TMI Blog2011 (5) TMI 371X X X X Extracts X X X X X X X X Extracts X X X X ..... categorized as short-term or long-term capital gain depending upon the period of holding - Held that: ld. CIT(A) was not justified in holding that income from Index based or non-Index based derivatives be treated as 'business income', whether speculative or non-speculative - Decided in favor of the assessee - 2645 AND 2691 (MUM.) OF 2008 - - - Dated:- 27-5-2011 - R.S. SYAL, VIJAY PAL RAO, JJ. Rajan Vora for the Appellant. Ms. Usha S. Nair for the Respondent. ORDER R.S. Syal, Accountant Member. These two cross appeals one by the assessee and the other by the revenue - arise out of the order passed by the ld. CIT(A) on 29-1-2008 in relation to the assessment year 2004-05. 2. The revenue has raised the following effective ground in its appeal : "On the facts and in the circumstances of the case and in law, the ld. CIT(A) erred in directing the Assessing Officer to treat the losses incurred by the assessee on futures and options on indexes as loss under the head income from business or profession and to re-compute the income and charge tax as per the provisions of section 115AD of the Act." 3. The assessee is aggrieved against the impugned order on the ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ives - Option contracts and Future contracts - were routed through the Stock Exchange without any actual delivery. Considering the provisions of section 43(5), he held that before the insertion of proviso (d) by the Finance Act, 2005, transactions in respect of trading in derivates were to be considered as speculative. It was also opined by him that the insertion of proviso (d) by the Finance Act, 2005, commanding that the transactions in respect of trading in derivatives shall not be deemed to be speculative transactions, is prospective and hence could not apply to the year under consideration. In view of the above opinion, the Assessing Officer held that the loss of Rs. 11.27 crores arising on account of derivative transactions was to be assessed as speculation loss and hence the same was not eligible for set off against the short-term capital gain earned by the assessee from the sale of shares. 5. The assessee went up in appeal before the ld. CIT(A) contending that it was registered as FII as per SEBI Regulations, which entitled it only to make investments in securities. It was, therefore, contended that 'Investment' implied purchase and sale of capital assets and not earning ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... defines 'speculative transaction' to mean "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". Such a transaction is deemed to be speculative transaction unless a case falls under any of the specific clauses of the proviso to this sub-section. Here, it is important to mention that up to assessment year 2005-06, there were three clauses (a) to (c) to this proviso. However, by the Finance Act, 2005, with effect from 1-4-2006, the following clause (d) has been inserted, which reads as under : "(d) an eligible transaction in respect of trading in derivatives referred to in clause (ac) of section 2 of the Securities Contracts (Regulations) Act, 1956 (42 of 1956) carried out in a recognized Stock Exchange." 7.1 The effect of this insertion from the assessment year 2006-07 is that transactions in respect of trading in derivates are not to be deemed as speculative transactions, as a result of which the gain or loss from such transactions shall not be considered as gain or loss from speculation business. The Special B ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... the two sets of transactions. It is for the reason that the derivates are finance instruments whose value depend on the value of the other underlying finance instruments. The underlying asset may be a particular share or the Index such as BSE Index and Nifty Index. In other words, the Index based derivatives are not based on the value of a particular share in the Futures but on the Index as a whole, which comprises of a number of shares included in such Index. Derivative, in itself, cannot be compared with the underlying share or Index. In fact, these are Futures contracts in both Index as well as Stocks which can be purchased or sold through recognized Stock Exchange. It has been noticed by the Hon'ble jurisdictional High Court in the above noted case in para 31 that "Futures contracts expire on the last Thursday of the expiry month. All futures contracts are settled in cash either on a daily basis or at the expiry of the respective contracts as the case may be. Clients/Trading members are not required to hold any stock of the underlying for dealing in the Futures Market." It is still further noticed that in the case of Shree Capital Services Ltd. (supra), the Special Bench dealt ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ulations, as per which the FIIs can only make investment in securities and not undertake trade in them. 8.1 In the opposition, the ld. D.R. relied on the impugned order to contend that section 115AD(2) envisages the existence of business income, distinct from capital gains qua the dealings in securities. It was submitted that the argument advanced on behalf of the assessee that there can be no business income from the transactions in derivatives, was devoid of any force. 8.2 In order to appreciate the rival contentions, it would be apposite to consider the marginal note as well as the provisions of section 115AD, as under : "115AD. Tax on income of Foreign Institutional Investors from securities or capital gains arising from their transfer. (1) Where the total income of a Foreign Institutional Investor includes (a) income other than income by way of dividends referred to in section 115-O received in respect of securities (other than units referred to in section 115AB); or (b) income by way of short-term or long-term capital gains arising from the transfer of such securities, the income-tax payable shall be the aggregate of (i) the amount of income-tax calculate ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... specifically made by the SEBI for FIIs, which are known as the Securities and Exchange Board of India (Foreign Institutional Investors) Regulation, 1995. Regulation 2(f) defines "Foreign Institutional Investors" to mean "an institution established or incorporated outside India which proposes to make an investment in India in securities". It is imperative to observe that the SEBI has allowed the FIIs to operate in a limited field. The restrictions on the making of Investment by the FIIs are contained in Regulation 15(1) which reads as under : "15. (1) A Foreign Institutional Investor may invest only in the following : (a) securities in the primary and secondary markets including shares, debentures and warrants of companies unlisted, listed or to be listed on a recognised stock exchange in India; and (b) units of schemes floated by domestic mutual funds including Unit Trust of India, whether listed on a recognised stock exchange or not,units of scheme floated by a Collective Investment Scheme. (c) dated Government Securities; (d) derivatives traded on a recognised stock exchange; (e) commercial paper; (f) security receipts;" 8.4 From the prescription of R ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... r the purpose of this regulation." 8.6 The consequences which follow from non-compliance of the relevant regulations by a FII have been provided for in Regulation 7A. When we view Regulation 15(1) in juxtaposition to Regulation 15(3), it becomes abundantly clear that a FII is eligible to make only investments (not trading) in the specified securities and secondly, investment in the secondary market can be only on the basis of taking and giving delivery of securities purchases or sold. The restriction regarding taking and giving delivery of securities purchased or sold does not apply to any transaction in derivates provided these are routed through recognized Stock Exchange : "Section 2(h) of the Securities Contracts (Regulation) Act defines "securities" to include (i) shares, scrips, stocks, bonds, debentures, debenture stock or other marketable securities of a like nature in or of any incorporated company or other body corporate; (ia) derivative; (ib) units or any other instrument issued by any collective investment scheme to the investors in such schemes; (ic) security receipt as defined in clause (zg) of section 2 of the Securitisation and Reconstruction of ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ntitled to invest in the `specified securities', which also, include shares and derivatives. Thus, it is patent that for the purposes of section 115AD, both the derivatives and shares have been categorized as `securities' to be treated alike, notwithstanding the different tax treatment in the hands of non-FIIs to the income from the transfer of shares, which may vary from `Business income' to `Capital gains' depending upon the facts and circumstances of each case and from the transfer of derivatives which shall be speculative income up to the assessment year 2005-06. 8.9 We again slip back to sub-section (1) of section 115AD, clause (a) of which refers to income in respect of securities and clause (b) refers to income way of short-term or long-term capital gain arising from the transfer of such securities. Thus, the scope of clause (a) encompasses the income earned by retaining the 'securities' other than from transfer of such 'securities' and clause (b) specifically deals with income arising from the transfer of such 'securities'. Therefore, it is manifest that the income earned by a FII either by way of retention or by way of transfer of securities (including derivates) is subj ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 93-94 and subsequent years." (Emphasis supplied.) 8.11 From the Memorandum explaining the provisions of the Finance Bill, it is palpable that the foreign institutional investors shall be allowed to invest in the country's capital market. Income in respect of securities and income from transfer of securities has been made the subject matter of section 115AD. As per this provision, the income arising from the transfer of such securities is to be considered as short-term or long-term capital gain. 8.12 Thus, on a close scrutiny of the SEBI (FII) Regulations, 1995 together with section 115AD seen in the light of the Memorandum explaining this provisions of the Finance Bill, 1993, it is visible that a FII is allowed to invest only in the 'securities' and further the income from securities, either from their retention or from their transfer, is to be taxed as per this section alone. Coming to income arising from the transfer of securities, it has been provided in section 115AD that it shall be charged as short-term or long-term capital gain, which depends upon the period of holding of such securities. A FII is not allowed by the Central Government to do 'business' in the 'securities' ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... gains', which is covered under section 115AD(1)(b) and also business income, as comes out from section 115AD(2)(b). This argument though looks attractive at first flush, but does not stand scrutiny in depth. The rationale behind section 115AD(2)(b) is that the income of a FII, other than that arising from the holding or transfer of securities, should find its place in the total income and the deductions under Chapter VI-A be allowed by considering gross total income net of income received in respect of securities or arising from the transfer of such securities. It is quite possible that a FII may deposit its surplus funds in banks resulting into interest income. Such interest income, which shall not fall under sub-section (1) of section 115AD, shall constitute part of the gross total income. It is a simple and plain interpretation of sub-sections (1) and (2) of section 115AD. We want to make it clear that the question before us is not to determine whether a FII can have any business income or not. We are confined to determining whether the income from the transfer of securities would fall under sub-section (1) or (2). If it is presumed as a hypothetical case that a FII may also ha ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... s behalf. The FIIs as are registered with the Securities and Exchange Board of India will be automatically notified by the Central Government for the purpose of section 115AD." 8.15 From the above Press Note, it is abundantly clear that FIIs have been considered as "investors" (and not as traders). Secondly, income from transfer of securities has been viewed as chargeable to tax under the head `capital gains' as long-term or short-term capital gain depending upon the period for which such securities are held. 8.16 In view of the above discussion, it is out-and-out that income arising to a FII from the transfer of 'securities' as specified in Explanation (b) to section 115AD can only be considered as short-term or long-term capital gain and not as 'business income'. As the 'derivatives' have been included in the definition of 'securities' for the purposes of this section, the income from derivatives shall also be considered as short-term or long-term capital gain depending upon the period of holding. If the viewpoint of the Department, to the effect that income from transfer of shares or debentures etc. should be considered as short-term or long-term capital gain (as has been ac ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ansfer of securities of the FIIs has been included under section 115AD(1)(b) to be categorized as short-term or long-term capital gain depending upon the period of holding. In such a situation, it is impermissible to consider such income as falling under the head "Profits and gains of business or profession". Such income arising from the transfer of securities shall be charged to tax under the head "capital gains" alone. Once inclusion of such income from the transfer of securities is held to be falling only under the head "Capital gains", it cannot be considered as `Business income', whether speculative or non-speculative. 10. The heading of section 43 is : 'Definitions of certain terms relevant to income from profits and gains of business or profession'. The opening part of this section is : "In sections 28 to 41 and in this section, unless the context otherwise requires-". Thereafter, six sub-sections have been given, of which sub-section (5) defines "speculative transaction". It is, therefore, clear that section 43(5) defining 'speculative transaction' is relevant only in the context of income under the head 'Profits and gains of business or profession'. It rules out its appl ..... X X X X Extracts X X X X X X X X Extracts X X X X
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