share broker loss from trading of derivative transaction is business loss

Assessee, a share broker, loss incurred in trading of derivative transaction i.e. future and options, was to be regarded as ‘business loss’ and thus same could be set off against its commission income earned on sale and purchase of shares

IN THE ITAT CHENNAI BENCH ‘C’

Deputy Commissioner of Income-tax, Co. Circle-I(1)

v.

Aishwarya & Co. (P.) Ltd.

IT APPEAL NO. 860 (MDS.) OF 2014
[ASSESSMENT YEAR 2008-09]

MAY  29, 2015

A.V. Sreekanth, JCIT for the Appellant. Pushya Seetharaman, Sr. Adv. and Ms. J. Sree Vidya for the Respondent.

ORDER

Chandra Poojari, Accountant Member – This appeal by the Revenue is directed against the order of the Commissioner of Income-tax (Appeals) dated 26.12.2013

2. The only ground raised by the Revenue in this appeal is with regard to deletion of addition of Rs. 1,08,22,078/- being the loss on account of futures and options set off against the business profit.

3. The facts of the case are that the assessee is engaged in the business of broking and trading in securities. The assessee filed return of income on 27.9.2008 admitting total income of Rs. 13,20,640/-. The assessee incurred a loss to the tune of Rs.1,08,22,078/- for the period in question and debited the same to its profit and loss account under the head “loss on purchase and sale in future options.’ The assessee had claimed the same as revenue expenditure, since according to the assessee, trading in futures and options is no longer speculative transactions as per proviso (d) to sec.43(5) inserted by the Finance Act, 2005 w.e.f. 1.4.2006. However, the AO held that loss incurred out of trading in futures and options is speculation loss and hence could not be allowed to be set off against brokerage income. Accordingly, he completed the assessment u/s.143(3) of the Act determining total income at Rs. 1,21,52,718/- making disallowances of Rs.1,08,22,078/- on ‘loss on purchase and sale in futures and options’ and disallowance u/s.14A of Rs. 10,000/- on the dividend earned of Rs. 98,992/-. Aggrieved by this assessment order, the assessee went in appeal before the Commissioner of Income-tax(Appeals).

4. On appeal, the Commissioner of Income-tax(Appeals) after going through the facts of the case observed that the AO is not justified in treating the loss of Rs.1,08,22,078/- as speculation loss. Further, he observed that the assessee has traded in future and options in a recognized stock exchange i.e NSE and this was not disputed by the AO. In fact, the assessee has submitted a complete statement of trading in future and options for AO’s verification. Therefore it is not in dispute that the transactions only related to the futures and options, which are types of derivatives. Derivatives are financial instruments, whose value depends on or is derived from the performance of secondary sources such as an underlying bond, currency or commodity. In this regard, the ICAI Guidance Note on Accounting for Equity Index and Equity Stock Futures and Options describes options as under: “An Option is a type of derivative instrument whereby a person gets the right to buy or sell at an agreed amount an underlying asset on or before the specified future date and The ICAI Guidance Note on Accounting for Equity Index and Equity Stock Futures and Options says: “Futures and options” are both standardised derivative instruments traded on a stock exchange. From the above definitions it is clear that futures and options are also derivatives, i.e. an instrument whose value depends on an underlying source or asset. For stock derivatives the price of the shares of a particular company is the underlying source. For an index derivative, the value of the index is the underlying source. The Assessing Officer has treated the loss on trading of future and options as loss in speculation business by virtue of explanation to Sec 73. He has come to that conclusion based on the decisions wherein it has been stated that the loss suffered by an assessee company on dealing its shares on its own account was a speculation loss and therefore could not be allowed to be set off against the brokerage income, failing to see that in the present case, the trading was not in stocks and shares, but in derivatives.

4.1 Further, CIT(A) observed that the AO failed to see that the explanation to sec. 73 was introduced to prevent companies from trading in their own group shares and showing losses to be set off against business profits. When the legislature has decided to exempt the derivatives from the purview of ‘speculative transactions’ only after confirming that there were sufficient transparency in the transactions, i.e. only trading in derivatives carried out in a recognised stock exchange; the loss incurred by the assessee arising out of forward and options ought to be set off against regular business income. The derivatives include contract which derives its value from the prices, or index of prices, of underlying securities. As such, the explanation to sec. 73 cannot apply to derivatives, but only to purchase and sale of shares simpliciter. Further a speculative transaction as per sec.43(5) means a transaction in which the contract for the purchase or sale of any commodity, including stocks and shares, is periodically or ultimately settled otherwise than by actual delivery or transfer of commodity or scrip. A derivative can also be traded on the value of the underlying shares but is not a trade in any actual stock. It does not have a physical existence. Derivatives are not a contract for purchase or sale of any physical commodity as such. So, these are not speculative transactions in the strict sense of terms of s. 43(5), therefore the loss on I account of derivative cannot be treated as speculation loss. The dealings in derivative being a separate kind of transaction, without force of law, it is not possible to hold that the transaction was speculative in nature.

4.2 According to the CIT(A), the assessee has transacted in future and options and the loss incurred in this regard by the assessee should be allowed to be set off against its brokerage income. The AO disallowed the claim based on the decisions, which are solely in relation with companies engaged in pure purchase and sale of shares and does not have anything to do with derivatives. The CIT(A) observed that the AO has failed to consider various decisions of the Tribunal, which clearly state that the transactions pertaining to purchase and sale of derivatives are not the purchase and sale of shares. Therefore, the Assessing Officer is not justified in making disallowance of Rs. 1,08,22,078, since the assessee has correctly claimed set off of losses arising from trading in future and options (derivatives) from its business profit. Against this, the Revenue is in appeal before us.

5. The ld. DR submitted that the loss on share trading to a share broker is not a business loss and it is to be treated as a speculation loss by virtue of Explanation to sec.73 and Explanation 2 to sec.28, since brokerage income on shares and securities does not find a place in the list of exceptions provided in the Explanation to sec.73 of the Act. Further, he submitted that the loss suffered by an assessee on dealing its shares on its own account was a speculation loss and therefore, could not be allowed to be set off against brokerage income. He relied on the following judgments:

6. The ld. AR has submitted written submissions, wherein it was stated that for the assessment year 2008-09, the assessee claimed set off of loss from purchase and sale in future and options, against the business income, as derivatives had been excluded from the definition of “speculative business” u/s.43(5) by sub-clause (d) to the Proviso inserted with effect from 1.4.2006. He further submitted that the Department has relied on the decision of the Delhi High Court in the case of CIT v. DLF Commercial Developers Ltd. [2013] 218 Taxman 45  to support its view, wherein it was held that since the Explanation to sec.73 is applicable to sale of shares, it would be equally applicable to derivatives – “once removed from it and entirely dependent on stocks and shares for determination of their value”. Further, he pointed out that the Explanation to sec.73 was introduced to prevent companies from trading in their won group shares and showing losses to be set off against business profits. The legislature decided to exempt the derivatives from the purview of ‘speculative transactions’ only after confirming that there were sufficient transparency in the transactions’, i.e. only trading in derivatives carried out in a recognized stock exchange. The ld. AR has relied on the following decisions in support of its stand:

6.1 He also relied on the following cases, which relate to companies, the transactions in derivatives are treated as regular business transactions and not speculative transactions:

6.2 Further, on the issue of whether the Delhi High Court is a binding precedent, he submitted that the Karnataka High Court has taken a different view and where two views are possible, the one in favour of the assessee should be followed, as held by the Supreme Court in the cases of CIT v. Vegetable Products Ltd. [1973] 88 ITR 192 and CIT v. Podar Cement (P.) Ltd. [1997] 226 ITR 625 He has also relied on various decisions of the Supreme Court and High Courts in support of his argument.

7. We have heard both the parties and perused the material on record. In this case, the assessee is engaged in the business of share trading which involves stock and share broking activities, purchase and sale of delivery based shares and purchase and sale of non-delivery based shares i.e. derivative trading. The assessee incurred loss on delivery based purchase and sale of Rs. 1,08,22,078/-. The assessee claimed it as business loss. The AO during the course of assessment proceedings, considered this loss as speculation loss and not allowed set off against business loss. According to the AO, Explanation to sec.73 is applicable to the facts of the assessee’s case and disallowed the claim of set off of losses from dealing of shares. The assessee carried the matter to the CIT(A), who allowed the claim of the assessee by holding that the loss incurred by the assessee in derivative transactions to be set off with the profits earned from derivative transactions. According to the ld. DR, the derivative transaction cannot fall under sec.73. Explanation to sec.73 creates a deeming fiction by which among the assessee, who is a company, as indicated in the said Explanation dealing with the transaction of share and suffer loss, such loss should be treated to be speculative transaction within the meaning of sec.73 of the Act, notwithstanding the fact that the definition of speculative transaction mentioned in sec.43(5) of the Act, the transaction is not of that nature as there has been actual delivery of the scrips of share. As per the definition of sec.43(5), trading of shares which is done by taking delivery does not come under the purview of the said section. Similarly, as per clause (d) of sec.43(5), derivative transaction in shares is also not speculation transaction as defined in the said section. Therefore, both profit/loss from all the share delivery transactions and derivative transactions are having the same meaning, so far as sec.43(5) of the Act is concerned. Again, in view of the fact that both delivery transactions and derivative transactions are non-speculative as far as sec.43(5) is concerned, it follows that both will have the same treatment as far as application of Explanation to sec.73 is concerned. Therefore, aggregation of the share trading profit and loss from derivative transactions should be done before the Explanation to sec.73 is applied. The above view has been taken by Special Bench of this Tribunal, Mumbai Bench, in the case ofAsstt. CIT v. Concord Commercial (P.) Ltd. [2005] 95 ITD 117/2 SOT 276  In this case, the Special Bench held that :

“Before considering whether the assessee’s case is hit by the deeming provision of Explanation to Sec. 73 of the Act, the aggregate of the business profit / loss has to be worked out based on the non-speculative profits; either it is from share delivery or from share derivative.”

8. From the above, it is concluded that both trading of shares and derivative transactions are not coming under the purview of Section 43(5) of the Act which provides definition of “speculative transaction” exclusively for purposes of section 28 to 41 of the Act. Again, the fact that both delivery based transaction in shares and derivative transactions are non-speculative as far as section 43(5) is concerned goes to confirm that both will have same treatment as regards application of the Explanation to Section 73 is concerned, which creates a deeming fiction. Now, before application of the said Explanation, aggregation of the business profit/loss is to be worked out irrespective of the fact, whether it is from share delivery transaction or derivative transaction.

8.1 Now, this view has been confirmed by the Hon’ble Calcutta High Court in the case of Baljit Securities (P). Ltd. 88 CCH 313 and held as under:—

“Clause (d) of Section 43(5) became effective with effect from 1st April, 2006. Therefore, prior to 1st April, 2006 any transaction in which a contract for the purchase or sale of any commodity including stocks and shares was periodically or ultimately settled otherwise than by the actual delivery or transfer of the commodity or scrip was a speculative transaction. Sub-section 1 of Section 73 provides as follows:

‘(1) Any loss, computed in respect of a speculation business carried on by the assessee, shall not be set off except against profits and gains, if any, of another speculation business.’

The resultant effect was that any loss arising out of speculative transaction could only have been set off against profits arising out of speculative transaction. In the present case, the assessee, as already indicated, has been dealing in shares where delivery was in fact taken and also in shares where delivery was not ultimately taken. In other words, the assessee has been dealing in actual selling and buying of shares as also dealing in shares only for the purpose of settling the transaction otherwise than by actual delivery. The question arise whether the losses arising out of the dealings and transaction in which the assessee did not ultimately take delivery of the shares or give delivery of the shares could be set off against the income arising out of the dealings and transactions in actual buying and selling of shares. An answer to this question is to be found in the explanation appended to Section 73 which reads as follows:

‘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”, or a company the principal business of which is the bu9siness of 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. In order to resolve the issue before us, the section has to be read in the manner as follows:

“Explanation : Where any part of the business of a company (… … … … … … … … … … … … … … …. … … … … … …. … … … … … … … … …. … … .. .. … .. … … … .. … .. … … … .. … … .. …. … … … .. … .. … … … … …. … … …) consist 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.”

It would, thus, appear that where an assessee, being the company, besides dealing in other things also deals in purchase and sale of shares of other companies, the assessee shall be deemed to be carrying on a speculation business. The assessee, in the present case, principally is a share broker, as already indicated. The assessee is also in the business of buying and selling of shares for self where actual delivery is taken and given and also in buying and selling of shares where actual delivery was not intended to be taken or given. Therefore, the entire transaction carried out by the assessee, indicated above, was within the umbrella of speculative transaction. There was, as such, no bar in setting off the loss arising out of derivatives from the income arising out of buying and selling of shares. This is what the learned Tribunal has done.”

9. From the above decision of the Calcutta High Court in the case of Baljit Securities (P.) Ltd. (supra), the issue stands covered in favour of the assessee. Hence, we confirm the order of the CIT(A) and this ground is dismissed.

10. In the result, the appeal of the Revenue is dismissed.