2017 (4) TMI 868 - AT - Income Tax

Adjustment between loss on security trading activity and profit on derivative trading by KSSBL - Held that - As mentioned here-in-above, Derivative is an instrument whose value depends on its underlying cash or physical asset. Hence it means that the value is derived from the value of the underlying asset like securities and commodities. In view of the above, the order of learned CIT(A) is set aside and the AO is directed to verify having identical underlying shares (1.1/ grounds of appeal), integral part of composite arbitrage / hedging mechanism (1.2 / grounds of appeal), adjunct of simultaneous opposite transactions in derivative segment (1.4 / grounds of appeal). The assessee is directed to file the details on the above before the AO. If after verification, the contentions of the assessee in grounds of appeal 1.1; 1.2 & 1.4 are found to be correct then the AO is directed to accept the additional income of ₹ 1,88,56,982/- offered by the assessee as per revised computation of income filed along with the application dated 15.11.2011 before him. In case the assessee fails to prove the above , then the AO is directed to arrive at business income as done in his assessment order after complying with the direction in para 7.1 here-in-above.

Issues Involved:
1. Treatment of loss arising from share arbitrage/hedging activity as 'speculative loss' instead of 'business loss'.
2. Application of Explanation to Section 73 of the Income Tax Act.
3. Adjustment of non-speculative derivative income against loss arising in delivery-based share transactions.
4. Error in determining assessed income.

Issue-Wise Detailed Analysis:

1. Treatment of Loss from Share Arbitrage/Hedging Activity:
The primary issue is whether the loss arising from share arbitrage/hedging activity should be treated as 'speculative loss' or 'business loss'. The assessee contended that the loss from delivery-based share transactions in the cash segment should be set off against profits from reverse positions in the derivative segment. The assessee argued that these transactions fall under the exceptions in Section 43(5)(b) and Section 43(5)(c) of the Income Tax Act, as they are integral parts of a composite arbitrage/hedging mechanism. The AO, however, treated the loss as speculative by invoking Explanation to Section 73, which deems certain transactions by companies as speculative.

2. Application of Explanation to Section 73:
The AO applied Explanation to Section 73, which deems certain share trading activities by companies as speculative transactions, thereby treating the loss from share trading as speculative. The assessee argued that Explanation to Section 73 should not apply, as their transactions in the cash segment were part of a composite arbitrage/hedging mechanism and not standalone share transactions. The CIT(A) upheld the AO's decision, stating that the assessee's main income is from share trading, and thus, the loss or profit from these transactions is deemed speculative as per Explanation to Section 73.

3. Adjustment of Non-Speculative Derivative Income:
The assessee argued that the remaining non-speculative derivative income should be adjusted against the loss arising from delivery-based share transactions. The AO did not allow this adjustment, leading to the assessee's appeal. The Tribunal directed the AO to verify the nature of the transactions and if found to be part of a composite arbitrage/hedging mechanism, to allow the adjustment of the non-speculative income against the loss.

4. Error in Determining Assessed Income:
The assessee pointed out an error in the assessed income, where the AO took the business loss at ?1,21,60,460 instead of the correct figure of ?1,32,24,729. The Tribunal recognized this as a mistake apparent from the record and directed the AO to verify and rectify the error.

Conclusion:
The Tribunal partly allowed the appeal, directing the AO to verify the nature of the transactions and, if found to be part of a composite arbitrage/hedging mechanism, to accept the additional income offered by the assessee and allow the adjustment of non-speculative income against the loss. The AO was also directed to rectify the error in the assessed income. The Tribunal emphasized the need for adequate opportunity for the assessee to present their case during the verification process.

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