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The Bombay High Court has ruled that transactions involving derivatives trading on a recognized stock exchange are not considered “speculation transactions” under the Income Tax Act of 1961. 

In the case of Souvenir Developers (I) Pvt. Ltd. vs. Union of India (Income Tax Appeal No. 79 of 2018), the two-judge bench of Honourable Justices R.D. Dhanuka and S.G. Mehare held that an assessee is thus entitled to claim set off of the loss suffered in the said derivatives transactions against its business income. The Court also stated that the explanatory notes to the provisions of the Finance Act, 2005 clearly state that an eligible transaction in respect of trading in securities derivatives on a recognized stock exchange shall not be considered a speculative transaction. 

Facts of the Case: 

M/s. Souvenir Developer (India) Pvt Ltd, the assessee/appellant, collects toll fees and also trades in shares and derivatives. The appellant’s income tax return was selected for examination. The Assessing Officer (AO) issued an order adding certain amounts to the appellant’s income. The AO refused to consider the appellant’s loss on derivatives transactions when calculating his net taxable income. 

M/s. Souvenir Developer (India) Pvt Ltd, the assessee/appellant, collects toll fees and also trades in shares and derivatives. The appellant’s income tax return was selected for examination. The Assessing Officer (AO) issued an order adding certain amounts to the appellant’s income. The AO refused to consider the appellant’s loss on derivatives transactions when calculating his net taxable income. 

The appellant filed an appeal with the ITAT against the CIT(A) order. The ITAT dismissed the appeal, ruling that the appellant was not entitled to claim set-off under Section 73. The appellant filed an appeal with the Bombay High Court against the ITAT’s decision. 

The Income Tax Act defines a “speculative transaction” as one in which a contract for the purchase or sale of any commodity, including stocks and shares, is settled on a regular or final basis other than by the actual delivery or transfer of the commodity or scrips. 

The proviso (d) to Section 43(5) states that an eligible transaction involving derivatives trading, as defined in Clause (ac) of Section 2 of the Securities Contracts (Regulation) Act, 1956, and conducted on a recognized stock exchange shall not be considered a speculative transaction. 

Section 73 (1) states that any loss incurred by the assessee in connection with a speculation business may only be offset against the profits and gains of another speculation business. 

The explanation to Section 73 states that where any part of a company’s business, other than the exceptions carved out therein, consists in the purchase and sale of shares of other companies, such companies are deemed to be carrying on a speculation business for the purposes of Section 73 to the extent that the business consists in the purchase and sale of shares. 

M/s Souvenir Developer, the assessee/appellant, contended before the Bombay High Court that the appellant had engaged in securities and derivatives transactions at a recognized stock exchange and through registered brokers. The appellant claimed that it had suffered losses in the aforementioned securities and derivatives transactions. 

As a result, the appellant contended that the aforementioned transactions were not speculative in accordance with Section 43(5)(d) of the Income Tax Act. 

The appellant contended that the CIT (A) erroneously denied the appellant’s claim for set off because he failed to consider the provisions of Section 43(5)(d) of the Income Tax Act. 

According to the revenue department, a deeming fiction is created under Section 73 of the Income Tax Act. According to the revenue department, losses in the speculation business would not be governed by proviso (d) to Section 43(5), which carves out an exception to the definition of speculative transaction, in light of the definition of speculative transaction and the provisions of Section 73 of the Income Tax Act. 

Court Findings: 

The High Court ruled that none of the authorities had considered or dealt with the impact of the addition of proviso (d) to Section 43(5) of the Income Tax Act, which was made by the Finance Act of 2005. 

The Court noted that the appellant had sought set-off for the loss incurred as a result of the derivatives transactions. The Court noted that the Finance Act of 2005 included derivative transactions as an exception to the definition of speculative transaction. 

The Court determined that the explanatory notes to the provisions of the Finance Act, 2005, clearly state that an eligible transaction in respect of trading in derivatives of securities on a recognized stock exchange is not a speculative transaction. 

The High Court noted that in the case of Snowtex Investment Limited vs. Principal Commissioner of Income Tax (2019), the Supreme Court ruled that the impact of the Finance Act, 2005 amendment to Section 43 (5) of the Income Tax Act was that an eligible transaction on a recognized stock exchange in respect of trading in derivatives was deemed not to be a speculative transaction. 

As a result, the Court ruled that transactions involving derivatives trading on a recognized stock exchange were not covered by the definition of “speculation transaction” as defined in Section 43 (5) of the Income Tax Act. 

The Court also stated that Section 73 (1), as well as the explanation to Section 73, inserted by the Taxation Laws (Amendment) Act, 1975, would not apply to the appellant because the appellant’s loss in derivatives trading was not a speculative transaction. The Court also stated that the transaction was not a “speculation transaction” as defined by Section 43(5) of the Income Tax Act. 

The Court ruled that the ITAT could not have confirmed any additions to the assessee’s income based on derivatives transactions on a recognized stock exchange. The Court also stated that, as a result of the addition of clause (d) to the proviso to Section 43 (5), transactions involving derivatives trading, as defined in Section 43 (5) (d), would not be considered speculative. 

The Court noted that the appellant had claimed set off in respect of the loss suffered by it in the transaction in derivatives against the income arising out of infrastructure business under the head of income from business or profession. 

The Court held that the appellant was entitled to claim set off of the loss suffered by it in the said transactions in derivatives against the business income of the appellant under the Income Tax Act. The Court thus allowed the appeal of the assessee. 

Judgement Reviewed By Manju Molakalapalli. 

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