2011 (5) TMI 270 - AT - Income Tax

Revision - Carry forward and set off of business loss - whether or not the losses incurred in dealing in derivatives in earlier assessment years are eligible to set off against the profits from the same activity post amendment to definition of speculation transactions under section 43(5) with effect from 1st April, 2006 - only purpose of segregating losses of speculation and non-speculation business is to ensure that the losses incurred by the assessee in speculation business, which lack sufficient transparency, and leave the scope for generating fictitious losses through artificial transactions or shifting of incidence of loss from one person to another, are not allowed to be set off against profits of another business other than a similar business - section 43(5) with effect from 1st April 2006, losses incurred in derivative trading are held to be eligible for being set off against normal business profits, as derivate trading itself is treated as a non-speculative business, and losses of any non- speculative businesses can be adjusted profits of any non-speculative business the provisions of carry forward and set off are to be construed in a manner so as not to defeat the plain and unambiguous intention of the legislature - this amendment was to provide relief to the taxpayers and is to be viewed as beneficial provisions, as such, and one cannot possibly proceed on the basis that the object of making amendment in section 43(5) was to kill the brought forward losses of dealing in derivatives or make them ineligible for being set off against the profits of the same business in subsequent years - Decided in the favour of the assessee

Issues Involved:
1. Correctness of the assessment order under section 143(3) of the Income-tax Act, 1961.
2. Set off of business income earned during the year against business loss carried forward from previous years.
3. Eligibility of set off of losses incurred in derivatives transactions in earlier years against income earned in derivatives transactions in the assessment year 2006-07.

Issue-wise Detailed Analysis:

1. Correctness of the Assessment Order under Section 143(3):
The assessee challenged the impugned order passed by the Commissioner of Income-tax (CIT) under section 263, which held that the original assessment order under section 143(3) was erroneous and prejudicial to the interest of revenue. The CIT's basis was that the losses incurred by the assessee were not correctly carried forward, and the set off granted by the Assessing Officer (AO) rendered the assessment order erroneous.

2. Set Off of Business Income Earned During the Year Against Business Loss Carried Forward from Previous Years:
The CIT held that the business income earned by the appellant during the year in derivatives transactions amounting to Rs. 1,91,48,060 should be set off against business loss carried forward of Rs. 1,95,56,066 for the assessment year 2005-06, rather than against the loss of the assessment year 2001-02 incurred in derivatives transactions. The assessee contended that the losses from derivatives transactions in earlier years should be set off against the current year's profits from the same activity.

3. Eligibility of Set Off of Losses Incurred in Derivatives Transactions in Earlier Years Against Income Earned in Derivatives Transactions in the Assessment Year 2006-07:
The core issue was whether the losses incurred in derivatives transactions in earlier assessment years, which were treated as speculative transactions, could be set off against the profits from the same activity post the amendment to the definition of 'speculative transactions' under section 43(5) with effect from 1st April 2006. The amendment excluded eligible transactions in derivatives from being considered speculative, thus treating them as normal non-speculative business.

The Tribunal analyzed the nature of derivative transactions and their treatment under the Income-tax Act, 1961. It noted that derivatives are financial instruments whose values depend on underlying assets and can be used as insurance against business risks. The Tribunal referred to the Securities Contracts (Regulations) Act, 1956, which extended the definition of 'securities' to include derivatives effective from 22nd February 2000. However, the Income-tax Act did not initially recognize trading in derivatives, treating such transactions as speculative due to the lack of actual delivery.

The Tribunal further noted that the Finance Act, 2005, amended section 43(5) to exclude eligible transactions in derivatives on recognized stock exchanges from being treated as speculative transactions. This amendment aimed to provide relief to taxpayers by allowing set off of losses incurred in derivative trading against normal business profits.

The Tribunal emphasized that the amendment was intended to align the Income-tax Act with developments in the capital market and to provide relief to taxpayers. It held that the losses incurred in derivative trading in earlier years should be eligible for set off against profits from the same activity in the assessment year 2006-07 and subsequent years.

The Tribunal relied on the principles laid down by the Hon'ble Supreme Court in the case of Manmohan Das and the Hon'ble Bombay High Court in the case of Western India Oil Distributing Co. Ltd., which recognized the statutory right of the assessee to carry forward and set off business losses against profits from the same business in subsequent years. The Tribunal concluded that the assessee was entitled to set off the carried forward losses from derivative trading against the profits from the same activity in the assessment year 2006-07.

Conclusion:
The Tribunal quashed the impugned revision proceedings under section 263 and set aside the CIT's order. It held that the assessee was eligible to set off the losses incurred in derivative trading in earlier years against the profits from the same activity in the assessment year 2006-07. The appeal was allowed in favor of the assessee.

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