The new Finance Minister, Mr. Arun Jaitley has made many amendments to the Income-tax Act. In this article the author has analysed amendments relating to Speculation transactions and speculation business, keeping in view provisions of section 43(5) and Explanationto section 73.
SPECULATIVE TRANSACTIONS IN RESPECT OF COMMODITY DERIVATIVES
1. The existing provisions contained in section 43(5) define the term speculative transaction. The proviso to the said clause (5) excludes certain categories of transactions as speculative transactions. The Finance Act, 2013 had made a provision for levy of commodities transaction tax (CTT) on commodity derivatives in respect of commodities other than agricultural commodities. As a consequence to the levy of commodities transaction tax, clause (e) was inserted in the proviso to clause (5) of section 43 to provide that eligible transactions in respect of trading in commodity derivatives carried out in a recognised association shall not be considered as a speculative transaction. The Central Board of Direct Taxes had clarified vide Circular No. 3, dated 24-1-2014 explaining the provisions of the Finance Act, 2013 that the eligible transactions shall include only those transactions in commodity derivatives which are liable to commodities transaction tax.
Accordingly, for the sake of clarity, the Finance Minister has made amendment in clause (e) of the proviso to the said clause (5), so as to provide that eligible transactions in respect of trading in commodity derivatives carried out in a recognised association and chargeable to commodities transaction tax under Chapter VII of the Finance Act, 2013 shall not be considered to be a speculative transaction.
This amendment will take effect retrospectively from 1st April, 2014 and will, accordingly, apply w.e.f. the assessment year 2014-15.
2. LOSSES IN SPECULATION BUSINESS VIS-À-VIS EXPLANATION TO SECTION 73
2.1 Circumstances in which the business of purchase and sale of shares of a company may be deemed as speculation business: As per the Explanation to section 73, where any part of the business of a company (other than a company mentioned hereinafter) consists of purchase and sale of shares of other companies, such company shall, for the purposes of section 73, 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.
However, the above deeming provision is not applicable to :
| (i) | 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"; | |
| (ii) | a company the principal business of which is the business of banking or the granting of loans and advances. |
2.2 Existing provisions of section 73: The existing provisions of section 73 provide that losses incurred in respect of a speculation business cannot be set off, or carried forward and set off except against the profits of any other speculation business. Sub-section (5) of section 43 defines the term 'speculative transaction' as a transaction in which a contract for purchase or sale of any commodity, including stocks and shares, is settled otherwise than by way of actual delivery. However, the proviso to the said section exempts, inter alia, transaction in respect of trading in derivatives on a recognised stock exchange from its ambit.
2.3 Case of CIT v. Lokmat Newspapers (P.) Ltd.: It would be relevant to refer to the decision of the Bombay High Court in the case of CIT v. Lokmat Newspapers (P.) Ltd. [2010] 322 ITR 43/ 189 Taxman 370wherein it was held that section 73 deems those transactions as speculative transactions which are not speculative transactions under section 43(5) in the specified cases. Therefore, exclusion of transactions from speculative transactions under section 43(5) does not in any way effect the applicability of the Explanationto section 73.
2.4 Amendment made by Finance (No. 2) Act, 2014 : The aforesaid Explanation has been amended so as to provide that the provision of the Explanation shall also not be applicable to a company, the principal business of which is the business of trading in shares. This is a laudable step and those engaged in the business of trading in shares will now be spared from the deeming provisions of treating their losses as speculation losses.In fact, the Government needs to review the Explanation as a whole. Now that there is transparency in share transactions as well as commodity transactions, particulary on which Security Transaction Tax or Commodity Transaction Tax is payable, any loss arising therefrom should not be seen with suspicious eyes. The department should go by the reality. A transaction should be treated as speculative only if in essence it is speculative, otherwise not. Section 43(5) should be the yardstick. The amendment is likely to provide relief to taxpayers engaged in share trading and should provide boost to the capital market as well. This amendment will take effect from the assessment year 2015-16.
3. SOME RELEVANT CASE LAWS
When we are making study of speculation loss under section 73, it would be useful to refer to some decisions on the provision as it exists.
3.1 The Karnataka High Court in the case of Mysore Rolling Mills (P.) Ltd. v. CIT [1992] 195 ITR 404/63 Taxman 416 held that the facts of each case will have to be examined to arrive at a conclusion as to whether the transaction in question is a speculative venture or business. The nature of the assessee's business in general, the purpose behind the particular transaction, the effect of the transaction, etc., are all to be considered. The assessee contended that no company would throw away large sums of money by purchasing shares and later on sell the same at a loss and then claim the said loss to reduce the tax burden, because the loss sustained in the process will be far more than the actual tax relief. Unless it is conclusively established that the assessee entered into the transaction clearly as a speculative venture, the Courts subsequently cannot infer that the transaction was a speculative venture only because the assessee derived the benefit of tax reduction. In fact, the crucial time and the stage is the time when the assessee purchased the shares and if possible to find out the intention behind such a purchase, and not to draw an inference of speculation from the fact that subsequently the shares were sold at a low price.
3.2 The ITAT Calcutta Bench in the case of Off-Shore India Ltd. v. ITO [1986] 15 ITD 549 has held that –
| (i) | The principal business can be determined if one looks at the amount of investment made and not looking at the profit earned or loss suffered in this year or that year. It was found that the maximum amount invested in the share business was Rs. 40.65 lakhs as on 31-8-1978 which was much more than the maximum amount of Rs. 26.75 lakhs invested in the moneylending business as on 28-2-1978. Similarly, as on the last date of the previous year under consideration, the amount invested in the share business was more than three times the amount invested in the moneylending business. | |
| (ii) | The income chargeable under the head 'Profits and gains of business or profession' in the instant case became less than the income chargeable under the head 'Income from other sources' only after the set off of the loss suffered in share dealing business and if not entitled to such set off, the assessee would not come under section 109(ii), because in that case the income chargeable under the head 'Profits and gains of business or profession' would be much more than that chargeable under the head 'Income from other sources' as loss was not chargeable at all. The aforesaid set off could not be taken for granted, especially when that was the central issue in this case. The assessee had to show that even without such set off, the income assessable under the head other than business was much more. | |
| (iii) | The objects in the memorandum were not conclusive of the nature of business carried on by the assessee-company. As has been observed by the Supreme Court in the case of CIT v. Dharmodayam Co. [1977] 109 ITR 527, it is notorious that the memoranda and Articles of Association of companies usually cover a variety of activities, but the activity which the company actually engages in alone determines the nature of its business. |
3.3 In the case of CIT v. Arvind Investments Ltd. [1991] 192 ITR 365/ 58 Taxman 216 (Cal.) it was contended on behalf of the assessee that since the assessee's only business was in share-dealings, the Explanation could have no application, as it applies when such a share dealing is only a part of the business carried on by the assessee. But on behalf of the Revenue it was contended that the Explanationapplies even if the business is only in share-dealings since "part" includes "whole". Secondly, the assessee also had business in moneylending in which case the Explanation was indisputedly applicable. The Court held that the phrase "to the extent to which the business consisted of purchase and sale of such shares" would not indicate that the Legislature had several other actual and existing non-speculative activities of business in mind. It merely indicated that the business activity which consists of purchase and sale of shares will be treated as speculation business. If the entire business activity of a company consists of purchase and sale of shares of other companies, then the entire business will be treated as speculation business. But, if apart from purchase and sale of shares, the company has other business activities, then those other activities will not be treated as speculation business. [However, now with the amendment in the Finance (No. 2) Act, 2014 the taxpayers engaged in the trading of shares will be outside the purview of the Explanation to section 73]
3.4 It was held in the case of CIT v. Sun Distributors & Mining Co. Ltd. [1993] 68 Taxman 223 (Cal.) that the said Explanation to section 73 does not require that both sale and purchase of the shares should take place in one and the same year. It may be that in a particular year shares were only sold or in a particular year shares were only purchased. What is to be seen is whether the business of the company consists of purchase and sale of shares. [However, now with the amendment in the Finance (No. 2) Act, 2014 the taxpayers engaged in the trading of shares will be outside the purview of the Explanation to section 73]
3.5 In the case of Western Metal Caps Ltd. v. Asstt. CIT [2000] 110 Taxman 237 (Ahd.) (Mag.) it was held by the ITAT that Explanationto section 73 is not applicable if shares are purchased as investments or if the assessee-company is not engaged in the business of purchase and sale of shares.
3.6 The Supreme Court in the case of CIT v. S.C. Kothari [1971] 82 ITR 794 held that the loss of an illegal speculative transactioncould not be set off against the profit of another lawful speculative transaction. If, however, the business was the same, then the loss would be liable to be taken into account while computing the profits under section 28(i).
3.7 The Supreme Court in the case of R.B. Seth Champalal Ramswarup v. CIT [1966] 60 ITR 493 held that the burden of proving that the assessee had suffered a speculation loss lay upon the assessee.
3.8 The units of the Unit Trust of India are not treated as shares either under the Companies Act or under the UTI Act. The fact that the income received by the unit-holder from the trust is deemed to be his income by way of dividends and the trust is deemed to be a company will not make the unit a share. Hence, the provisions of the Explanation to section 73 will not apply to dealings in such units - Apollo Tyres Ltd. v. CIT [2002] 255 ITR 273/122 Taxman 562 (SC).
3.9 Similarly, dealings in governmental securities does not amount to dealings in shares – ANZ Grindlays Bank v. Dy. CIT [2004] 88 ITD 53 (Delhi).
3.10 ITAT Bombay Bench in Rajan Enterprises (P.) Ltd. v. ITO [1992] 41 ITD 469 has held that to determine whether an assessee is an investment company or not, one has to determine what is its gross total income computed as per the provisions of the Act before Chapter VI-A deductions. The gross total income should be computed as per the provisions of the Income-tax Act, as if no special treatment is to be given to the loss incurred by an assessee on purchase and sale of the share transactions. The ITAT also held in this case that there was no specific exclusion of the loss incurred by the assessee on purchase and sale of share transactions from the gross total income, either under section 73 or under section 109, and held that the nature of the transaction of sale and purchase was to be determined with respect to the gross total income of the assessee without applying the provisions of the Explanation to section 73. On that basis, the gross total income of the assessee would be Rs. 9,176 which consisted wholly of dividend income, being income chargeable under the head "income from other sources" and, therefore, the assessee would be an investment company and the loss incurred by the assessee on purchase and sale of shares would not be speculative in nature within the meaning of the provisions of the Explanation to section 73 of the Act.
3.11 The Calcutta Bench of the ITAT has held in the case of Himalaya Co. Ltd. v. ITO [1989] 30 ITD 139 that section 109(iv) defines gross total income as total income computed in accordance with the provisions of the Act before making any deduction under Chapter VI-A. So, the CIT(A) should have compared the figures charged as business income and the figures of income from dividend income charged as "Income from other sources" of a company whose gross total income consisted mainly of income which was chargeable under the heads "Interest on securities", "Income from house property", "Capital gains" and "Income from other sources". If such a comparison was done the assessee had to be treated as an investment company because its gross total income computed consisted mainly of dividend income of Rs. 78,400 before deduction u/s 80M, assessed under the head "Income from other sources".
3.12 The Calcutta High Court in the case of Eastern Aviation & Industries Ltd. v. CIT [1994] 208 ITR 1023/ 74 Taxman 641, has held that contention that the dividend income being a positive figure of Rs. 3,87,603 was undoubtedly higher than the business loss which was a minus figure could not be maintained as it was well-settled that the words "income" or "profits and gains" should be understood as including losses also, so that in one sense "profits and gains" represent "positive income" whereas "losses" represent "negative income". In other words, "loss" was "negative profit". Both positive and negative profits were of revenue character. Both must enter into computation, wherever it becomes material, in the same mode of the taxable income of the assessee. Reference in this context may be made to the decision of the Supreme Court in CIT v. Harprasad & Co. (P.) Ltd. [1975] 99 ITR 118. The Supreme Court in the case of CIT v. J. H. Gotla [1985] 156 ITR 323/23 Taxman 14J, in construing the word "income" with reference to section 16(3) of the Indian Income-tax Act, 1922, held that the word "income" would include loss. The Explanation to section 73 was clearly applicable and loss suffered by the assessee-company in its share trading transactions inclusive of interest paid on borrowed monies attributable to that business was rightly treated by the Tribunal as a loss in speculative business.
The decision in the above case has been followed in Aryasthan Corpn. Ltd. v. CIT [2002] 253 ITR 401/124 Taxman 516 (Cal.).
CONCLUSION
4. In fact, the Government needs to review the Explanation to section 73 as a whole, considering the real life situation of working of the stock exchanges and the commodity associations. Now that there is transparency in share transactions as well as commodity transactions, particularly on which Security Transaction Tax or Commodity Transaction Tax is payable, any loss arising therefrom should not be seen with suspicious eyes. The department should go by the reality. A transaction should be treated as a speculative one only if in essence it is speculative. Section 43(5) should be the yardstick. The artificial deeming provisions like Explanation to section 73 should be revisited and withdrawn from the statute book to avoid unnecessary harassment to taxpayers. A limited step has been taken in this budget. This is likely to provide relief to taxpayers engaged in share trading and would provide boost to the capital markets as well.
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