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TMI Blog2017 (12) TMI 1054X X X X Extracts X X X X X X X X Extracts X X X X ..... culation loss against non-speculative business income by invoking the explanation to section 73 of the Act and for this Revenue has raised following ground No.1: - "On the facts and in the circumstances of the case and in law, the Ld. CIT(A) erred in directing the AO to delete the addition of deemed speculation loss of 36,87,83,681/- made by the AO under explanation to section 73 of I.T. Act as the assessee has wrongly set off speculative loss against non-speculative income." 3. Briefly stated facts are that the assessee company earned profit in derivative transactions at Rs. 36.87 crores (precisely Rs. 36,87,83,681/-) . The assessee has set off these losses incurred in purchase and sales of shares/ securities against income earned in derivative transactions amounting to Rs. 36.42 crores (precisely Rs. 36,41,73,414/-). The AO required the assessee to explained as to why explanation to section 73 of the Act should not be applied and loss incurred in purchase and sale of shares by the assessee need to be treated as deemed speculative loss of Rs. 36.87 crores and should not be disallowed? The assessee stated that it is a NBFC and principal business is of financing, including money ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... From a perusal of the details submitted by the appellant it is clear that the appellant was mainly engaged in the business of granting of loans and advances. A bare perusal of the balance sheet revealed employed in lending activities was he appellant in money lending business on year to year to basis. FY 2008-09 FY 2009-10 FY 2010-11 Loan Book 24.58 97.50 65.42 Interest income from lending business 5.43 9.83 15.65 It would, therefore, be wrong to conclude on the true nature of the business of the appellant by looking at the financial numbers of the previous year 2007-08 and 2008-09 since it takes time to build a lending business. The appellant is engaged in two types of business activity i.e. NBFC business and other than NBFC business. Majority of the expenses are pertaining to NBFC business activity. The appellant drew my attention to the segment reporting part of audited financial statements. As per the segment reporting requirement, Auditors have certified as per requirements of Accounting Standard 17 that out of total revenue of Rs. 101,813,462/-, Rs. 54,340,193/- is contributed by Lending Activities which constituents 53% of total revenue. The assessing o ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... the trade is allowable u/s 28 of the Income Tax Act, 1961 itself on ordinary principles of commercial trading. The appellant prays that the loss suffered in cash segment is incidental to the profit earned in derivative segment. Therefore, the loss from Cash segment should be allowed as "business loss" u/s 28 of Income Tax Act, 1961 to be adjusted against profit earned from F&O segment. ........................................................... 2.3.7 From the details of arbitrage transactions submitted during the remand proceedings, it is observed that, in majority of the transactions, the net quantity in cash segment and F&O segment are similar and in few transactions only the quantity differs. The difference occurs because of non-availability of the same quantity at the same rate at that particular point of time and thus unwinding of position in the respective exchanges/segments (However, in all cases net open position is maintained as Nil). The appellant has purchased 2050 shares in cash segment and sold them in the same segment and on the other hand purchased 2050 stock futures in F&O segment and sold them in F&O segment only. On the basis of her observation she conclude ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e of business of the appellant that wherein in most of the cases, at the time of initiation of the arbitrage transaction, it is not known to the appellant whether and in which segment he. is going to earn profit and in which segment he is going to incur loss. His only concern is that the profits earned in any segments should be more than the losses incurred in other segment/s. The Ld. Assessing officer has failed to appreciate and understand the nature of business of appellant and differentiated the F&O transactions separately as normal business activity and cash delivery transactions as speculative transactions. The Ld. assessing officer has applied sec. 43(5)(d) to the F&O transactions for holding the same as normal business transaction and ignored the provisions of Sec. 43(5'(c' of arbitraae and jobbing transactions, which according to the section shall normal business transactions, thereby the Ld. assessing officer has separated the part of the transactions without understanding the business of the appellant. .......................................................... 2.3.16 Without prejudice to the above, as observed supra in the case of CIT v. DLF Commercial Deve ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... erivative transactions should be done before the application of explanation to section 73 of the Income Tax Act is applicable. As is evident from the extant provisions of the section 43(5) of the Act, that none of the transactions are speculative in nature and that they are all hedge transactions between the two segments. If at all one segment of the transaction is to be considered as speculative then, the opposite segment transaction should also be considered as a speculative, here again the loss in the cash segment need to be allowed as a set off against the derivative profit considering both are speculative in nature. Similar issue was also involved in the case of MIs. Arena Textiles & Industries Ltd., Kolkata in ITA No. 1019/KoI/201 1 for A.Y. 2008-09 before the Hon'ble ITAT, Kolkata. The grounds of appeal raised by the Revenue were as under:- 1. Whether on the facts and circumstances of the case and settled legal position, the Ld. CIT(A) is justified in holding that transactions in derivatives are not hit by section 43(5) of the I.T. Act. 2. Whether on the facts and circumstances of the case and settled legal position, the Ld. CIT(A) was justified on facts and in law in ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ar 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. ITA 94/2013 Page 10 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, and foreign currencies.‖ 10. It is no doubt, tempting to hold that since the expression "derivatives" is defined only in Section 43 (5) and since it excludes such transactions from the odium of speculative transactions, and further that since that has not been excluded from Section 73, yet, the Court would be doing violence to Parliamentary intendment. This is because a definition enacted for only a restricted purpose or objective should not be applied to achieve other ends or purposes. Doing so would be contrary to the statute. Thus contextual application of a definition or term is stressed; wherever the context and setting of a provision indicates an intention that an e ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... of certain types or classes of companies are deemed to be speculative. That in another part of the statute, which deals with ITA 94/2013 Page 12 computation of business income, derivatives are excluded from the definition of speculative transactions, only underlines that such exclusion is limited for the purpose of those provisions or sections. To borrow the Madras High Court's expression, ―derivatives are assets, whose values are derived from values of underlying assets‖; in the present case, by all accounts the derivatives are based on stocks and shares, which fall squarely within the explanation to Section 73 (4). Therefore, it is idle to contend that derivatives do not fall within that provision, when the underlying asset itself does not qualify for the benefit, as they (derivatives - once removed from it and entirely dependent on stocks and shares, for determination of their value). 12. In the light of the above discussion, it is held that the Tribunal erred in law in holding that the assessee was entitled to carry forward its losses; the question framed is answered in favour of the revenue and against the assessee. The appeal is, therefore, allowed; ther ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... on 04-01-2008 of 2025 shares and sold the same on the same date of 2025 shares. The learned Counsel took us through the entire pages and shown that there is no stock kept by the assessee and the entire derivative sale is in cash segment are sold without delivery. The learned Counsel for the assessee argued against the objection of the AO that assessee is not engaged in arbitrage and doing another activity in toto, hence, assessee's cash segments is hit by the explanation to section 73 of the Act as speculation. On the other hand, purchase and sales of shares in future are derivatives in F & O segment will be hit by section 43(5)(d) of the Act and established termed as non-speculative transaction i.e. to normal business transactions. He referred to the remand report of the AO vide Para 6.1, wherein, details of transactions of shares are given as under: - Cash Segment Derivative Segment Sl N Transa ction Date Scrip Name Buy Value Sale Value Quality bought Qunatity Sold Buy Value Sale Value Quanti ty Bought Quanti ty Sold 1. 4/1/08 Reliance 4,782,857 4,688,900 2,050 2,050 4,631,165 4,754,614 2,025 2,025 2. 4/1/08 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ase of ESSAR OIL at Sr. No. 1, the buy quantity is 7080 in cash segment, while the sell quantity in ESSAROIL is (7060) in F&O segment. This was the bone of contention of AO for not allowing set off of loss between the two segments on account of quantity mismatch. However, in arbitrage it is not always possible to match the quantity, as it depends upon availability of shares/derivatives in respective segments. Also, due to sudden price fluctuation in any of the segment of markets, one has to continuously look at the new opportunity in order to increase profit or to reduce loss. Accordingly, the remaining portion of transactions is done in any segment keeping the net open position as always NIL thereby keeping all transaction at all point of time hedged against each other. It was explained that in cash/future (derivative) arbitrage, hedge position is created by taking delivery in cash segment and selling in F&O segment. The price in future segment will trade at premium as compared to cash segment. Thus, a stock is purchased in cash segment and sold in future segment. With course of time when position in future segment comes closer to the expiry date, the price gap between cash and fu ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... he facts remain same and the residual loss of Rs. 7.21 lacs also form part of the composite activity. In view of the above facts and circumstances of the case Ld. Counsel only prayed that explanation to section 73 of the Act will not apply to the case of the assessee. 8. Alternatively also, he argued that the loss from cash segment and profit from derivative segment should be set off against each other. Loss in cash market is incidental to the profits earned in the F&O segment and therefore, to that extent, this loss from cash segment should be allowed to be set off as business loss. It is obvious that business profit cannot be computed without allowing a business loss. A loss other than a capital loss which is incidental to the trade is allowable u/s 28 of the Act itself on ordinary principles of commercial trading. He prayed that the loss suffered in cash segment is incidental to the profit earned in derivative segment. Therefore, the loss from cash segment should have to be allowed as business loss u/s 28 of the Act to be adjusted against profit earned from derivative segment. 9. Without prejudice to the above, he also argued that on account of composite nature of business i.e ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... tion of transactions is done in any segment keeping the net open position as always NIL thereby keeping all transaction at all point of time hedged against each other. In view of these facts we are of the view that in cash/future (derivative) arbitrage, hedge position is created by taking delivery in cash segment and selling in F&O segment. The price in future segment will trade at premium as compared to cash segment. Thus, a stock is purchased in cash segment and sold in future segment. With course of time when position in future segment comes closer to the expiry date, the price gap between cash and future segment narrows down. In such situation, arbitrager will roll over its position in future segment from current month to next month. Therefore, in such kind of scenario one will see a trading in future segment only and not in cash segment. 11. We find that this issue is even dealt by Hon'ble Delhi High court in the case of CIT vs. DLF Commercial Developers Limited wherein it is held that in terms of explanation to section 73, derivative based on stock and share fall squarely within explanation to section 73 and therefore, loss from purchase and sale of derivative would be specu ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... rate melt down....‖ The High Court then, after examining the nature and characteristics of derivatives transactions, observed that: 5. 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, and foreign currencies. 1 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... mstances. Similarly, in N.K. Jain and Ors. v C.K. Shah and Ors. AIR 1991 SC 1289, it was held that: 4. The subject matter and the context in which a particular word is used are of great importance and it is axiomatic that the object underlying the Act must always be kept in view in construing the context in which a particular word is used........... 11. The stated objective of Section 73- apparent from the tenor of its language is to deny speculative businesses the benefit of carry forward of losses. Explanation to Section 73 (4) has been enacted to clarify beyond any shadow of doubt that share business of certain types or classes of companies are deemed to be speculative. That in another part of the statute, which deals with computation of business income, derivatives are excluded from the definition of speculative transactions, only underlines that such exclusion is limited for the purpose of those provisions or sections. To borrow the Madras High Court's expression, ―derivatives are assets, whose values are derived from values of underlying assets‖; in the present case, by all accounts the derivatives are based on stocks and shares, which fall squarely withi ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ch is not so set off, can be carried forward to the following Assessment Year. However, a loss cannot be carried forward for more than four Assessment Years immediately succeeding the Assessment Year in which the loss was first computed. 7. The explanation to Section 73 creates a deeming fiction. The explanation postulates a situation where the assessee is a Company and where any part of the business of the Company consists of the purchase and sale of shares of other Companies. In such a case, the assessee is for the purposes of Section 73 deemed to be carrying on a speculation business, to the extent to which the business consists of the purchase and sale of shares. The explanation carves out an exception in the case of a Company whose gross total income consists mainly of income under the heads of 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 of loans and advances. The exception carved out by the explanation, however, is not attracted to the facts of this case and its interpretation, therefore, does not call for consideration here. What is ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e former as one, not involving an actual delivery of shares. Hence, it was submitted that a transaction which involves an actual delivery of shares would not constitute a speculative transaction and the assessee who is engaged in a business involving the actual delivery of shares, cannot be regarded as being engaged in speculation business. 10. The submission which has been urged on behalf of the Revenue, cannot be accepted, having regard to the plain meaning of the explanation to Section 73. The submission of the Revenue is that a loss which arises on account of a transaction of the sale and purchase of shares would constitute a loss from a speculation business for the purposes of the explanation. But, that the profit which arises from a transaction involving the actual delivery of shares would not constitute a profit for the purposes of subsections (1) and (2) of Section 73 in respect of which a set off can be granted. To accept the submission of the Revenue would be to introduce a restriction into the scope and ambit of the deeming fiction which is created by the explanation to Section 73, which is not contemplated by Parliament. Once a deeming fiction is created by law, it m ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ve transaction for the purpose of section 28 to section 41 of the Act. The fact that both delivery based transaction in shares and derivative transactions are non-speculative as per section 43(5) of the Act is concerned, it goes to confirm that both will have same treatment as regards to application of the explanation to section 73 of the Act is concerned which creates a deeming fiction. As in the present case, the assessee had undertaken cash/future arbitrage activity as one single business activity i.e. the position in a cash segment in a particular scrip is taken on a particular date and at the same time the reverse position is taken in the same scrip in F&O segment. The transactions in cash segment and F&O segment are inextricably linked with each other and are so interwoven that it is not possible to divorce these transactions and decide the nature of the income/loss. And hence, the loss suffered in cash segment, being an integrated part of the total arbitrage activities has to be allowed / set off against income from derivative segment. Accordingly, we confirm the order of CIT(A) allowing loss earned by assessee on account of purchase and sale of securities against income ear ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... oking subsidiaries (ABL) to NBFC (AGCPL) was for the following reasons: 'The Assessee Company being NBFC & holding company in the Angel group used to facilitate the common clients of broking companies in the group by giving funds to them for trading activities which in turn helped ABL to generate substantial brokerage and other income (demat income). As on March 31, 2010, the Assessee Company had debtors outstanding to the extent of Rs. 97.50 crores. These debtors were common clients among the Assessee Company and the broking subsidiaries. One of the prime considerations for clients to open accounts with any broking house is availability of all facilities under one roof i.e. trading in equity, commodity, funding by NBFC. Pertinently, clients took finance from NBFC and in turn did trading i.e. purchase and sale of shares in broking entity in the Angel group. Hence, movement of funds between group companies on account of client position was inevitable. Thus, the flow of funds between Angel group was purely and potently business transaction. In order to facilitate its brokerage business, ABL provided credit facility to its trading clients in the normal course of business and ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ined that placing ICDs between group companies is a normal practice in the Angel group. The learned counsel referred the Tribunal decision in assessee's own case in various group entities and he referred to the Tribunal decision in ITA Nos. 2083 to 2086/Mum/2013 for AY 2008-09, vide order dated 26-07-2013, wherein Tribunal has considered all the aspects and deleted the addition by observing in Para 58 to 66 as under: - "58. When we are dealing with the transactions, based on factual legality, we must remember that source of law is either facts or logic and not the vise versa. Keeping this in mind, we have to First examine the nature and conduct of the assessee. In the present set of circumstance, we have seen that the assessee(s) were having miniscule share capital, as compared to the transactions entered into by them, Within the group. The huge gamut of transactions were undertaken for the sake of clients, whom the assesses were catering to. What the revenue authorities have looked into is the overall result of the impugned transaction, what the revenue authorities tiLt! not See, Was the quantum involved, which was in excess of Rs. 1,600 crores. When we look into the assessment ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ision in the Act, which suggests that the assessee has to seek permission and guidance from the AO, as to how to conduct its business. The purpose of bringing in die impugned provisions was to curb the mal practices, not to thwart the assessee conducting its business in a normal course. In the present cases, the AO acted on a pre conceived notion to import the provisions of section 2(22)(e) without actually examining the nature and purpose and extent of the transactions. In our opinion, the revenue authorities, erred in not looking at the circumstances from the eyes of the assessee(s) and then conclude whether the Act and various judicial decisions gave him the window to bring to tax under a legal fiction. 63. When we look from the angle of ICDs, as well, the issue before us is answered by various for a, including the decision in the case of the group's own company, Angel Infin Limited (supra). We are not inclined to accept the reasoning of the CIT(A) that charging of interest inter se, shall strike the chord to invite the mischief of section 2(22)(e) as it is only the manner to charge back to compensate in respect of transfer of funds and similarly the assessee also charged at ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... the transactions, which are purely and patently, normal business transactions, without any hidden agenda amongst the group companies to devise any tax saving measures. We, therefore, respectively, following the decisions, relied upon by the assessee and the Senior Counsel, covering the various angles, including the angle of funds used by the group company as ICDs, set aside the order of the CIT(A) and direct the AO to delete the addition made under section 2(22)(e) in the group companies, whose appeals are being dealt with by us." 19. The learned Counsel also alternatively argued that it is in the business of lending of money and lending of money was substantial part of business and for which he referred to the working as under: - Capital deployed in the business of lending Capital deployed by way of trade receivables* in the lending business (Avg.) Total capital deployed in the lending business Average Capital Employed 1.Average share capital 2.Average Share application money 3.Average reserves 4.Avearge inter corporate deposits 5. Average trade payables Total average capital employed Ratio of total capital deployed in lending business to the average capital deploye ..... X X X X Extracts X X X X X X X X Extracts X X X X
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