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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 ..... e year, in derivatives transactions in shares amouting to Rs. 1,91,48,060 be set off against business loss carried forward of Rs. 1,95,56,066 for assessment year 2005-06, as against such income being set off against the loss of assessment year 2001-02 incurred by the appellant in derivatives transactions. 3. The learned CIT in not accepting the appellant's claim that loss incurred by the appellant in earlier years, being in derivatives transactions, be entitled to set off against the income earned in derivatives transactions in assessment year 2006-07, without properly appreciating the facts of the case and law applicable thereto. 2. The assessee is a chartered accountant by profession, but if his income details as culled out in the assessment order are anything to go by, he has found greener pastures in the stock markets. In the net profit of Rs. 3,07,82,539 disclosed by the assessee, while professional receipts are only at Rs. 18,00,000, most of his remaining income consists of profits from trading in derivatives and shares including profits from dealing in derivatives at Rs. 1,91,48,060. However, ne has not been as lucky in derivatives dealings in all the pr ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... s carried out in a recognized stock exchange shall be not be treated as speculative transaction.....". It is denial of this set off which is core issue in appeal before us. 4. We have heard the rival contentions, perused the material on record and duly considered factual matrix of the case as also the applicable legal position. 5. In the course of hearing before us, as indeed in the order of the learned Commissioner, a lot of emphasis has been placed on whether or not the transactions in derivatives amounted to 'speculative transactions' under section 43(5) at the relevant points of time, i.e. at the point of time when losses were incurred in preceding assessment years , as also at the point of time when profits are made in the same type of transactions, but, in our humble understanding, that aspect of the matter is still a step away from actual and core controversy involved in this appeal, i.e. 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. Undoubtedly, this is ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ewellery anticipates that he would require a particular quantity of gold at a specified distance of time, he may enter into a contract with the seller of gold bars for the supply of the same at a future date, at the rate specified in the contract. This contract reduces the risk for the buyer, against a possible steep rise in the price of gold. It equally reduces the risk of the seller against a steep fall in the price. Thus the contract acts as an insurance cover. When the transaction goes through without any dispute, the contract is fulfilled. But when the transaction fails and the motive behind the transaction is not necessarily the sale and supply of gold, but the receipt or payment of the difference in the price (difference between the prevailing price and the price fixed in the contract), many eyebrows are raised and many questions are asked. This is the point where the transaction takes a detour from a simple contract of insurance. 7. There are atleast 4 categories of derivatives, commonly in use. Some of them are traded through exchanges and they are known as Exchange-Traded-Derivatives (ETD). Others are traded directly between the parties and they are known as Over-the- Co ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e because they provide efficient ways to manage and transfer risk. A business owner who is exposed to changes in market prices can enter into an appropriate derivatives contract and the risk can be assumed by a trader or speculator who is prepared to live with uncertainty in return for the prospect of achieving an attractive return. A large financial institution can withstand more risk than a small corporate and thus may choose to engage in derivatives products for a reasonable compensation. Nobel Laureate Kenneth Arrow predicted that this would increase economic prosperity since people would be more prepared to engage in risk-taking activities. It could also serve to improve the quality of prediction of future events in the world of finance and investments. Derivatives provide a global network for intelligent assessment, management, and distribution of risk on a large scale. " 8. Securities Contracts (Regulations) Act, 1956 seeks to regulate the business of dealing in securities, but the definition of expression 'securities', in the said Act, was confined to shares, scrips, stocks, bonds, debentures, debenture stock or other marketable securities of a like nature in or of any inc ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... sent purposes. A transaction in derivatives was thus characterized as a speculative transaction for the purposes of the Income-tax Act. In view of this definition of speculative transaction, read with Explanation to section 28 which provides that "where speculative transactions carried on by an assessee are of such a nature as to constitute a business, the business (hereinafter referred to as "speculation business") shall be deemed to be distinct and separate from any other business", the profits and losses from transactions in derivatives, which constituted speculation business, were characterized as speculation profits and losses. The rationale behind this characterization of business into speculation business and non-speculation business is that the profits and gains of non-speculation business can not be set off, whether within the assessment year or in subsequent assessment years, against losses of speculation business. This restriction has been placed because non-delivery based transactions, as it appears from the stand taken by the Central Board of Direct Taxes, leave substantial "scope for generating fictitious losses through artificial transactions or shifting of incidence ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... and that "....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". Thus, even in the cases of transactions in derivatives trading, in the esteemed views of Their Lordships, as long as delivery of underlying asset does not take place, the transactions must be held to be speculative in nature. The views so stated by Their Lordships are binding on us and we must, therefore, proceed on the basis that even when physical delivery of underlying asset is impossibility, the transactions are to be treated as speculative transaction simply because the transaction is settled otherwise than by delivery. 10. Coming back to the narration of related developments, we find that it was by way of amendments brought about by the Finance Act, 2005 effective from 1st April, 2006, that Income-tax Act, 1961 took note of business of dealing in derivatives. Clause (d) was inserted to section 43(5) and this clause provided that, for the purpose of section 43(5), following shall not be deemed to be a speculative transaction: (d) an eligible transaction in respect of trading in derivatives referred to in clause [(ac)] of ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... in financial derivatives. We have also established a transparent system of trading with adequate safeguards for audit trail. Hence, I propose to amend the Income-tax Act to provide that trading in derivatives in specified stock exchanges will not be treated as "speculative transactions" for the purposes of the Income-tax Act." It is also interesting to note that only such derivative trading was taken out of the scope of 'speculative transaction' as was on the recognized stock exchanges, and it is to be seen in the light of the treatment given to derivatives trading OTC (Over the Counter), as is clear from the observation made by Hon'ble Finance Minister to the effect, "Over the counter (OTC) derivatives play a crucial role in mitigating the risks of corporates, banks and other financial entities. There is, however, some ambiguity regarding the legality of OTC derivative contracts which has inhibited their growth. I, therefore, propose to take measures to provide for clear legal validity of such contracts". The demarcation in derivatives trading was thus between derivatives trading over the counter vis-a-vis derivatives trading in the recognized stock exchanges. While former were no ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... put at a huge disadvantage. What was meant to be a source of relief to the taxpayers has also turned into a cause of unintended difficulties for many taxpayers. The way it has so happened is like this. While, as in this case, the assessee has incurred losses in derivatives trading in earlier assessment years, and he wants such losses to be set off against the profits of the same activity in this assessment year, the assessee has been declined set off on the ground that the losses incurred in past are treated as 'losses of speculation business' and profit earned now is treated as of 'profits of non- speculation business', and speculation losses cannot be set off against the non-speculation profits. Going by this interpretation, which is what the learned Commissioner has followed in the impugned order as well, thus, losses from derivatives trading, in the assessment years prior to 2006-07, stand killed, unless, of course, assessee has some other speculation profits against which the same can be set off. 13. Viewed in this perspective, the fundamental legal issue really is whether this interpretation about the ineligibility of the losses, incurred in past in the activity of dealing i ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... the amount of loss not so set off shall be carried forward to the following assessment year and so on: Provided that where the whole or any part of such loss is sustained in any such business as is referred to in section 33B which is discontinued in the circumstances specified in that section, and thereafter, at any time before the expiry of the period of three years referred to in that section, such business is re-established, reconstructed or revived by the assessee, so much of the loss as is attributable to such business shall be carried forward to the assessment year relevant to the previous year in which the business is so re-established, reconstructed or revived, and - (a) It shall be set off against the profits and gains, if any, of that business or any other business carried on by him and assessable for that assessment year; and (b) If the loss cannot be wholly so set off, the amount of loss not so set off shall, in case the business so re-established, reconstructed or revived continues to be carried on by the assessee, be carried forward to the following assessment year and so on for seven assessment yea ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ess to the extent to which the business consists of the purchase and sale of such shares. 15. As evident from a plain reading of the above statutory provisions, the broad scheme of carry forward and set off of business losses, so far as relevant to the facts before us, is like this. The profits and gains of the business, for the purpose of carry forward and set off of losses, are classified in two baskets - of speculation business and of non-speculation business. These two categories are mutually exclusive and the losses incurred of each category can only be set off against profits of the same category. When an assessee incurs loss, in any of these categories, under the head 'profits and gains from business and profession' in a particular assessment year and cannot set it off against eligible incomes under the other heads, the loss so incurred is carried forward to subsequent year and, subject to certain conditions -which are not relevant in the present context, the assessee can set it off against income of the same business, or any other business, carried on by the assessee assessable for that subsequent year. 16. Interestingly, while section 72(1)(ii)(b) specifically refers to ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ssessee in the assessment year was in the nature of business loss and that the same is to be carried forward and set off against the profits of the assessee, from same business, in the subsequent year. These contentions were upheld by a coordinate bench of this Tribunal and the view so taken by the Tribunal was confirmed by Hon'ble Allahabad High Court and by Hon'ble Supreme Court. It was in this backdrop that Hon'ble Supreme Court, inter alia, observed as follows : "Section 24(2)* confers a statutory right (subject to certain conditions which are not material) upon the assessee who sustains a loss of profits in any year in any business, 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. Whether the loss of profits or gains in any year may be carried forward to the following year and set off against the profits and gains of the same business, profession or vocation under section 24(2) has to be determined by the Income-tax Officer who deals with the assessment of the subsequent year. It is for the Income ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... easurer under the agreement as a profession, for a profession involves occupation requiring purely intellectual or manual skill, and the work of the treasurer under the contract cannot be so regarded. Occupation of a treasurer is not one of the recognized professions, nor can it be said that it partakes of the character of a business or trade. In performing his duties under the agreement, the assessee exercised his skill and judgment in making proper appointments and made arrangements for supervising the work done by the staff in the cash department of the bank's branches. The remuneration received by him was for due performance of the duties and also for the guarantee against loss arising to the bank out of the acts or omissions of the cash and other staff of the bank. Taking into consideration the nature of the duties performed, and the obligations undertaken, together with the right to remuneration subject to compensation for loss arising to the bank from his own acts and omissions or of the servants introduced by him into the business of the bank, the assessee may be regarded as following a vocation. The remuneration must therefore be computed under section 10 of the Income-tax ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... f the assessee for both the years must properly be regarded as having arisen from the pursuit of a vocation and, further, that because of this the assessee was liable to have the preceding year's loss set off against the income for the assessment year 1951-52. It brushed aside the argument of the revenue that the preceding year's decision by the ITO had become final and by reason of such finality the assessee in 1951-52 would not be entitled to set off the loss incurred in 1950-51, although the correct legal position was that the income was from the pursuit of a business, profession or vocation and that, if this was so, the assessee was entitled to carry forward the loss. [These views were approved by Hon'ble Supreme Court in the judgment reported as CIT v. Western India Oil Distributing Co. Ltd. [2001] 249 ITR 517/117 Taxman 372. However, since Hon'ble Supreme Court's judgment was rather brief and to the point, relevant extracts have been reproduced from Hon'ble High Court's order.] 20. In our humble understanding, Hon'ble Supreme Court's judgment in Manmohan Das' s case (supra), read with Hon'ble Bombay High Court's judgment in the case of Western India Oil Distributing Co. Ltd ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... come-tax Officer declared that the loss computed in that year could not be carried forward to the next year under section 24(2) of the Income-tax Act, as it was not a business loss" and yet, while dealing with the assessment proceedings for the assessment year 1951-52, it was held that loss incurred by the assessee in 1950-51 was 'business loss' in nature. Similarly, as held by Hon'ble Bombay High Court in the case of Western India Oil Distributing Ltd. (supra) and as confirmed by Hon'ble Supreme Court, losses determined under the head 'income from other sources', which had attained finality, were subsequently treated as 'business losses' - though for the limited purposes of eligibility for set off against profits from same activity in subsequent years. 21. Let us now come back to the facts of the case before us. It is not even in dispute that the assessee has earned profits from the same business in which losses were incurred in the earlier years. Going by the plain words of Hon'ble Supreme Court's judgment, in the case of Manmohan Das (supra), to the effect that section 24(2) of 1922 Act confers "a statutory right upon the assessee who sustains a loss of profits in any year in a ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... -07 losses in derivatives trading were speculation losses, and when admittedly profits of derivatives trading are not profits of speculation business, the set off of these types of business results cannot be given. In Shri Bharat R. Ruia (HUF) case (supra), the assessee had suffered loss in the assessment year 2003-04, i.e. one of the assessment years prior to assessment year 2006-07, which he claimed is to be carried forward as business loss, not being in the nature of speculation loss. The only difference in speculation loss and non-speculation loss obviously was the limitation on the profits against which such losses could be set off, but the issue in dispute nevertheless remained confined to the nature of loss carried forward. The Assessing Officer held that it is a loss of speculation business and liable to be carried forward as such. When the matter travelled in appeal before a coordinate bench of this Tribunal, it was held that the loss is a normal business loss, since amendment in section 43(5) is only clarificatory in nature and must relate back to the earlier assessment years as well. However, the stand so taken by the coordinate bench did not find favour with Hon'ble Hig ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e transaction for purchase or sale of stocks & shares. In other words, section 43(5) does not seek to expand the scope of 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. (35) The argument that section 43(5) refers to contracts which are capable of settlement by actual delivery whereas the transactions in futures are incapable of settlement and therefore, transactions in futures would fall outside the scope of section 43(5) is also without any merit, because, the very object of section 43(5) is to treat transactions which are settled otherwise than by actual delivery as speculative transactions. As noted earlier, section 43(5) refers to contracts for purchase/sale of any commodity and it is not restricted to contracts which are capable of performance by actual delivery. Therefore, the fact that the futures contracts are settled otherwise than actual delivery cannot be a ground to hold that the futures contracts are not ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... r adjudication before Hon'ble jurisdictional High Court, and Their Lordships did not also have any occasion to examine the scope of statutory provisions regarding carry forward and set off of business losses and the manner in which Hon'ble Courts have interpreted the same. In our humble understanding, therefore, this decision cannot be viewed as an authority for the proposition that losses incurred in dealing in derivatives, prior to the assessment year 2006-07, cannot be set off against the profits of the same business in the assessment year 2006-07 or later assessment years. That aspect of the matter did not come up for consideration before Their Lordships. Similarly, the scope of provisions for set off and carry forward of losses did not come up for consideration before a coordinate bench of this Tribunal in the case of Asstt. CIT v. Shreegopal Purohit [2009] 33 SOT 1 (supra). The coordinate bench apparently proceeded on the assumption that if a loss is characterized as speculation loss, in assessment proceedings for the assessment year in which loss was incurred, and profits from the same business in a subsequent year is characterized as non-speculation business profit, the for ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ent years. It is a peculiar situation in which the law governing definition of speculative transaction itself has undergone a change within the relevant period, and, therefore, there cannot be a uniform view in respect of the entire period of business. Having said that, if at all a uniform finding on the nature of business is needed to be given, as we believe is warranted on the facts of this case, the nature of the business must be held to be non-speculative business in nature, since, in view of the law as it stands now, the business cannot be said to be speculative business in nature. This finding, in view of our understanding of law laid down by Hon'ble Bombay High Court in the case of Western Oil Distributing Co. Ltd. (supra), is relevant only for the purpose of the set off in the present assessment year and it will have no bearing on the earlier assessments which have received finality. This may somewhat incongruous at the first sight, but then this is how Hon'ble Courts has interpreted the legal position and, to our limited understanding, this seems to be the only way to iron out the wrinkles of complexities, and alleviate genuine hardship, caused due to change in definition ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... rities is losing relevance. The Finance Act, 2005 has, accordingly, amended section 43(5) to provide that an eligible transaction in respect of trading in derivatives of securities carried out on a recognised stock exchange shall not be deemed as speculative transaction........ 26. As we have pointed out earlier, the 'systemic and technological changes' brought about by the SEBI (Securities and Exchange Board of India) which, as per CBDT's own stand, lead to derivatives dealings being specifically taken out of the ambit of 'speculative transactions' were not overnight changes but the changes which were brought about, as Hon'ble Finance Minister noted in the relevant budget speech referred to earlier in this order, by 'significant developments over the past decade'. The screen based trading, with audit trail, was as much in existence in 2001-02 as it was in 2006-07. The nature of business thus was the same in every significant manner, and there was no other earlier occasion when 'derivatives trading' was taken note of the Income-tax Act, 1961. A school of thought was thus indeed possible, at least until a Special Bench of this Tribunal and until Hon'ble jurisdictional High Court r ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ns made by Hon'ble Supreme Court, in the case CIT v. Hindustan Bulk Carriers [2003] 259 ITR 449/126 Taxman 321, as follows: A construction which reduces the statute to a futility has to be avoided. A statute or any enacting provision therein must be so construed as to make it effective and operative on the principle expressed in maxim ut res magis valeat quam pereat i.e., a liberal construction should be put upon written instruments, so as to uphold them, if possible, and carry into effect the intention of the parties. [See Broom's Legal Maxims (10th Edition), page 361, Craies on Statutes (7th Edition) page 95 and Maxwell on Statutes (11th Edition) page 221.] A statute is designed to be workable and the interpretation thereof by a Court should be to secure that object unless crucial omission or clear direction makes that end unattainable - Whitney v. Commissioner of Inland Revenue [1926] AC 37 p. 52 referred to in CIT v. S. Teja Singh AIR 1959 SC 352, Gursahai Saigal v. CIT AIR 1963 SC 1062. The Courts will have to reject that construction which will defeat the plain intention of the Legislature even though there may be some inexactitude in the language used - Salmon v. Duncombe ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... n and in the context of the setting in which it occurs. We cannot ignore the context and the collection of the provisions in which . . ., appears, because, as pointed out by judge Learned Hand in the most felicitous language : interpret '. . . the meaning of sentence may be more than that of the separate words, as a melody is more than the notes, and no degree of particularity can ever obviate recourse to the setting in which all appear, and which all collectively create. . . .'" 29. In view of the guidance so given by Their Lordships, we have to proceed on the basis that despite 'inexactitude in the language used', as was the expression approved by Hon'ble Supreme Court, 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. In our considered view, 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 s ..... X X X X Extracts X X X X X X X X Extracts X X X X
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