Derivatives Loss is not Speculative Loss u/s 73

By | June 9, 2016

Held

 We have no difficulty in accepting the views of the Delhi High Court when they say that shares fall squarely within the Explanation to Section 73(4) but we are unable to agree when derivatives are treated at par with the shares because the legislature has treated them differently.

HIGH COURT OF CALCUTTA

Asian Financial Services Ltd.

v.

Commissioner of Income-tax-3, Kolkata

GIRISH CHANDRA GUPTA AND ASHA ARORA, JJ.

G.A. NO. 3250 OF 2015
ITAT NO. 139 OF 2015

MARCH  9, 2016

J.P. Khaitan, Sr .Adv., S. Kejriwal and P. Jhunjhunwala, Advs. for the Appellant. M.K. Lodh, Adv. for the Respondent.

ORDER

Girish Chandra Gupta, J. – The appeal is directed against a judgment and order dated 22nd May, 2015 passed by the learned Income Tax Appellate Tribunal, ‘B’ Bench, Kolkata, pertaining to the assessment year 2009-10 allowing an appeal preferred by the revenue.

The assessee, thus has come up in appeal.

The questions raised by the assessee are as follows:—

“(a) Whether the Tribunal was justified in law in reversing the order of the Commissioner of Income Tax (Appeals) and in upholding the disallowance of Rs.9,79,873/- made by the Assessing Officer under section 14A of the Income Tax Act, 1961 as expenditure incurred in relation to the dividend income of Rs.33,288/- and its purported findings in that behalf are arbitrary, unreasonable and perverse?
(b) Whether on a true and proper interpretation of the Explanation to section 73 of the Income Tax Act, 1961, the Tribunal was justified in law in holding that the loss of Rs.3,24,76,185/- incurred in eligible transactions within the meaning of proviso (d) to section 43(5) not involving any purchase or sale of shares as such was speculation loss ?
(c) Whether and in any event, the appellant having earned profit in its business of purchase and sale of shares, the Tribunal should have directed the aforesaid loss in eligible transactions to be set off against such profit ?”

2. With regard to the first question, Mr. Khaitan submitted that the tax free income earned by the assessee is a meagre sum of Rs.33,288/-. He added that there can be no dispute that the expenditure incurred in relation to the exempt income cannot be deducted from the taxable income. Therefore, the assessing officer was within his jurisdiction to determine the amount of expenditure incurred by the assessee for the purpose of earning exempt income. He was entitled to resort to Rule 8D in case he was not satisfied with the correctness of the claim put forward by the assessee in respect of such expenditure.

3. The assessing officer, according to him, did not take recourse to Rule 8D because that would have led to deduction of a very high amount. What he, therefore, did was to disallow a sum of Rs.9,79,873/-which is aggregate of Rs.56,162/- on account of service tax + Rs.11,587/- on account of D-mat charges + Rs.5,85,124/- on account of administrative expenses and Rs.3,27,000/- on account of salaries and bonus. He contended that the administrative expenses and salaries and bonus in its entirety could not have been undertaken for the purpose of earning the exempt income. Therefore, the CIT (A) had reduced the sum of Rs.9,79,873/- by 50% but the learned Tribunal without any reason restored it to 100%.

4. With regard to the second and the third questions, Mr. Khaitan submitted that the loss incurred by the assessee to the tune of Rs.3,24,76,184/- was on account of settlement of future and option. This loss has to be treated as a business loss under the proviso to section 43(5) of the Income Tax Act. Once it is deemed to be a business loss on the basis of the proviso appended to section 43(5), the question of applying section 73 or the explanation thereto for the purpose of refusing the loss to be set off against the business income is palpably wrong. He submitted that the judgment of the Delhi High Court relied upon by the learned Tribunal does not lay down good law. According to him, the Delhi High Court erred in holding that dealing in derivatives is also speculation within the meaning of section 73.

5. Mr. Lodh, learned Advocate appearing for the revenue submitted that Section 43(5) is a general provision whereas Section 73 is a specific provision. He in particular, drew our attention to the explanation to Sub-section (4) of Section 73 which reads as follows:—

‘(4) No loss shall be carried forward under this section for more than [four assessment years] immediately succeeding the assessment year for which the loss was first computed.

Explanation .- Where any part of the business of a company (other than a company whose gross total income consists mainly of income which is chargeable under the heads “Interest on securities”, Income from house property”, “Capital gains”, and Income from other sources”), or a company (the principal business of which is the business of trading in shares or banking) or the granting of loans and advances) consists in the purchase and sale of shares of other companies, such company shall, for the purposes of this section, be deemed to be carrying on a speculation business to the extent to which the business consists of the purchase and sale of such shares.’

6. From the aforesaid explanation he wanted us to read the relevant portion as follows:—

“Where any part of the business of a company …………………consists in the purchase and sale of shares of other companies, such company shall, for the purposes of this section, be deemed to be carrying on a speculation business to the extent to which the business consists of the purchase and sale of such shares.”

7. He submitted that a company dealing in purchase and sale of shares amongst others, which does not come within the exceptions carved out in the explanation itself, is hit by the mischief of the aforesaid explanation. He added that when the business consisting of purchase and sale of shares of other companies amounts to a speculation business, can it be said that business in derivatives, which depend upon the value of the underlying shares, is anything other than a speculation business? According to him, the view taken by the Delhi High Court is the correct view and therefore, this Court should answer the question against the assessee. The view expressed by the Delhi High Court, relied upon by Mr. Lodh, reads as follows:—

‘To borrow the Madras High Court’s expression, “derivatives are assets, whose values are derived from values of underlying assets”; in the present case by all accounts the derivatives are based on stocks and shares, which fall squarely within the Explanation to Section 73(4).’

8. We have not been impressed by the submissions advanced by Mr.Lodh. How can it be said that Sub-section (5) of Section 43 is a general provision and the provision contained in Section 73 is specific in nature? On the contrary, we are inclined to think that the object of Sub-section (5) of section 43 is to define ‘speculative business’.

9. Group-D of Chapter-IV of the Income Tax Act consists of Sections 28 to 44DB. When the statute talks of profit, it also talks of losses because loss has been construed as a negative profit. Sections in Group-D of Chapter-IV evidently deal with profits and losses of business or profession. Explanation 2 to Section 28 provides as follows :

‘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.’

10. From a plain reading of the Explanation – 2, the following deductions can be made:—

(a) Speculative transactions carried on by an assessee may be of such a nature as to constitute a business;
(b) Such speculation business carried on by an assessee shall be deemed to be distinct and separate from any other business.

We can thus arrive at a conclusion that speculation transaction may partake the character of deemed business where statute so provides. Definition of ”speculative transaction” has been provided in Sub-section (5) of Section 43, which in so far as material for our purposes, is as follows:-

‘(5) “speculative transaction” means a transaction in which a contract for the purchase or 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 clause-

(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
(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 shares through price fluctuations; or
(c) a contract entered into by a member of a forward market or a stock exchange in the course of 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 (Regulation) Act, 1956 (42 of 1956) carried out in a recognised stock exchange; [or]
(e) an eligible transaction in respect of trading in commodity derivatives carried out in a [recognised association, which is chargeable to commodities transaction tax under Chapter VII of the Finance Act, 2013 (17 of 2013)] shall not be deemed to be a speculative transaction;’

11. It would appear that the activities appearing in Clauses (a) to (e) are not to be deemed to be speculative transactions. Therefore, this comes within the category of deemed business which is however distinct and separate from any other business. Now, the question is, whether loss arising out of such deemed business can be set off against the profit arising out of other business or businesses which may for clarity be called proper business. Under Section 70 of the Act, the assessee is entitled to have the loss set off against his income from any other source under the same head unless otherwise provided. Therefore answer to the question is that the assessee is entitled to have the loss arising out of deemed business set off against the income arising out of business proper unless otherwise provided. The question however remains whether the explanation to Sub-Section (4) of Section 73 relied upon by Mr. Lodh provides otherwise. A plain reading of the explanation quoted above cannot be said to have provided otherwise. In that case the irresistible conclusion is that the assessee is entitled to set off such loss arising out of deemed business against the income arising out of business proper.

12. The learned Tribunal has supported the contention of the revenue relying upon the judgement of the Delhi High Court quoted above. The views expressed by the Hon’ble Delhi High Court are contained in a part of the sentence, which is as follows:

“by all accounts the derivatives are based on stocks and shares, which fall squarely within the Explanation to Section 73(4).”

13. We are inclined to think that the clause of the sentence ‘which fall squarely….’, qualifies the word ‘shares’ ‘and not the word ‘derivatives’. We have no difficulty in accepting the views of the Delhi High Court when they say that shares fall squarely within the Explanation to Section 73(4) but we are unable to agree when derivatives are treated at par with the shares because the legislature has treated them differently.

14. For the aforesaid reasons, the question no.(b) is answered in the negative. Question no.(c) need not be answered. Question no.(a) is kept open to be decided in an appropriate case.

15. The appeal is, thus disposed of.

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