2011 (4) TMI 37 - HC - Income Tax

Section 43(5) - Assessee is an HUF engaged in the business of trading in shares and securities, etc. - In the assessment year 2003-04, the assessee had entered into certain transactions in exchange traded derivatives which resulted in loss -The assessee claimed the above loss as business loss - In the assessment order passed under Section 143(3), 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. - 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 - Various decisions of the ITAT wherein it is held that the derivative transactions are not speculative transactions, which 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 Act is retrospective in nature are also distinguishable on facts as the ratio laid down therein have no relevance in interpreting the provision of Section 43 (5) of the IT Act - The futures contracts cannot be equated with insurance contract, because, unlike futures contract, the insurance contract is not an article of trade which can be traded - Thus, the futures contract being an article of trade created by an authority under the 1956 Act, the transactions in futures contracts would constitute transaction in commodity under Section 43(5) of the IT Act.39) Held that the exchange traded derivative transactions carried on by the assessee during AY 2003-04 are speculative transactions covered under Section 43(5) of the Act and the loss incurred in those transactions are liable to be treated as speculative loss and not business loss and clause (d) inserted to the proviso to Section 43(5) with effect from 1/4/2006 is prospective in nature and the ITAT was in error in holding that clause (d) to the proviso to Section 43(5) applied retrospectively so as to apply to the transactions carried on by the assessee during AY 2003-04 - Allow the appeal filed by the Commissioner of Income Tax

Issues Involved:
1. Whether the transactions in exchange-traded financial derivatives are "speculative transactions" as defined in Section 43(5) of the Income Tax Act, 1961.
2. Whether clause (d) inserted to the proviso to Section 43(5) of the Act w.e.f. 1-4-2006 would apply to such transactions undertaken in the assessment year 2003-04.

Issue-wise Detailed Analysis:

1. Definition of Speculative Transactions:
The court first considered the nature of derivative transactions, citing a detailed explanation from the Madras High Court in the case of Rajshree Sugars & Chemicals Ltd. Derivatives are financial instruments whose values depend on the value of other underlying financial instruments. The court noted that derivatives could be legally traded under the Securities Contracts (Regulation) Act, 1956 ('1956 Act') with effect from 22/2/2000.

The court then examined Section 43(5) of the Income Tax Act, which defines "speculative transaction" as 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. The court concluded that futures contracts, being articles of trade and commerce legally permitted to be traded on the stock exchange, constitute transactions in a commodity as contemplated under Section 43(5) of the Act.

The court rejected the argument that the expression "commodity" does not include "stocks & shares." It emphasized that Section 43(5) does not seek to expand the scope of the 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.

2. Retrospective Application of Clause (d) to Section 43(5):
The court addressed whether clause (d) inserted to the proviso to Section 43(5) by Finance Act, 2005 with effect from 1/4/2006 is retrospective in nature. Clause (d) provides that an eligible transaction in respect of trading in derivatives carried out in a recognized stock exchange shall not be deemed to be a speculative transaction. The court noted that the legislature specifically provided that clause (d) would come into operation prospectively with effect from 1/4/2006.

The court rejected the argument that clause (d) is clarificatory and retrospective, stating that the insertion of clause (d) was not necessitated by the fact that the provisions of Section 43(5) were unworkable or resulted in unintended consequences. The court emphasized that even after the insertion of clause (d), not all transactions in derivatives are taken outside the purview of Section 43(5). Only those derivative transactions covered under clause (d) are excluded from Section 43(5) with effect from 1/4/2006.

Conclusion:
The court held that the exchange-traded derivative transactions carried on by the assessee during AY 2003-04 are speculative transactions covered under Section 43(5) of the Act. The loss incurred in those transactions is liable to be treated as speculative loss and not business loss. The court further held that clause (d) inserted to the proviso to Section 43(5) with effect from 1/4/2006 is prospective in nature and does not apply retrospectively to the transactions carried on by the assessee during AY 2003-04. The appeal filed by the Commissioner of Income Tax was allowed, with no order as to costs.

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