TaxTMI 
TaxTMI 
2011 (5) TMI 371
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....12,744,596 arising from exchange traded derivative transactions as a business loss and ignoring the special provisions contained in section 115AD of the Act, applicable to your appellant, being a Foreign Institution Investor ("FII"). 2. In treating the short-term capital loss of Rs. 18,818,500 arising from non-indexed exchange traded derivative transactions as speculative loss and thereby, disallowing its set-off against short-term capital gains earned on equity shares." The other grounds taken by the assessee are in support of the main issue contained in ground nos. 1 and 2 as reproduced above. 4. Briefly stated, the facts of the case are that the assessee is a company incorporated in Cayman Islands and a tax resident of Cayman Islands. At the material time, there was no Double Taxation Avoidance Agreement between India and Cayman Islands. The assessee is registered with the SEBI as a sub-account of Lloyd George Investment Management (Bermuda) Ltd., which is registered with SEBI as a Foreign Institutional Investor (hereinafter called "FII"). The status of the assessee in the titles of the assessment order has also been given as FII. The assessee showed ....
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....ed by the special provision contained in section 115AD and as such the resultant income from the derivatives could be taxed only under the head 'Capital gains'. The ld. CIT(A) noted that the assessee traded in Future contracts based on individual company's shares and also Nifty Indexes. He noticed that the Index Futures were the artificial trade instruments created by Stock Exchanges which could have a lifespan of not more three months and hence it was not possible to have the physical/actual delivery because the underlying Index was not a physical commodity. Once these artificial securities were not capable of delivery from one person to another, he held that the same could not be considered as a commodity and hence the provisions of section 43(5) would not apply. As regards loss from the Non-Index based derivatives, that is, where the underlying asset is some specific share, the ld. CIT(A) held that the same would qualify as speculative transaction inasmuch as there was a possibility of delivery of shares underlying such Futures and hence the resultant loss would be speculative loss. He finally held that the loss incurred by the assessee in non-index based derivatives was hit by ....
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.... CIT [2009] 121 ITD 498 (Kol.) has held that the 'derivative' in which underlying asset is a share, falls under the expression 'commodity' under section 43(5) and thus loss on account of transactions in futures and options derivates with the underlying assets as shares is speculative loss up to assessment year 2005-06. It has further been held in this case that the insertion of clause (d) of proviso to section 43(5), taking such transactions outside the purview of the speculative transactions, is prospective in operation and applies only from assessment year 2006-07. Thus the Special Bench of the tribunal in the aforenoted case held that the transactions in derivatives with the underlying assets as non index are speculative transactions upto assessment year 2005-06. It is further noticed that the Hon'ble jurisdictional High Court in CIT v. Shri Bharat R. Ruia (HUF) [2010] 199 Taxman 87 (Bom.) has held that transactions in Exchange traded finance derivatives are speculative transactions as defined in section 43(5) and further clause (d) inserted to the proviso to section 43(5) with effect from 1-4-2006 is prospective. In view of the judgment of the Hon'ble jurisdictional High Court ....
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...., and such transactions have been eventually held to be a speculative transactions. From the above discussion, it is clear that the transactions in derivates, whether having underlying assets as shares or Index, are speculative transactions within the meaning of section 43(5). As such, we hold that the ld. CIT(A) was not justified in coming to the conclusion that the Index based derivative transactions be treated as normal business or non-speculative transactions. We, therefore, overturn the impugned order to the extent of holding that the loss in Option trading in Index Futures be considered as non-speculative. The net result is that in a normal case, the loss in Option trading on individual shares or Index has to be held as speculative loss. II. Section 115AD and Income from derivatives by F.I.Is. 8. Having held that transactions in derivatives, both Index based and individual shares based, are to be considered as speculative transactions under section 43(5) in a normal case, their nature needs to be examined in the hands of FIIs. The ld. A.R. contended that section 115AD deals with taxation on income of FIIs from securities or capital gains arising from their transfer and ....
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....e securities referred to in clause (a), if any, included in the total income, at the rate of twenty per cent; (ii) the amount of income-tax calculated on the income by way of short-term capital gains referred to in clause (b), if any, included in the total income, at the rate of thirty per cent; Provided that the amount of income-tax calculated on the income by way of short-term capital gains referred to in section 111A shall be at the rate of fifteen per cent; (iii) the amount of income-tax calculated on the income by way of long-term capital gains referred to in clause (b), if any, included in the total income, at the rate of ten per cent; and (iv) the amount of income-tax with which the Foreign Institutional Investor would have been chargeable had its total income been reduced by the amount of income referred to in clause (a) and clause (b). (2) Where the gross total income of the Foreign Institutional Investor- (a) consists only of income in respect of securities referred to in clause (a) of sub-section (1), no deduction shall be allowed to it under sections 28 to 44C or claus....
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....traded on a recognised stock exchange; (e) commercial paper; (f) security receipts;" 8.4 From the prescription of Regulation 15(1), it can be viewed that there are restrictions on a FII in making investments, which can only be in the specified securities which, inter alia, include shares, debentures and derivatives traded on a recognized Stock Exchange. It is further essential to note that the regulations, apart from providing that a FII can invest only in the specified securities, also provides for certain additional conditions, which have been laid down in Regulation 15(3), the relevant part of which is as under : "(3) In respect of investments in the secondary market, the following additional conditions shall apply :- (a) a foreign institutional investor or sub-account shall transact in the Indian securities market only on the basis of taking and giving delivery of securities purchased or sold : Provided that nothing contained in this clause shall apply to any transactions in derivatives on a recognised stock exchange : Provided further that a foreign institutional investor or sub-account may enter into short selling transactions only in....
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....ib) units or any other instrument issued by any collective investment scheme to the investors in such schemes; (ic) security receipt as defined in clause (zg) of section 2 of the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002; (id) units or any other such instrument issued to the investors under any mutual fund scheme; (ii) Government securities; (iia) such other instruments as may be declared by the Central Government to be securities; and (iii) rights or interest in securities;" From the above definition of 'securities', it is discernible that derivatives and shares etc., have been kept on a single platform. 8.7 Having taken insight into the Regulations governing FIIs, we return to section 115AD. Explanation (a) defines the expression 'Foreign Institutional Investor' to mean such an investor as the Central Government may, by notification in the official Gazette, specify in this behalf. On a conjoint reading of Regulation 15 with Explanation (a) to section 115AD, it is easily perceptible that a FII can only `Invest' but not trade in the specified securities. Further Expla....
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....h 'securities' and clause (b) specifically deals with income arising from the transfer of such 'securities'. Therefore, it is manifest that the income earned by a FII either by way of retention or by way of transfer of securities (including derivates) is subject matter of sub-section (1) of section 115AD. 8.10 Before we proceed further, it would be apt to note that section 115AD was inserted by the Finance Act, 1993. The Memorandum explaining the provisions of the Finance Bill, 1993 reported at 200 ITR (St) 152 provides as under : "Measure to Promote Capital Market Tax incentive for Foreign Institutional Investors Investing in securities While presenting the Budget for 1992-93, the Finance Minister had stated that ways would be considered of allowing reputable foreign investors to invest in the country's capital markets. In pursuance of this announcement, guidelines have been issued through a Press Note dated 14th September, 1992, for such investment by Foreign Institutional Investors. Income from such investment is to be taxed at concessional rates. Accordingly, the Bill seeks to insert a new section 115AD in the Income-tax Act relating to tax on income of Foreign Inst....
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....sfer of securities, it has been provided in section 115AD that it shall be charged as short-term or long-term capital gain, which depends upon the period of holding of such securities. A FII is not allowed by the Central Government to do 'business' in the 'securities'. Once it is noticed that a FII can only 'invest' in 'securities' and tax on the income from the transfer of such securities is covered by a special provision contained in section 115AD, the natural corollary which follows is that tax should be charged on income arising from transfer of such securities as per the prescription of this section alone, which refers to income by way of short term or long term capital gains. 8.13 The ld. D.R. has relied on sub-section (2) of section 115AD for contending that the existence of 'Business income' from dealing in securities is also envisaged. We find that sub-section (2) of section 115AD has two clauses. Clause (a) provides that where the gross total income of a FII consists only of income in respect of security referred to in clause (a) of sub-section (1) (i.e., income received in respect of securities, otherwise than from their transfer), then no deduction shall be allowed t....
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....n before us is not to determine whether a FII can have any business income or not. We are confined to determining whether the income from the transfer of securities would fall under sub-section (1) or (2). If it is presumed as a hypothetical case that a FII may also have any business activity, whether legal or illegal, then the income from such activity shall be considered as 'Business income' covered under sub-section (2)(b). The only embargo against the above presumption is that the business should not be that of dealing in 'securities'. Once there is a special provision slicing away the income to a FII from the transfer of 'securities' from the other income, it has to find its home only under sub-section (1)(b), irrespective of the fact that the securities are viewed as 'Investment' or 'Stock in trade'. If the revenue ventures to make a distinction between such securities as constituting capital asset or stock in trade, which is not contemplated by the Central Government as is evident from SEBI(FII) Regulations and the definition of FII in Explanation (a) to section 115AD, then this provision will become otiose. In our considered opinion if a FII receives any income in respect o....
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....income from derivatives shall also be considered as short-term or long-term capital gain depending upon the period of holding. If the viewpoint of the Department, to the effect that income from transfer of shares or debentures etc. should be considered as short-term or long-term capital gain (as has been accepted by the Assessing Officer in the instant case) but that from derivatives should be considered as 'Business income' (speculation business), then it would mean considering shares and debenture etc. as distinct from derivatives. Moreover there is nothing on record to demonstrate that the assessee was visited with any consequences as per Regulation 7A for violation of Regulations 15 or 16. It shows that the regulations have been conscientiously followed by the assessee as per which it simply made only Investment in securities and there is nothing of the sort of trading. Although in common parlance, the shares or debentures etc., are distinct from derivatives, and their taxation may also differ in the case of non-FIIs, but such distinction is obliterated in the context of FIIs due to the inclusion of both shares and debentures etc. on one hand and derivatives on the other, in th....