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TMI Blog2011 (5) TMI 270X X X X Extracts X X X X X X X X Extracts X X X X ..... eculative 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 - IT APPEAL NO. 1798 (MUM.) OF 2010 - - - Dated:- 31-5-2011 - D. MANMOHAN, PRAMOD KUMAR, JJ. S.L. Jain for the Appellant. Pavan Vaid for the Respondent. ORDER Pramod Kumar, Accountant Member. ‑ By way of this appeal, the assessee appellant has called into question correctness of impugned order passed by the learned Commissioner of Income-tax under section 263 of the Income-tax Act, 1961, in the matter of assessment under section 143(3) of the Act for the assessment year 2006-07, on the following grounds: 1. The learned CIT erred in holding that the assessment or ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... sal of the assessment records, however, learned Commissioner was of the view that the set off so granted by the Assessing Officer rendered the assessment order "erroneous insofar as it is prejudicial to the interest of the revenue to the extent of carry forward of losses". In response to show cause notice issued by the Commissioner calling upon the assessee to show cause as to why the set off so granted not be withdrawn, the assessee, inter alia, submitted that "the assessee has carried out derivative transactions and incurred losses in certain years and earned profits in certain other years" and that since "nature of transactions, being derivatives trading, profit and loss is mutually adjusted and balance loss has been carried forward in earlier years, being on derivatives transactions, current year's profits, also being in derivatives transactions, is thus entitled to be set off against such carried forward losses". Learned Commissioner did not accept the plea so advanced by the assessee. He took note of the amendment brought about in section 43(5), with effect from 1st April, 2006, by virtue of which eligible transactions of dealing in derivatives were no longer hit by the defin ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ferred to with approval by Hon'ble Bombay High Court in the case of CIT v. Bharat R. Ruia (HUF) [IT Appeal No. 1539 of 2010, dated 18-4-2011] in the following terms: " What are these derivatives which have gained such a great deal of notoriety ? In simple terms, derivatives are financial instruments whose values depend on the value of other underlying financial instruments. The International Accounting Standard (IAS) 39, defines "derivatives" as follows: 'A derivative is a financial instrument (a) whose value changes in response to the change in a specified interest rate, security price, commodity price, foreign exchange rate, index of prices or rates, a credit rating or credit index, or similar variable (sometimes called the 'underlying'); (b) that requires no initial net investment or little initial net investment relative to other types of contracts that have a similar response to changes in market conditions; and (c) that is settled at a future date'." Actually, derivatives are assets, whose values are derived from values of underlying assets. These underlying assets can be commodities, metals, energy resources, and financial assets such as shares, bonds a ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ar future dates. Swaps are OTC (Over the counter) products. Swaps are used to manage or hedge risk associated with volatile interest rates, currency exchange rates, commodity prices and share prices. Swaps can be considered as series of forward contracts. (4) Options: An option gives the holder right to buy or sell an underlying asset at a future date at a predetermined price. A call option is the right to buy. The buyer of a "call option" has the right, but not the obligation to buy an agreed quantity of a particular commodity or financial instrument (underlying instrument), from the seller (or writer) at a certain time (the expiration date) for a certain price (strike price). The buyer pays a premium for this right. In contrast, a put option is the right to sell. The buyer of a "put option" has the right, but not the obligation to sell an agreed quantity of a particular commodity or financial instrument (underlying instrument), to the seller (or writer) at a certain time (the expiration date) for a certain price (strike price). We have a variety of options such as American and European options, depending upon the time of exercise of the right. Both call option and put option ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... lly traded under the 1956 Act with effect from 22nd February, 2000, and the transactions in derivatives were to be treated as legal and valid only if they are traded on a recognized stock exchange and cleared on the clearing house of recognized stock exchange. It was thus practically in the financial year 2000-01, which is relevant to the assessment year 2001-02, that trading in derivatives in India. 9. While trading in derivatives started in India in previous year relevant to the assessment year 2001-02, Income-tax Act, 1961 did not have any changes corresponding to this new development in securities market. Trading in derivatives was not recognized in its own right, and, as such, profits and losses were treated as profits and losses of speculation business. The underlying principle was this. Every derivative instrument, by definition, derived its value from the underlying asset or security, and delivery of such underlying asset or security was never taken. In effect thus a derivative transaction was treated as a transaction in the underlying asset or securities which never changed hands in physical delivery section 43(5) provides that speculative transaction is "a transaction i ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... o what was impossible anyway, assessee could be placed at a disadvantage of rather disabling provisions of section 43(5). Segregation of speculation and non-speculation business results is not an end in itself, but such a segregation is to restrict the set off of losses incurred a particular type of business activities. One way of looking at section 43(5) is to hold, as has been held by Hon'ble Bombay High Court in the case of Shri Bharat R. Ruia (HUF) (supra), that "the very object of section 43(5) is to treat transactions which are settled otherwise than by actual delivery as speculative transactions", though, viewed from a rather academic and conceptual point of view, treating a transaction as speculative transaction is only a modality with the objective of ensuring that there is least possible "scope for generating fictitious losses through artificial transactions or shifting of incidence of loss from one person to another". The line of demarcation being visualized and drawn up between speculative and non-speculative transaction, from this perspective, is not an end but means of achieving the end of minimising tax manoeuvrings. However, these discussions, which are somewhat aca ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... d contract note issued by such stock broker or sub-broker or such other intermediary to every client indicating in the contract note the unique client identity number allotted under any Act referred to in sub-clause (A) and permanent account number allotted under this Act; (ii) "recognised stock exchange" means a recognised stock exchange as referred to in clause (f) of section 2 of the Securities Contracts (Regulation) Act, 1956 (42 of 1956) and which fulfils such conditions as may be prescribed and notified the Central Government for this purpose;] 11. As a result of this amendment, broadly speaking, as long as the transactions in derivatives were bona fide transactions screen based systems in accordance with the rules regulations and bye laws of the respective governing bodies, evidenced by time stamped contracted note and carried out through a recognized stock exchanges, these transactions could not be held to be 'speculative transactions'. The net result of this amendment was that the losses incurred in such derivatives transactions did not suffer the disabilities as a result of related transactions being termed as 'speculative transactions' and could be freely set off a ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ofit in the derivatives market can be set-off along with losses in the cash market or vice-versa. Till now, this facility was not available for trades done in the derivatives market. ... 12. What clearly emerges from the above is (i) that it was not on account of a some sudden development, which changed the securities market overnight, but to keep pace with, as Hon'ble Finance Minister put it, "significant developments in the past decade (emphasis by underlining supplied by us now) in the capital market including the introduction of trading in financial derivatives"; (ii) that the relief was meant for only such derivatives trading as was done on the recognized stock exchanges; (iii) that it was the first time when Income-tax Act, 1961 took note of the derivatives trading ; and (iv) that this measure of amending section 43(5) was a measure to bring relief to the assessee. As a result of the above amendment, 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-speculat ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... has earned from the same business in the present assessment year when the said business cannot be treated as speculation business due to legislative amendments in section 43(5) of the Act. 14. In order to be able to deal with this question, it will be useful to now refer to, and set out, the provisions of the Act so far as the carry forward and set off of business losses is concerned. These provisions are as follows: SECTION 72 : CARRY FORWARD AND SET OFF OF BUSINESS LOSSES (1) Where for any assessment year, the net result of the computation under the head "Profits and gains of business or profession" is a loss to the assessee, not being a loss sustained in a speculation business, and such loss cannot be or is not wholly set off against income under any head of income in accordance with the provisions of section 71, so much of the loss as has not been so set off or, where he has no income under any other head, the whole loss shall, subject to the other provisions of this Chapter, be carried forward to the following assessment year, and - (i) It shall be set off against the profits and gains, if any, of any business or profession carried on by him and assessable for that ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ect to the other provisions of this Chapter, be carried forward to the following assessment year, and - (i) It shall be set off against the profits and gains, if any, of any speculation business carried on by him assessable for that assessment year; and (ii) If the loss cannot be wholly so set off, the amount of loss not so set off shall be carried forward to the following assessment year and so on. (3) In respect of allowance on account of depreciation or capital expenditure on scientific research, the provisions of sub-section (2) of section 72 shall apply in relation to speculation business as they apply in relation to any other business. (4) No loss shall be carried forward under this section for more than eight 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 banking or the granting o ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ns, thus is that the business loss, speculative or non-speculative, incurred by an assessee in one assessment year can be set off against the business loss against the profits of the same business, speculative or non-speculative, or any other business in the same category. 17. While on the question of eligibility of set off of losses, incurred by the assessee in a particular assessment year, against profits of the same business or any other business in the same category, i.e. speculative or non-speculative, in a subsequent assessment year, it is also useful to make a brief reference to Hon'ble Supreme Court's judgment in the case of CIT v. Manmohan Das [1996] 59 ITR 699. That was a case in which assessee incurred a business loss of Rs. 38,027 in the assessment year 1950-51, but the Assessing Officer, while framing assessment order for the said assessment year, held that the loss so incurred by the assessee is not in the nature of business loss, and, accordingly, the same cannot be carried forward. The assessee did not appeal against the stand so taken by the Assessing Officer. However, when assessee was declined set off of the loss of Rs. 38,027 against profit of Rs. 34,445 in th ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... set off against the profits and gains, if any, of any business, profession or vocation carried on by him in that year." 18. One of the questions before Their Lordships was as to under which head income of the assessee, from his association with Allahabad Bank as 'treasurer', was to be taxed, and this question was to be determined qua the assessment year in which loss had incurred because unless such loss was to be determined under the head 'business income', this loss could not have been carried forward. Dealing with the question as to what was the true nature of assessee's income, i.e. whether it was to be assessed under the head salaries or under the head business profits, Their Lordships further observed as follows : .On a careful consideration of the covenants, we are of the view that the treasurer was not a servant of the Allahabad Bank under the terms of the agreement dated January 2, 1931, and the remuneration received by him was not "salaries" within the meaning of section 7 of the Income-tax Act. But that is not sufficient to conclude the matter in favour of the assessee. The benefit of section 24(2) of the Indian Income-tax Act may be availed of by the assessee only ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... n the case of Manmohan Das (supra)] be properly analysed, it would seem that the application of the principle of finality, which has been submitted for our acceptance by counsel for the revenue and which found favour with the Tribunal has been rejected by the Supreme Court in a substantially similar set up when it opined that the decision of the ITO in the preceding year that the loss cannot be set off against the income of the subsequent year is not binding on the assessee despite the fact that he has rested content with that decision and not carried further the matter by way of appeal. To put it in other words, in the assessment year 1950-51, the ITO, dealing with the assessee's case, held that there was a net loss but that this could not be carried forward inasmuch as the income received by the assessee was not from the pursuit of any business, profession or vocation. For the succeeding year 1951-52, the assessee contended that his income was from pursuit of business, profession or vocation and sought to set off the preceding year's loss against the income for the succeeding year. This contention was urged despite the fact that in the preceding year the income had been held to b ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... profession or vocation to carry forward the loss as is not set off under sub-section (1) to the following year, and to set it off against his profits and gains, if any, from the same business, profession or vocation for that year". The proposition that is set out is infact in the words employed by Their Lordships and it does not need any elaboration. Once this statutory right is recognized, it is a natural corollary of that recognition that when an assessee incurs a loss in a business, speculative or non-speculative, in an year, such loss has to be, subject to fulfilment of other preconditions, is to be set off against the profits of the same business in subsequent year. III. Third, that in the course of proceedings of the subsequent assessment year, i.e. the assessment year in which set off of loss is claimed, it is open to even decide the true nature and character of loss incurred in the earlier relevant assessment year. In other words, even a finding about the nature of loss, in the assessment year in which loss is incurred, does not bind the assessee, and that aspect of the matter can be decided afresh in the course of proceedings in the assessment year in which set off is ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... section (2) of section 73 is inclusive" and, therefore, the loss carried forward can thus be set off or adjusted against the income of the same business, or against the income of any other business in that category, i.e. speculation or non-speculation, carried on by the assessee in the following assessment year. For this short reason alone, in our considered view, the set off of losses incurred by the assessee in the same business in preceding years, if otherwise eligible, must be allowed. In coming to this conclusion, we have taken note of, and relied upon, learned counsel's statement at the bar that there is no change whatsoever in the nature of business dealing of the assessee inasmuch as it was all along on the basis of screen based transactions, evidenced by the same type of date stamped contract notes and on the same stock exchanges. As we hold so, we must also deal with Hon'ble Bombay High Court's judgment in the case of Shri Bharat R. Ruia (HUF) case (supra) wherein Hon'ble Bombay High Court had an occasion to deal with the characterization of income from dealing in derivatives prior to and post the amendment in section 43(5) by the virtue of Finance Act, 2005. Learned Depa ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... Moreover, section 43(5) of the Act provides that a transaction for purchase/sale of any commodity would be a speculative transaction if it is settled otherwise than by actual delivery. For the purposes of section 43(5), it is not necessary that the commodity agreed to be purchased or sold must be capable of actual delivery. Therefore, future contracts for purchase/sale of an underlying security permitted to be traded on the stock exchange and settled otherwise than by actual delivery would be speculative transactions under section 43(5) of the Act. (34) It is contended that the expression 'commodity' does not include 'stocks shares', however, for the purposes of section 43(5), the expression 'commodity' has been expanded to include 'stocks shares' and since transactions in derivatives are not specifically included in section 43(5), the same would fall outside the purview of section 43(5). We see no merit in the above contentions. The expression 'commodity' would cover all articles of trade including stocks shares. Even under section 43(5), the expression 'commodity' is not expanded to include 'stocks shares'. In fact, use of 'comma' in between the word 'commodity' and th ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ome into operation prospectively with effect from 1-4-2006. Secondly, insertion of clause (d) was not necessitated on account of the fact that the provisions of section 43(5) were unworkable or interpretation of section 43(5) resulted in unintended consequences. Thirdly, even after insertion of clause (d), all transactions in derivatives are not taken outside the purview of section 43(5). It is only those derivative transactions which are covered under clause (d) are taken outside the purview of section 43(5) and the rest of the transactions in derivatives would continue to be covered under section 43(5) of the IT Act. In these circumstances, the argument that clause (d) inserted to the proviso to section 43(5) has retrospective effect cannot be accepted. 22. In the light of the views so expressed by Hon'ble jurisdictional High Court, we must proceed on the basis that the losses incurred in the assessment years prior to 2006-07, in dealing in derivatives, must be held to be losses of speculation business. To that extent, the issue is covered against the assessee. However, the question whether such losses of dealing in derivatives, which have been treated as losses of speculation ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... are of no significance. In our humble understanding, whatever be the status of finality of characterization of income in the assessment, which stands on a different fitting anyway, the norms applied in determination of character of income, for the purpose of eligibility of set off, in the assessment year in which loss is incurred and in the assessment year in which set off is claimed, must be the same. It is more so for the reason that as a result of this characterization of income, and as held in the case of Western India Oil Distributing Co. Ltd. (supra), only the set off is to be determined and the characterization in assessment, which has attained finality anyway, remains unchanged. When we go by the theory of a vested right being conferred on the assessee, by the virtue of section 73(2) and for setting off the losses incurred by the assessee in one year against the profits of subsequent year, which, as we have seen in the foregoing discussions, has the sanction of Hon'ble Supreme Court, this question is a wholly academic question. However, when we are examining whether a business is a speculative business or not and this examination is with respect of the nature of the busines ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... eave 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. This aspect of the matter also become clear from the observations in CBDT circular dated 27th February 2006, explaining the amendments made to section 43(5) vide Finance Act 2005, as follows: Existing provisions of clause (5) of section 43 define 'speculative transaction' to mean a transaction in which a contract for the purchase or sale of any commodity including stocks and shares is settled otherwise than by the actual delivery or transfer of the commodity or scrips. The proviso to section 43(5) lists out certain transactions which are not deemed to be speculative transactions. Systemic and technological changes introduced by SEBI have resulted in sufficient transparency in the stock markets and have to a large extent curbed the scope for generating fictitious losses through artificial transactions or shifting of incidence of loss from one person to another. The screen based computerized trading provides for audit trail. In the wake of these ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... y Hon'ble Supreme Court itself and which must, therefore, be treated to be correct position of law always, was contrary to the view adopted in the assessment order, the assessment order could not be said to be erroneous because the same was in accordance with the judicial precedents available to the Assessing Officer as at the time of assessment. Viewed thus, at the minimum, the view adopted by the Assessing Officer could not be subjected to revision proceedings under section 263. The assessee appellant must succeed for this reason as well. 27. As a result of the amendment in 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. Ironically, however, this apparently well-intended measure of relief to the assessee has resulted in an absurd situation in which past losses of derivatives trading cannot be set off against profits of derivatives trading itself. What was meant to be a source of relief has turned in ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... . . The task of interpretation of a statutory enactment is not a mechanical task. It is more than a mere reading of mathematical formulae because few words possess the precision of mathematical symbols. It is an attempt to discover the intent of the Legislature from the language used by it and it must always be remembered that language is at best an imperfect instrument for the expression of human thought and, as pointed out by Lord Denning, it would be idle to expect every statutory provision to be "drafted with divine prescience and perfect clarity". We can do no better than repeat the famous words of judge Learned Hand when he said : '. . . it is true that the words used, even in their literal sense, are the primary and ordinarily the most reliable source of interpreting the meaning of any writing : be it a statute, a contract or anything else. But it is one of the surest indexes of a mature and developed jurisprudence not to make a fortress out of the dictionary; but to remember that statutes always have some purpose or object to accomplish, whose sympathetic and imaginative discovery is the surest guide to their meaning.' We must not adopt a strictly literal interpretatio ..... X X X X Extracts X X X X X X X X Extracts X X X X
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