Futures and Option – speculative transactions – Section 43(5)(d), section 73 and retrospectivity of the amendment in Explanation to section 73
a) Assessee was an NBFC, registered under RBI Act 1934
b) Before the Assessing Officer, assessee stated that the Principal business activity of the assessee is trading in shares and securities. Accordingly, Assessing Officer treated the loss from share trading as speculation loss. The Assessing Officer further held that in view of provisions of section 43(5)(d), activities pertaining to futures and options cannot be treated as speculative transactions. Hence, loss from speculation business cannot be adjusted against the profits from futures and options transactions.
c) CIT(A) held that trading loss from share trading, being speculation loss, cannot be adjusted against the profit from F&O transactions, being business loss. However, CIT held that the principal business of the assessee company was of giving loans and advances and therefore, provisions of Explanation to section 73 was not applicable.
d) On filing appeal by Revenue, ITAT held that the assessee was in the business of share trading, entire activity of purchase and sale of shares which comprised of both delivery based and non-delivery based trading, was one composite business. Hence, the claim of the assessee for set-off of loss from share dealing should be allowed from the profits from F&O transactions in share transactions, the character of income being the same. ITAT also held that before application of Explanation to section 73, aggregation of the business profit or loss is to be worked out irrespective of the fact whether it is from share delivery transactions or derivative transactions.
e) Jurisdictional High Court reversed the order of ITAT holding that the profit from trading in futures and options was not the profit from speculating business. Hence, the loss on trading in shares could not be set off against the profit from business of futures and options. High Court also held that the amendment in Explanation to section 73, exempting companies dealing in shares from the ambit of section 73, is not retrospective in effect.
f) Accordingly, assessee filed the appeal before the Hon’ble Supreme Court. Supreme Court decided the issue on presumption that the sole business of the assessee during the relevant assessment year was dealing in share. On this premises, Supreme Court held that the assessee cannot be taken away from the ambit of provisions of Explanation to section 73 and the deeming fiction u/s 73 would be attracted.
g) In so far as retrospectivity regarding amendment in Explanation to section 73 is concerned, Supreme Court observed that while amending provisions of section 43(5) (whereby sub-clause (d) was inserted exempting an eligible transaction in respect of trading in derivatives carried out in a recognised stock exchange), Parliament was indeed cognizant of the provisions of section 73(4) which were simultaneously amended so as to reduce the period of carry forward of speculation losses from eight assessment years to four assessment years. Had the Parliament intended to bring about parity with the provisions of section 43(5), it would have amended the provisions of Explanation to section 73. It was only w.e.f. 01 Apr 2015 that an amendment was brought about to exclude trading in shares from the deeming provision contained in Explanation to section 73.
Accordingly, Supreme Court held that the Parliament, in its legislative wisdom, amended section 43(5) w.e.f. 01 April, 2006 in relation to the business of trading in derivatives, whereas a specific amendment in Explanation to section 73, in so far as trading in shares is concerned, was brought w.e.f. 01 April 2015. The latter amendment was intended to take effect from the date stipulated by Parliament and there is no reason to hold either that it was clarificatory or that the intent of Parliament was to give it retrospective effect.
I. Determination of Principal Business of the assessee
a) While deciding the issue Supreme Court has relied upon the admission made by the assessee before the Assessing Officer that its sole business, during the relevant year is dealing in shares and therefore, Supreme Court did not take into consideration the contention of the assessee that it is an NBFC and its principal business is to grant loans and advances.
b) It is a trite law that admission before the revenue authorities do not confer jurisdiction on the Assessing Officer. When all the facts are before the Hon’ble Court then it is upon the Revenue Authority to analyze those facts and to determine as to what was the principal business of the assessee particularly when the assessee is contending before the Court that it is an NBFC. Even CIT(A) had held that the principal business of the assessee company was to grant loans and advances and on that account had granted relief.
Hence, it was incumbent upon ITAT, being final fact finding authority to decide as to what was the principal business of the assessee.
c) Explanation to section 73 lays down that where any part of the business of a company, other than a company whose gross total income consist 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 of loans and advances, consist in the purchase and sale of shares of other companies, such companies shall for the purposes of this section be deemed to be carrying on a speculation business to the extent to which the business consists of the purchase and sale of such shares.
d) Thus certain exceptions have been carved out to which explanation is not applicable i.e.
(i) the company whose gross total income consist mainly of income which is chargeable under the head “Interest on Securities, Income from house property, capital gain and income from other sources i.e. an investment company,
(ii) the company, whose principal business is banking,
(iii) or the company whose principal business is the granting of loans and advances.
e) The contention of the assessee was that its principal business is granting of loans and advances. It submitted that it is not merely the interest received on loans and advances but the deployment of fund which has a relevant bearing on determining the principal nature of business. Assessee relied upon the judgement of Kolkata High Court in CIT vs. Savi Commercial (P) Ltd. (2015) 373 ITR 243 (Kol) in order to buttress its argument that the profit alone cannot be made a decisive/distinctive factor.
f) In Nawn Estates (P) Ltd. vs. CIT (1977) 106 ITR 45 (SC), the Supreme Court considered not only the income of the year but the major source of income for the company in the immediate past in the context of similar language used for defining an investment company under section 109 of the Act.
g) A similar view was taken in CIT vs. Coochbehar Trading Co. Pvt. Ltd. (1979) 120 ITR 535 (Cal), SLP against this decision was refused by the Supreme Court in 141 ITR (ST) 43 in the context of section 23A of the Indian Income Tax Act 1922 (Analogous to section 104 (now deleted) of Income-tax Act 1961) where the company was found to be an investment company, because its primary business was from investments, though the income of the year happened to be larger from business. After review of case law including many Supreme Court decisions, the test were found to be not with reference to the percentage of income but with reference to the fact, whether its primary activity was from business or otherwise.
h) In CIT vs. Amrit Lal & Co. (1995) 212 ITR 540 (Bom), it was found that the assessee’s main income was from investment and that the overall view has to be taken in such a case for the inference that the principal business is that of an investment company. What is relevant is nature of income and not what may happen in a particular year. It is in this view, the Tribunal found notwithstanding larger loss, the main business should be one of landing loans and advances so that explanation was not applicable. The word “mainly” should be understood as a reference to source and not the extent of income.
i) However, Supreme Court relied upon the bald admission of the assessee before Assessing Officer, when the contrary contention was made before CIT(A) and on that ground only, CIT(A) had allowed relief to the assessee. Supreme Court was also influenced by the fact that out of total advances of ₹ 11.32 crore, assessee had given interest free loan to the extent of ₹ 9.58 crore and therefore, held that the principal business of the assessee was not of granting loan and advances but was of dealing in shares.
II. Section 43(5)
a) Section 43(5) has defined the term “speculative transaction”.
b) Section 43 is placed in Part-D of Chapter-IV which deals with computation of profit and gains of business or profession, whereas section 73 is placed in Chapter-VI which deals with aggregation of income and set off or carry forward of losses. Thus both the provisions acts in a different sphere. Steps under Chapter-VI are applied when computation under Chapter-IV is over.
c) Marginal note to section 43 is “Definitions of certain terms relevant to income from profits and gains of business or profession”. Further definitions in section 43 are relevant only for sections 28 to 41 and section 43 itself as section 43 starts with the phrase “in sections 28 to 41 and in this section, unless the context otherwise requires”. Thus the definitions incorporated in section 43 are not relevant for the purposes of section 73.
d) Section 43(5) defines the term “speculative transaction” as under:
“Speculative transaction means a transaction in which a contract for the purchase or sale of any commodity including stocks and shares, is periodically or ultimately settled otherwise than by the actual delivery or transfer of the commodity or scrips”.
Thus non-delivery based transactions are covered by the definition of speculative transaction. This definition is exhaustive in nature.
e) Proviso to section 43(5) carves out certain exceptions from the ambit of speculative transaction. One such exception is incorporated in clause (d), which was inserted by the Finance Act 2005 with effect from 01.04.2006, which is as under:
(d) – an eligible transaction in respect of trading in derivatives referred to in clause (ac) of section 2 of the Securities Contracts (Regulation) Act 1956 carried out in a recognised stock exchange. Certain conditions are attached to the eligible transactions as per Explanation 1.
f) The term derivatives is defined in section 2(ac) of the Securities Contracts (Regulation) Act 1956 as under :
2 – Definitions – in this Act unless the context otherwise requires – (ac) “derivative includes –
A – Security derived from a debt instrument, share, loan whether secured or unsecured, risk instrument or contract for differences or any other form of security;
B – A contract which derives its value from the prices, or index of prices of underlying securities.
g) The reason for introducing such exemption is given in the memorandum explaining provisions of Finance
Bill 2005 (reported at 273 ITR ST. 187 at 207).
“Recent systemic and technological changes introduced by stock markets have resulted in sufficient transparency to prevent generating fictitious losses through artificial transactions or shifting of incidence of loss from one person to another. The screen based computerized trading provides for an excellent audit trail. Therefore, the present distinction between speculative and non-speculative transactions, particularly relating to derivatives is no more required”.
The proposed amendment therefore seeks to provide that an eligible transaction carried out in r/o trading in derivatives in a recognised stock exchange shall not be deemed to be a speculative transaction.
h) The scope and effect of this amendment with effect from 01.04.2006 has been explained in Circular No. 3 of 2006 dated 27.02.2006 as under :
3.10 Excluding trading in derivatives on recognised stock exchanges from the ambit of speculative transactions
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 developments, the present distinction between speculative and non-speculative transactions, in respect of trading in derivatives of securities 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. The notification prescribing the rules and the conditions to be fulfilled by a stock exchange to be recognized by the Central Government for the purposes of section 43(5) [i.e., Rules 6DDA and 6DDB of the Income-tax Rules, 1962] has been published in the Official Gazette on 1st July, 2005 vide S. O. No. 932(E).
Thus provisions of section 43(5) read with proviso pre-supposes that it deals with non-delivery based transactions whereas Explanation to section 73 deals with all the transactions whether delivery based or non-delivery based.
i) Section 73 lays down that any loss in r/o speculation business shall not be set off except against profit and gains if any of another speculation business. However, Explanation incorporates for a deeming provision. It lays down that where any part of the business of a company consists in the purchase and sale of shares of other companies, such companies shall for the purposes of this section be deemed to be carrying on a speculation business to the extent to which the business consist of the purchase and sale of such shares. Explanation carves out certain exceptions which are
i) the company whose 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
ii) a company, the principal business of which is the banking or
iii) the principal business of which is granting of loans and advances.
The fourth exemptions is carved out by the Finance (No. 2) Act 2014 w.e.f. 01.04.2015 and the exemption is given also to
iv) the companies, the principal business of which is the business of trading in shares.
Thus the companies who are dealing in shares are exempted from the rigors of section 73.
The present case pertains to assessment year 2008-09 and therefore, Supreme Court held that the said amendment is not applicable as it is not retrospective in nature.
j) Main provisions of section 73 deals with speculative business which apparently consisted of speculative transactions i.e. non delivery based transaction. However, Explanation provides for a deeming fiction that even the business of share dealing is also to be deemed as speculative business. Thus even the delivery based transactions are treated as speculative business. No distinction is made between delivery based transactions and non-delivery based transactions.
k) Here it is once again though at the cost of repetition stated that section 43 is relevant only for the purposes of section 28 to 41 and 43 and starts with unless the context otherwise requires. Therefore, exclusion of derivative transactions from the ambit of section 43(5) is not applicable to section 73 and therefore, derivative transactions are also to be treated as speculative transactions. Accordingly, loss incurred by the assessee from the share dealing can be adjusted against the profit from derivative transactions.
l) In this regard, reliance is placed on the judgement of Jurisdictional High Court in the case of CIT vs. DLF Commercial Developers Ltd. (2013) 35 Taxmann.com 280 / 218 Taxmann 45 / 261 CTR 127 (Del). After analyzing the provisions of section 43(5) and section 73 r/w Explanation, Hon’ble Court held as
“It is no doubt tempting to hold that the expression “derivatives” is defined only in section 43(5) and it exclude such transactions from the odium of speculative transactions, 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 expression defined in some other place in the enactment, cannot be applied, that intent prevails, regardless of whether standard exclusionary terms (such as “unless the context otherwise requires”) are used”.
Accordingly, High Court held in this case that the derivative based on stocks and shares fall squarely within Explanation to section 73, loss from sale/purchase of such derivative would be speculative loss which could not be permitted to be carried forward. Hon’ble Supreme Court has not considered this judgement.
a) The provisions of Explanation to section 73 are remedial in nature. Before inserting the Explanation, the loss of a speculation business was not being allowed against profit and gains of any other business. However, as per Wanchu Committee’s Report, the business houses controlling groups of companies were manipulating their results from share dealing in such a manner within the group so as to avoid the tax. Therefore, it was recommended to treat such companies, other than investment, banking and finance companies as the companies carrying on speculation business. Accordingly, the explanation was inserted. Circular No.204 is also to the same effect. Therefore, it is evident that the explanation had been inserted to cure the mischief or defect embedded into the main provision. Thus explanation is remedial in nature and has to be strictly construed.
b) Allahabad High Court in CIT vs. Nitro Phosphetic Fertilizer (174 ITR 266 AT 292) have held that in order to arrive at true intendment of a statute, the Court should pose to itself the question (i) what was the situation prior to provision under construction, (ii) what mischief or defect was noticed before introducing the provision, (iii) whether it was remedial and (iv) the reason for remedy.
c) The Explanation is again amended so as to remove the defect and now the companies dealing in shares are exempted from the ambit of section 73. Due to this amendment, it cannot be deemed that the companies dealing in shares are covered by the provisions of section 73. In the case of CIT vs. Vatika Township (P) Ltd. (2014) 367 ITR 466 (SC), Hon’ble Supreme Court has explained the law concerning retrospectivity in para 30 and onwards. Hon’ble Supreme Court has explained that one established rule is that unless a contrary intention appears, a legislation is presumed not to be intended to have a retrospective operation. However, where a benefit is conferred by a legislation, the rule against a retrospective construction is different. If a legislation confers a benefit on some persons but without inflicting a corresponding detriment on some other person or on the public generally and where to confirm such benefit appears to have been the legislator’s object then the presumption would be that such a legislation, giving it a purposive construction, would warrant it to be given a retrospective effect.
d) In the present case also, by making amendment in the Explanation, the benefit is conferred on the assessees carrying on business in share trading. As per the Circular No. 204 and Wanchu Committee Report, it was not the intention of the legislature to bring all such companies dealing in shares, within the ambit of Explanation. Only the companies which are adopting the tax avoidance devices by manipulating and reducing the taxable income of the companies under their control were intended to be brought within the ambit of Explanation. The issue was debatable.
In the case of Aman Portfolio (P) Ltd. vs. DCIT (2005) 92 ITD 324, Delhi Bench of ITAT have discussed the scope of Explanation to section 73 in detail in para 7 of the order and thereafter held that the Explanation is a provision against tax avoidance, which deems certain actual transactions in shares as speculative transactions. There is absolutely no material brought on record by the income tax authorities to show that the assessee is a company controlled by business house and that the share transactions have been effected with a view to manipulate and reduce its taxable income. Accordingly, ITAT decided the issue in favour of assessee.
Whereas in the case of SPFL Securities Ltd. vs. DCIT (2006) 6 SOT 562 (Del) and in the case of M/s SRJ Securities Ltd. vs. Additional CIT (2003) 86 ITD 583 (Del), ITAT has decided in favour of Revenue. Appeal by the assessee in M/s SRJ Securities Ltd. vs. Additional CIT is admitted by the Hon’ble High Court vide ITA No. 560 of 2005 and the same is still pending.
Revenue had also filed appeal in the case of Aman Portfolio Ltd. before the Hon’ble Delhi High Court, which had been admitted. However, the same is dismissed due to low tax effect. Even there was a controversy in the judgement of various High Courts. Calcutta High Court in M/s R.P.G. Industries Ltd. vs. CIT (2011) 338 ITR 313 (Cal) have held that the decision of Delhi Tribunal in the case of Aman Portfolio (P) Ltd. does not reflect the correct interpretation of the Explanation to section 73. The company dealing in shares has to be deemed to be a company carrying on speculation business. There is nothing illegal for the legislature to enact two different definition of speculation business applicable to the two different categories of the assessee in a taxing statute. Whereas Allahabad High Court in the case of CIT vs. Ram Kishan Gupta (2014) 361 ITR 387 held that share trading business on own behalf is “jobbing”. Jobbing is not speculative in view of proviso (c) to Section 43(5) and accordingly it was held that the loss suffered by the assessee in share trading cannot be termed as speculative loss. Thus issue is debatable. Now the amendment in Explanation to section 73 by the Finance (No. 2) Act 2014 with effect from 01.04.2015 has clarified the position and therefore, can be treated as being remedial. Accordingly, it can be argued that it can have retrospective effect in nature, however, the judgement of the Supreme Court is the law of the land and have binding effect under Article 141 of Constitution of India until the same is overturned by the larger bench of the Supreme Court.