proper sense of that expression. It is, however, unnecessary for us to go into a general question of that kind, having regard to the facts of the case. It would be going beyond the record in the case and the facts found to proceed on the footing that what was sold by the assessee to the Defence dept. was water directly from the well. The agreement between the assessee and the Defence dept. has been marked in the stated case. The agreement leaves no room for doubt as to what the assessee had undertaken. Its undertaking was to supply water from its 'open tank' and 'open chanel', both of which were situated within the precincts of the premises at Red Fields area, Coimbatore. The agreement was to supply that open tank water to the Defence dept. at a bulk supply point. The other provisions of the contract dealing with the mode of supply, the mode of leading water from the tank to the point of bulk supply wherefrom the Defence dept., was to make their own arrangement to lead it into their housing colony, all show that the subject-matter of the contract was the water in the open tank. There is no reference whatever in this agreement that the assessee should supply water baled out or pumped out from the well, situated in their agricultural land. The other provisions of the agreement under which the assessee had undertaken obligations to provide for laying of pipes, to maintain uninterrupted supply and to maintain the quality of the water, all would show that what was the subject-matter of this agreement was particularly a commercial bargain for sale of water as such. It may be observed that if the assessee had agreed to supply water from their open tank and open channel, any rain water which had filled up the open tank and open channel, would also be part of the supply. In such an event the Defence dept. could possibly raise no objection on the ground that what was supplied was not well water. The whole tenor of the agreement shows that what was dealt with between the assessee and the Defence dept. as the subject-matter or supply was not well water as such, but water as a saleanle commodity from the open tank and open canal. In these circumstances, we have little hesitation in agreeing with the finding of the Tribunal that the receipts from the Defence department arose to the assessee as a result of the contract entered into with the Defence department, under the terms of which the assessee had undertaken to supply specific quantities of water in return for a price. We also agree with the other finding of the Tribunal that there is nothing in the agreement to indicate any direct nexus between the supply of water and the agricultural land held by the assessee.
8. In the course of arguments at the bar, reference was made to an early decision of the Lahore High Court in Umar Hayat Khan v. CIT [1925] 2 ITC 52. In that case, the assessees were owners of private canals, through which the waters of the Jhelum were let out by the Government on payment of a fee. The assessee, in turn, diverted the water supplied to them by the Government to the owners of certain adjoining lands in consideration of the latter paying the assessees an one-fourth share of the produce of the lands irrigated thereby. The question was whether the share of produce which was turned over to the assessees by the owners of the lands who obtained water supply from the assessees' canals can be regarded as agricultural income in the assessee's hands. The Lahore High Court held that the income was not agricultural income within the meaning of s. 2(1) of the Indian I. T. Act, 1922, but was simply the price paid for water supplied by the assessee. In the present case too, as we have earlier observed, the receipts form the Defence dept. must be held to be non-agricultural income, since it arose from a contract to supply water, which is very much a commercial contract, and not from any source which can be regarded as an agricultural source.
9. The second of the question which we are asked to decide in this group of references relates to the computation of the profits of the assessee's business in ginning cotton and in the manufacture and sale of groundnut oil and cotton seed oil. In the accounting years relevant to all the assessment years before us in these references, the assessee, while carrying on a regular business in the sale of ginned cotton, groundnut oil and cotton seed oil, also entered into forward contracts for the supply of groundnut oil. On some occasions, the assessee had settled those forward contracts, not by actual delivery, but by way of settlement of differences in price. Losses were incurred by the assessee in the course of settling these forward contracts in the manner aforesaid. Year after year, the assessee accounted for those losses in its trading account; the figures of losses are as follows :
Rs.1965-66 7,3011966-67 16,1301967-68 9,9751968-69 18,8911969-70 3,5851970-71 16,500
10. In their relevant assessments for these years, the assessee claimed allowances for these losses, contending that the forward transactions in which they settled the contracts otherwise than by delivery must be held to be 'hedging contracts', which must be treated as an integral part of their regular business in those commodities. The ITO, however, rejected this contention. He held that theses transactions must be held to be 'speculative transactions' within the meaning of s. 43(3) of the Act. He further held that they cannot be regarded as heading contracts having regard to their nature and purpose and the mode of settlement. He hence considered the losses claimed by the assessee as speculation losse in speculative transaction which must be dealt with as constituting a seprate business. on this basis, he held that they should be set off only as against income from a similar speculative business by carrying them forward to the next year. This conclusion of the ITO was objected to by the assessee in the appeal before the AAC. The AAC accepted the ITO's finding that the transactions put through by the assessee in forward dealings, both in cotton seed oil and in groundnut oil, must be held to be speculative transactions. He also agreed with the further finding of the ITO that the transactions cannot be brought within the definition of 'hedging contracts' falling under prov. (a) to s. 43(5) of the Act. Having agreed with these findings of the ITO, the AAC nevertheless proceeded to hold that the losses from these speculative transactions must be set off against the assessee's regular business in cotton seed oil and groundnut oil. The reasoning of the AAC was that although these transactions were speculative, they cannot be regarded as constituting a seprate speculative business, but must be regarded as being part and parcel of the assessee's regular business, in cotton seed oil and groundnut oil. The reasoning of the AAC was the although these transactions were speculative, they cannot be regarded as constituting a separate speculative business, but must be regarded as being part and parcel of the assessee's regular business, in the course of which these transactions had been entered into. According to him, all these transactions were entered into only to subserve the larger purposes of the assessee's business in the manufacture and sale of groundnut oil. In this view, the AAC reversed the decision of the ITO and directed him to set off the losses from the speculative transactions as against the profits derived by the assessee from its regular business in cotton seed oil and groundnut oil.
11. Against this part of the order of the AAC, the department filed appeals before the Tribunal. The contention of the department before the Tribunal was that the AAC was not correct in holding that these speculative transactions could not be regarded as constituting a distinctive business in speculation.
12. The Tribunal accepted the contention of the department. They held that a number of contracts were entered into by the assessee during the years in question, and, even at the time of entering into such transactions the assessee did not intend that the contracts should be executed and settled by actual delivery of goods. The Tribunal further found that since the assessee was a dealer in groundnut oil and cotton seed oil, most of the contracts were performed by delivery, but a number of them, year after year, were settled otherwise than by delivery. The Tribunal found that those contracts in which settlement was made otherwise that by delivery can, by no means, be regarded as isolated or casual freaks in the assessee's business, but formed part and parcel of the integrated structure of the assessee's business. In the view, they held that the speculative transactions must be regarded as in the nature of a business. Applying the provisions of Expln. 2 to s. 28 of the Act, the Tribunal held that this speculation business must be deemed to be a separate business. In this view, they upheld the order of the ITO isolating the speculation losses from the speculation transactions from the business of the assessee and refusing a set-off of such losses as against the profits of the regular business during the years in question. In arriving at this decision, the Tribunal relied on a decision of a Division Bench of this court in R. Chinnaswami Chettiar v. CIT : [1974]96ITR353(Mad) . This part of the decision of the Tribunal is questioned by the assessee before us in this group of references by means of the second of the questions referred to by the Tribunal.
13. Mr. Subramaniam, learned counsel for the assessee, submitted that having regard to the nature of the transactions in forward dealings which were being effected by the assessee in all these years, they must be related to the regular business of the assessee, viz., in the sale of spot commodities such as groundnut oil and cotton seed oil. Learned counsel said that it would be artificial to separate all these transactions and string them together as though, by doing so, they can be regarded as forming an integral part of a separate speculation business in themselves.
14. We are unable to accept this argument on the basis of the relevant provisions of the Act. Section 43(5) of the Act carries a definition of 'speculative transaction'. It is, however, not necessary to go into this definition, because Mr. Subramaniam does not dispute that the transactions in question in the present case are only speculative transactions. Nor does he dispute the finding of both the AAC and the Tribunal that none of these transactions can be regarded as a hedging transaction, covered by prov. (a) to s. 43(5) of the Act. What the learned counsel urged before us was that given the number of speculative transactions in the assessee's business for the various years in question, it would yet be not correct to say that these transactions were of such a nature as to constitute a separate business. He referred to Expln. 2 to s. 28 of the Act, which read as under :
'Explanation 2. - where speculative transactions carried on by an assessee are of such a nature as to constitute a business, the business (hereinafter referred to as 'speculation business') shall be deemed to be distinct and separate from any other business.'
15. What the learned counsel urged was that from out of various speculative transactions, widely dispersed and dissociated from each other, it cannot be held that they formed a cohesive business in speculative transactions. Adopting the picturesque language employed by the AAC in this case, learned counsel said that we cannot take isolated transaction of speculative nature and 'string' them together artificially to hold that they constituted a business.
16. While in theory what the learned counsel urges might be a good argument, as to how a number of transaction can be held or not held as constituting a distinct business, the question before us falls to be decided on the application of Expln. 2 to s. 28, the next of which we have already reproduced. This Explanation says that where speculative transactions are of such a nature as to constitute a business, then such a business shall be deemed to be distinct and separate from any other business. In other words, it is unnecessary to find as a fact that there was a separate business in speculative transactions which was being carried on by way given assessee. It is enough that there is some business, whatever that business might be, in the course of carrying on which speculative transactions are being entered into by an assessee along with non-speculative transactions. If such a business, which we may roughly call a 'composite' business, is found to exist, then the statutory fiction enacted by Expln. 2 will come into operation. This was more or less the approach made by the Division Bench of this court, to which one of us a party, in R. Chinnaswami Chettiar v. CIT : [1974]96ITR353(Mad) . In that case, an assessee was carrying on regular business as a dealer in spot yarn. During the particular accounting year in question in that reference, the assessee had also indulged in four forward transactions in yarn, all of which he settled, not by actual delivery, but by settlement or otherwise. The assessee questioned the finding of the ITO that these were speculative transactions. The assessee further submitted that even if these transactions were speculative transactions, they could not be regarded as constituting a separate speculative business. The Division Bench which heard the reference held that the transactions were in the nature of speculative transactions. They further held that having regard to the nature of the assessee's business as a dealer in yarn and having regard to the fact that the forward transactions were also entered into in the same commodity, namely, yarn the transactions cannot be regarded as isolated transactions in the sense that they were totally unconnected with the assessee's business as a dealer in yarn. The following observations of the learned judges occurring at pp. 362 and 363 make the point clear :
'Explanation 2 to section 28 of the Act states that when a business is carried on in speculative transaction, that business is deemed to be distinct and separate from any other business.... In the instant case, the four transactions were entered into as part of the general business of the assessee. The assessee is a dealer in yarn and during the assessment year he had entered into a number of forward contracts of which these four transactions were speculative. The transactions were not isolated transactions in the sense that they are totally unconnected with his business as a dealer in yarn. These speculative transactions, which form part of the business, by a fiction of law under Explanation 2 to section 28 of the Act, are deemed to be distinct and separate from any other business. The losses incurred in respect of these transactions therefore, constituted a loss in a speculation business.'
17. The idea seems to be that where a trader carries on a regular business in spot dealings in a commodity and also indulges in speculative transactions in the same commodity, while in point of fact the business of that assessee may be regarded as an integrated business, combining in itself not only spot transaction but also forward dealings, by virtue of Expln. 2 to s. 28, the speculative transactions must be segregated and be regarded as constituting a separate business. The discussion of a question of this kind might assume a different dimension in cases where an assessee carries on no other business than a business of dealings in spot purchases and sales, or carries on a regular business in one commodity but indulges in forward dealings in a different commodity. In such cases, the question would be whether his speculative transactions considered in the gross can be regarded as constituting a separate business. In such cases, it might be possible to apply the well-known tests to find out whether the transactions, regarded as a whole, do or do not constitute a business at all. But, in cases of the kind which we are dealing with in the present references, and cases of the kind which the Division Bench had dealt with in R. Chinnaswami Chettiar v. CIT : [1974]96ITR353(Mad) , the moment it is found that an assessee carries on both a regular business as well as a forward business in the same commodity, the conclusion is easily arrived at by the simple expedient of applying Expln. 2 to s. 28 of the Act. In the present case, the AAC was at pains to point out that these speculative transactions indulged in by the assessee were very must a part and parcel of the assessee's regular business. This finding renders impossible any escape from Expln. 2 to s. 28. The AAC failed to realize the legal effect of his own factual finding in terms of the statutory provisions.
18. For all the above reasons, we answer both the questions in T. C. Nos. 734 to 739 of 1976, in the affirmative and against the assessee.
19. The two questions referred to us in T. C. No. 481 of 1976 are as follows :
'Whether, on the facts and in the circumstances of the case, the revenue derived from the agricultural land of the assessee from its irrigation well is not agricultural incom
2. Whether, on the facts and in the circumstances of the case, the transactions of the applicant are speculative transactions and that in any event the transactions are not within the exception under section 43(5) of the Income-tax Act. 196 ?'
20. The first question needs to be modified, as it is not properly framed, considering that it may be said to be a loaded question carrying to a certain extent its own answer. The proper question of law must be re-framed as under :
'Whether, on the facts and in the circumstances of the case, the Tribunal was right in holding that the amount received by the assessee from its contract with the President of India dated May 1, 1963, for the supply of water, did not represent agricultural incom ?'
21. The question, as re-stated above, is answered in the affirmative and against the assessee.
22. The second question also needs modification as would be evident from the discussion of the facts of the case and the submissions of either side, which we have set out in the earlier part of our judgment. The real question for our decision is :
'Whether, on the facts and in the circumstances of the case, the Tribunal was right in holding that the losses claimed by the assessee in the sum of Rs. 9,973 can be regarded as loss in a speculation business and is to be treated and dealt with separately for purposes of carry forward and set off under section 73 of the Income-tax Act, 196 ?'
23. We answer this question too in the affirmative and against the assessee. The department will have its costs of these references. Counsel's fee Rs.500 (one set).