TaxTMI 
TaxTMI 
2011 (4) TMI 37
X X X X Extracts X X X X
X X X X Extracts X X X X
....rading in shares and securities, etc. 3) In the assessment year 2003-04, the assessee had entered into certain transactions in exchange traded derivatives ('derivative transactions' for short) which resulted in loss amounting to Rs.28,37,707/-. The assessee claimed the above loss as business loss. In the assessment order passed under Section 143(3) of the Income Tax Act, 1961 ('IT Act' for short) the assessing officer rejected the contention of the assessee and held that the loss incurred was speculation loss covered under Section 43(5) of the Act. The appeal filed by the assessee against the order of the assessing officer was dismissed by C.I.T. (A). 4) On further appeal filed by the assessee, the ITAT following the Coordinate Bench decision of the Tribunal in the case of Grishma Securities Pvt. Ltd. held that clause (d) to the proviso to Section 43(5) of the Act being retrospective in nature, the losses incurred from the derivative transactions could not be treated as speculation losses incurred by the assessee in AY 2003-04. Challenging the aforesaid order, the revenue has filed the present appeal. 5) Mr. Gupta, learned counsel for the revenue submi....
X X X X Extracts X X X X
X X X X Extracts X X X X
....d there is no possibility of obtaining the underlying security which in very many cases is impossible to obtain delivery of the underlying security. 9) Relying on a decision of the Apex Court in the case of Davenport & Co. P. Ltd. V/s. CIT reported in 100 ITR 715 (S.C.), Mr. Mistri submitted that a transaction can be said to be a speculative transaction only if the transaction falls within the definition under Section 43(5) of the Act. To fall within the purview of Section 43(5) of the Act, the transaction must involve purchase or sale of any commodity including stocks and shares. The contracts entered into by the assessee are not contracts for the purchase or sale of any commodity and hence the transactions cannot fall within the ambit of Section 43(5) of the Act. 10) Mr.Mistri submitted that the expression 'commodity' as per Black's Dictionary means tangible goods which are article of trade or commerce such as raw materials, etc. Calcutta High Court in the case of CIT V/s. Nirmal Trading Co. reported in 82 ITR 782 has held that letters of renunciation conferring on the renouncee the right to apply for shares of the company would neither constitute 'shares' nor....
X X X X Extracts X X X X
X X X X Extracts X X X X
....p; 14) Mr. Mistri further submitted that a derivative contract is merely a contract to transfer or manage risk and is akin to a contract of insurance. It is, therefore, not a contract for the purchase or sale of anything which is a requirement to fall within the ambit of Section 43(5) of the Act. Further in order to fall within Section 43(5) of the Act, the contract in question must be of a type that can be settled by actual delivery or transfer of the commodity or scrip. In the present case, it is impossible to settle the contract by actual delivery (or in any manner otherwise than by payment of money) and, therefore, it is clear that the contract in question is not intended to fall within the scope of Section 43(5) of the Act. In support of the above contention, reliance is placed on the decision of the Apex Court in the case of CIT V/s. B.C. Srinivasa Setty reported in 128 ITR 294 (SC), PNB Finance Ltd. V/s. CIT reported in 307 ITR 75 (SC) and CIT V/s. Official Liquidator, Palai Central Bank Ltd. reported in 130 ITR 539 (SC). 15) Mr. Mistri submitted that clause (d) to the proviso to Section 43(5) of the Act inserted by the Finance Act, 2005 with effect from 1/4/200....
X X X X Extracts X X X X
X X X X Extracts X X X X
....iate to consider the nature of derivative transactions. 19) The nature of the derivative transaction has been lucidly brought out by the learned Judge of the Madras High Court in the case of Rajshree Sugars & Chemicals Ltd. rep. by its Directors and Chief Operating Officer Mr. R. Varadaraj. Coimbatore V/s. Axis bank Ltd. reported in (2008) 8 MLJ 261 in the following terms:- " 5. What are these derivatives which have gained such a great deal of notoriety ? In simple terms, derivatives are financial instruments whose values depend on the value of other underlying financial instruments. The International Accounting Standard (IAS) 39, defines "derivatives" as follows: " A derivative is a financial instrument (a) whose value changes in response to the change in aspecified interest rate, security price, commodity price,foreign exchange rate, index of prices or rates, a creditrating or credit index, or similar variable (sometimes calledthe 'underlying'); (b) that requires no initial net investment or little initial netinvestment relative to other types of contracts that have asimilar response to changes in market conditions; and ....
X X X X Extracts X X X X
X X X X Extracts X X X X
.... between forwards and futures (i) Futures contract is guaranteed against default (ii) They are standarized and (iii) They are settled on a daily basis. (3) Swaps: A swap is an agreement made between two parties to exchange payments on regular future dates. Swaps are OTC (Over the counter) products. Swaps are used to manage or hedge risk associated with volatile interest rates, currency exchange rates, commodity prices and share prices. Swaps can be considered as series of forward contracts. (4) Options: An option gives the holder right to buy or sell an underlying asset at a future date at a predetermined price. A call option is the right to buy. The buyer of a "call option" has the right, but not the obligation to buy an agreed quantity of a particular commodity or financial instrument (underlying instrument), from the seller (or writer) at a certain time (the expiration date) for a certain price (strike price). The buyer pays a premium for this right. In contrast, a put option is the right to sell. The buyer of a "put option" has the right, but not the obligation to sell an agreed quantity of a particular commodity or financial instrument (underlying instrumen....
X X X X Extracts X X X X
X X X X Extracts X X X X
....n derivatives could be legally traded under the 1956 Act with effect from 22/2/2000. Section 18A inserted in the 1956 Act with effect from 22/2/2000 provides that the contracts in derivative shall be legal and valid if such contracts are traded on a recognized stock exchange and settled on the clearing house of the recognized stock exchange in accordance with the rules and bye laws of such stock exchange. Thus, the transactions in derivatives is legal and valid only if they are traded on a recognized stock exchange and cleared on the clearing house of recognized stock exchange. 21) The question in the present case is, whether the loss incurred from the derivative transactions carried on, on a recognized stock exchange during the year 2003-04 would constitute loss from speculative transaction as contemplated under Section 43(5) of the IT Act. Section 43(5) as enacted at the commencement of the Act reads thus:- " Definitions of certain terms relevant to income from profits and gains of business or profession. 43. In sections 28 to 41 and in this section, unless the contextotherwise requires - (1) to (4) ------- (5) "specul....
X X X X Extracts X X X X
X X X X Extracts X X X X
....any transaction in the nature of jobbing or arbitrage to guard against loss which may arise in the ordinary course of his business as such member; [or] (d) an eligible transaction in respect of trading in derivatives referred to in clause (ac) of section 2 of the Securities Contracts (Regulations) Act, 1956 (42 of 1956) carried out in a recognised stock exchange; shall not be deemed to be a speculative transaction; Explanation - For the purposes of this clause, the expressions- (i) "eligible transaction" means any transaction.-- (A) carried out electronically on screen-based systems through a stock broker or sub-broker or such other intermediary registered under section 12 of the Securities and Exchange Board of India Act, 1992 (15 of 1992) in accordance with the provisions of the Securities Contracts (Regulation) Act, 1956 (42 of 1956) or the Securities and Exchange Board of India Act, 1992 (15 of 1992) or the Depositories Act, 1996 (22 of 1996) and the rules, regulations or bye-laws made or directions issued under those Acts or by banks or mutual funds on a recognised stock exchange; and (B) which is supported by a time stamped contract note is....
X X X X Extracts X X X X
X X X X Extracts X X X X
....on'. Explanation 2 to Section 28 provides that where speculative transactions carried on by an assessee are of such a nature as to constitute a business, then such speculation business shall be deemed to be distinct and separate from any other business. Section 72 of the Act provides for set off of the carried forward business losses not being a loss sustained in a speculation business. Section 73 provides that the carried forward losses in speculation business shall not be set off except against profits and gains, in any other speculation business. The assessee claims that the losses incurred in derivative transactions are business losses which could be set off against profits and gains of any other business / any other heads of income, whereas the revenue contends that the losses incurred by the assessee in derivative transactions are speculative transactions covered under Section 43(5) of the Act which could be set off only against profits of speculation business. 26) Section 43(5) of the Act defines the expression 'speculative transaction' to mean a transaction in which a contract for the purchase or sale of any commodity including stocks and shares is periodically or....
X X X X Extracts X X X X
X X X X Extracts X X X X
.... have to study one index instead of 100's of stocks Settled in cash and therefore all problems related to bad delivery, forged, fake certificates, etc. can be avoided. " 31) Futures contracts in both index as well as stocks can be bought and sold through the trading members of recognized stock exchange. Futures contracts expire on the last Thursday of the expiry month. All futures contracts are settled in cash either on a daily basis or at the expiry of the respective contracts as the case may be. Clients / Trading members are not required to hold any stock of the underlying for dealing in the Futures Market. There are presently 53 stocks which can be traded under the Futures / Options Contracts. 32) To illustrate, suppose the share value of a company 'X' in the Stock Exchange on 1st January is Rs.100/- per share. If an investor considers that the shares of Company 'X' are likely to shoot up in the next three months, then he may, if he has funds, purchase 100 shares of company 'X' on 1st January itself by paying Rs.10,000/ @ Rs.100/- per share. In the alternative, he may enter into a futures contract on 1st January itself to purchase 100 shares of company ....
X X X X Extracts X X X X
X X X X Extracts X X X X
....purposes of Section 43(5), the expression 'commodity' has been expanded to include 'stocks & shares' and since transactions in derivatives are not specifically included in Section 43(5), the same would fall outside the purview of Section 43(5). We see no merit in the above contentions. The expression 'commodity' would cover all articles of trade including stocks & shares. Even under Section 43(5), the expression 'commodity' is not expanded to include 'stocks & shares'. In fact, use of 'comma' in between the word 'commodity' and the words 'including stocks & shares' in Section 43(5) make it clear that transactions for purchase of any commodity would include transaction for purchase or sale of stocks & shares. In other words, Section 43(5) does not seek to expand the scope of expression 'commodity' but merely emphasizes that the transaction in commodity includes transactions in stocks & shares. Therefore, transactions in futures contracts like transactions in stocks & shares when settled otherwise than by actual delivery would be speculative transactions under Section 43(5) of the Act. 35) The argument that Section 43(5) refers to contracts which are capable of settlement b....
X X X X Extracts X X X X
X X X X Extracts X X X X
....tances, the argument that clause (d) inserted to the proviso to Section 43(5) has retrospective effect cannot be accepted. 38) We do not consider it necessary to deal with various decisions relied upon by the Counsel for the assessee, as in our opinion, all those decisions are distinguishable on facts. However, we may note that the decision of the Calcutta High Court in the case of Nirmal Trading Co. (supra) wherein it is held that the 'letters of renunciation' are neither transactions in commodity nor transactions in shares, has no relevance to the facts of the present case, because, firstly, the letters of renunciation cannot be treated on par with futures contracts and secondly letters of renunciation are not articles of trade, whereas futures contracts are articles traded on the stock exchange. Various decisions of the ITAT wherein it is held that the derivative transactions are not speculative transactions, in our opinion, do not correctly interpret Section 43(5) of the IT Act. Similarly, various decisions of the Apex Court relied upon by the counsel for the assessee in support of the contention that insertion of clause (d) to the proviso to Section 43(5) of the IT A....