TMI Blog2011 (4) TMI 37X X X X Extracts X X X X X X X X Extracts X X X X ..... sactions are not speculative transactions, which do not correctly interpret Section 43(5) of the IT Act - Similarly, various decisions of the Apex Court relied upon by the counsel for the assessee in support of the contention that insertion of clause (d) to the proviso to Section 43(5) of the IT Act is retrospective in nature are also distinguishable on facts as the ratio laid down therein have no relevance in interpreting the provision of Section 43 (5) of the IT Act - The futures contracts cannot be equated with insurance contract, because, unlike futures contract, the insurance contract is not an article of trade which can be traded - Thus, the futures contract being an article of trade created by an authority under the 1956 Act, the transactions in futures contracts would constitute transaction in commodity under Section 43(5) of the IT Act.39) Held that : the exchange traded derivative transactions carried on by the assessee during AY 2003-04 are speculative transactions covered under Section 43(5) of the Act and the loss incurred in those transactions are liable to be treated as speculative loss and not business loss and clause (d) inserted to the proviso to Section 43( ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... that a derivative transaction is in essence a contract for purchase or sale of underlying security which is ultimately settled otherwise than by actual delivery. Such a transaction which is settled otherwise than by delivery would be speculative transaction under Section 43(5) of the IT Act. Referring to Section 2(ac) and Section 2(h) of the Securities Contracts (Regulation) Act, 1956 ('1956 Act' for short) which define the expression 'derivative' and 'securities' respectively, Mr. Gupta submitted that by entering into a derivative contract, one has purchased or sold the underlying security and any difference in the price of the underlying security would have to be borne by the said purchaser or seller. Therefore, the transaction to purchase the underlying securities namely shares through the medium of derivative transactions which is settled otherwise than by delivery would be speculative transaction under Section 43(5) of the IT Act. Loss incurred in such transactions could be set off only against income from speculative business. 6) Mr. Gupta further submitted that clause (d) inserted to the proviso to Section 43(5) by Finance Act, 2005 specifically provides that with effect ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... would not be speculative transactions. Similarly, the transactions in futures does not involve purchase or sale of any commodity and, therefore, fall outside the scope of Section 43(5) of the Act. Therefore, purchase / sale of financial instruments for transfer of risks such as derivatives cannot be treated as speculative. 11) Mr. Mistri further submitted that the words 'including stocks shares' in Section 43(5) of the Act supports the contention of the assessee that stocks and shares are not as such commodities but artificially included within the meaning of commodity for the purposes of Section 43(5). However, in the present case, the transactions carried on by the assessee are not in law capable of purchasing or selling stocks and shares and, therefore, the transactions would not fall within the scope of Section 43(5) of the Act. 12) Relying on the decision of the Apex Court in the case of Bharat Co-operative Bank Ltd. V/s. Co-op. Bank Employees Union reported in (2007) 4 SCC 685, Mr. Mistri submitted that in a definition Section if the phrase 'means' is used, then what follows is intended to be exhaustive and no meaning other than that put in the definition can be assi ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... explaining the provisions of the Finance Bill, 2005, it is stated that there has been sufficient transparency to prevent generation of fictitious losses due to screen based computerised trading and, therefore, clause (d) has been inserted. Screen based trading was introduced on the Bombay Stock Exchange in the year 1995 and in the National Stock Exchange since its inception prior to 2005 amendment. Derivative trading from inception in the year, 2000 has been screen based only. Therefore, the insertion of clause (d) is clarificatory and curative in nature since the purpose of amendment as set out in the memorandum explaining the provision of the Finance Bill, 2005 were in existence at the time of introduction of derivative trading in India. Accordingly, Mr.Mistri submits that the only reasonable way to construe the insertion of clause (d) to the proviso to Section 43(5) is to hold that the said insertion is clarificatory and curative and applicable for all the assessment years prior to 2006-07. He submits that the insertion of clause (d) is intended to remedy a clearly unintended consequence and an amendment brought about to remedy the possible unintended consequence has to be trea ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... nderlying assets. These underlying assets can be commodities, metals, energy resources, and financial assets suchm as shares, bonds and foreign currencies. 6. Derivatives can be used as insurance cover against certaintypes of business risks such as fluctuations in the rate of foreignexchange, fluctuations in the rate of interest on borrowings,fluctuations in the value of specified assets etc. To take anexample, it is common knowledge that the price of gold keeps fluctuating. If a manufacturer of gold jewellery anticipates that hewould require a particular quantity of gold at a specified distanceof time, he may enter into a contract with the seller of gold bars forthe supply of the same at a future date, at the rate specified in thecontract. This contract reduces the risk for the buyer, against a possible steep rise in the price of gold. It equally reduces the riskof the seller against a steep fall in the price. Thus the contractacts as an insurance cover. When the transaction goes throughwithout any dispute, the contract is fulfilled. But when thetransaction fails and the motive behind the transaction is not necessarily the sale and supply of gold, but the receipt or paymentof ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... merican and European options, depending upon the time of exercise of the right. Both call option and put option can be combined to achieve "zero cost option." 8. Trading in these markets are regulated internationally by Commodity Futures Trading Commission (CFTC) and International Swaps and Derivatives Association (ISDA) and the National Futures Association (NFA). Experts in the field of economic, finance and investment feel that derivatives are valuable because they provide efficient ways to manage and transfer risk. A business owner who is exposed to changes in market prices can enter into an a,ppropriate derivatives contract and the risk can be assumed by a trader or speculator who is prepared to live with uncertainty in return for the prospect of achieving an attractive return. A large financial institution can withstand more risk than a small corporate and thus may choose to engage in derivatives products for a reasonable compensation. Nobel Laureate Kenneth Arrow predicted that this would increase economic prosperity since people would be more prepared to engage in risk-taking activities. It could also serve to improve the quality of prediction of future events in the wor ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... elivery or transfer of the commodity or scrips; Provided that for the purposes of this clause - (a) a contract in respect of raw materials or merchandise entered into by a person in the course of his manufacturing or merchanting business to guard against loss through future price fluctuations in respect of his contracts for actual delivery of goods manufactured by him or merchandise sold by him; or (b) a contract in respect of stocks and shares entered into by a dealer or investor therein to guard against loss in his holdings of stocks and shares through price fluctuations; or (c) a contract entered into by a member of a forward market or a stock exchange in the course of any transaction in the nature of jobbing or arbitrage to guard against loss which may arise in the ordinary course of his business as such member; shall not be deemed to be a speculative transaction; " 22) Section 43(5) has been amended by Finance Act, 2005 with effect from 1/4/2006 by inserting clause (d) and Explanation as follows:- " Definitions of certain terms relevant to income from profits and gains of business or profession. 43. In sections 28 to 41 and in this section, unless the context ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... zed stock exchange" means a recognised stock exchange as referred to in clause (f) of section 2 of the Securities Contracts (Regulation) Act, 1956 (42 of 1956) and which fulfills such conditions as may be prescribed and notified by the Central Government for this purpose; " 23) Plain reading of clause (d) to Section 43(5) makes it clear that with effect from 1/4/2006, only those eligible transaction in derivatives referred to under Section 2(ac) of 1956 Act which are carried out in a recognized stock exchange shall not be deemed to be a speculative transaction. It is only because, the transactions in derivatives referred to under Section 2(ac) of the Act carried out in a recognized stock exchange were covered under Section 43(5) of the Act, the legislature could exclude those transactions from the purview of Section 43(5) with effect from 1/4/2006. In other words, unless the transactions referred in clause (d) were covered under Section 43(5), there would be no question of excluding those transactions from the purview of Section 43(5). 24) It is however contended on behalf of the assessee that the derivative transactions carried out at the stock exchanges were not at all ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ual delivery, constitutes transactions or contracts for the purchase and sale of any commodity under Section 43(5) of the Act ? 28) The expression 'commodity' is not defined under the Act. Therefore, the expression 'commodity' in Section 43(5) has to be given meaning as understood in common parlance. As per Black's Dictionary (Eight Edition) the expression 'commodity' means an article of trade or commerce which are tangible in nature. As per "THE MAJOR LAW LEXICON' by Pramantha Aiyer (4th Edition) the expression 'commodity' has two meanings (one) in economics, it is any tangible goods that is traded and (two) it is raw materials and goods, especially such goods as cocoa, cofee, jute, potatoes, tea, etc. which may also be traded. Thus, in common parlance, the expression commodity means an article of trade or commerce which are tangible in nature. 29) In the present case, the assessee had entered into futures contracts for purchase of shares of certain companies at a specified future date and at a specified price, which were to be settled in cash without actual delivery of the shares. Such a contract, whether constitutes a contract for purchase of a commodity is the question. ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... hares of company 'X' on 29th March on the stock exchange are Rs.11,000/- then by paying Rs.12,000/- under the futures contract, the assessee would incur loss of Rs.1,000/-. 33) Thus, the futures contracts being articles of trade and commerce which are legally permitted to be traded on the stock exchange, the transactions in futures would be transactions in a commodity as contemplated under Section 43(5) of the Act. Ordinarily a transaction in a commodity relates to purchase / sale of an asset which is tangible and which is capable of being delivered. However, Section 18A of the 1956 Act inserted with effect from 22/2/2000 provides that notwithstanding anything contained in any other law for the time being in force, contracts in derivative (like futures contracts) shall be legal and valid if such contracts are traded on a recognized stock exchange and settled on the clearing house of a recognized stock exchange in accordance with the rules and bye-laws of such stock exchange. Thus, by operation of law, the transactions in futures are made legal and valid even if the underlying securities permitted to be purchased / sold under the futures contracts are not tangible and incapable ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... contracts for purchase / sale of any commodity and it is not restricted to contracts which are capable of performance by actual delivery. Therefore, the fact that the futures contracts are settled otherwise than actual delivery cannot be a ground to hold that the futures contracts are not speculative transactions under Section 43(5) of the Act. 36) The exceptions enumerated in the proviso to Section 43(5) clearly provide that where speculative transactions are carried out with a view to guard against loss in respect of contracts for actual delivery in cases referred to in clause (a), (b) (c) of the proviso, then, such speculative transactions shall not be deemed to be speculative transactions. So far as the transactions covered under clause (d) are concerned, they are deemed not to be speculative transactions only with effect from 1/4/2006. Therefore, the transactions covered under clause (d) would not be treated as speculative transactions only with effect from 1/4/2006. 37) The argument advanced on behalf of the assessee that clause (d) inserted to the proviso to Section 43(5) by Finance Act, 1995 with effect from 1/4/2006 is clarificatory and hence retrospective in na ..... X X X X Extracts X X X X X X X X Extracts X X X X
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