The Mumbai bench of the ITAT, recently in the case of J.M. Financial Services Ltd v. Joint Commissioner of Income Tax, held that the loss or profit earned in derivative/future arbitrage can be set off against the profit/loss of delivery based share transactions under the provisions of the Income Tax Act, 1961.
In the instant case, the assessee is aggrieved by the order AO that the loss on purchase and sale of shares was to be considered as speculative loss as per Explanation to section 73 of the Act.
Before the ITAT, the revenue contended that certain transactions such as hedging transactions, jobbing and arbitrage in commodities and securities are excluded from the preview of speculative transactions for the purpose of section 43(5) of the Act.According to them, the explanation to section 73 covers the share transactions done by a company, subject to certain exceptions, as speculative transactions. Therefore, it was contended that the assessee’s profit or loss from future arbitrage in derivatives are to be computed separately as normal business transactions, whereas, the transaction done by the assessee in cash segment in shares are to be treated as speculative transactions. Therefore, the loss or profit earned in derivative/future arbitrage cannot be adjusted or set off against the profit and loss arrived out of delivery based share transactions.
The bench noted that the peculiarity of the business of the assessee is that the assessee so manages his transactions of sale and purchase in shares in cash segment and in future segment that the final outcome will be a profit. Therefore, the transactions of the assessee cannot be segregated to arrive at profit and loss in both these transactions independently or separately.
“The nature of the business of the assessee is such that the transactions of the assessee in both segments are part of composite business of the assessee and the transactions are so managed that the resultant figure will be a profit. We, therefore, do not find any justification on the part of the lower authorities to interpret the provisions of the Income Tax Act to the disadvantage of the assessee and to segregate the transactions in cash and future segment which, in our view, will be against the spirit of the taxation laws.”
The bench further noticed the decision of the High Court in the case of CIT vs. DLF Commercial Developers’, wherein it was held that in terms of explanation to section 73, by all accounts, derivatives are based on stocks and shares which fall squarely within explanation to section 73 and therefore loss from sale-purchase of such derivatives would be speculative loss.
“the peculiarity of the business of the assessee is such that the transactions carried out by the assessee in cash segment and in future segment cannot be segregated. The business of the assessee survives on the ultimate resultant figure arrived at after setting off/adjusting of the profit and loss from each segment. It cannot be said that the transactions in each segment done by the assessee are independent of each other. Before parting we would like to further add that certain exceptions have been carved out under section 43(5) vide which certain transactions in derivative named as ‘eligible transactions,’ done on a recognized stock exchange, subject to fulfillment of certain requirements, are deemed to be non speculative. The said provisions have been inserted in the Act for the benefit of the assessees keeping in view the fact that in such type transactions on recognized stock exchange, the chance of manipulating and thereby adjusting the business profits towards speculative losses by the assessee is negligible because such transactions are done on recognized stock exchange and there are less chances of manipulation of figures of profits and losses. These provisions have been inserted for the benefit of the assessee so that the assessee may be able to set off and adjust his profit and losses from derivatives in commodities against the normal business losses. These provisions are intended to ease out the assessee from the difficulties faced due to the stringent provisions separating the speculative transactions from the normal transactions. However, these exclusions given to the assessee cannot be allowed to be so interpreted to the disadvantage of an assessee so as to give it a different meaning and thereby denying the assessee the set off of otherwise eligible business loss from one segment as against the other segment, especially when the activity done by the assessee is a composite activity and profit and loss in one segment not only depends but the very transaction is done taking into consideration not ‘expected’ but certain future profit or loss in other segment”.
Read the full text of the order below.