DEEMED SPECULATION BUSINESS IN SHARES OF OTHER COMPANIES- some finer issues.

[C.A. Uma Kothari]

Speculation business and loss:

Speculative business is considered as a separate business for the purpose of computation, set off and carry forward. Speculation business loss can be set off only against speculative business income. Earlier speculative loss was eligible for carry forward for eight years, that is similar to normal business loss. However, from A.Y. 2006-07 the carry forward of speculative loss will be  allowed only for four assessment years after the assessment year  in which loss is  computed. Therefore, if a normal loss is deemed as speculative loss the assessee suffer many disadvantages.

The restrictions relating to speculative loss are applicable even to normal business loss, if the loss is deemed as speculative loss as per Explanation to S. 73.

 Scope of this article:

An attempt is made to discuss some aspects relating to deemed speculative business in purchase and sale of shares by certain companies. Relevant provision is section 73 of the Income Tax Act, 1961 in which fiction is created by way of an explanation to deem real share business loss as speculative business. The focal points for issue are:  what is a share ? what is not a share ? which shares are not covered by deeming provision ? and certain type of  transactions in shares which  may not be regarded as purchase  / sale of  shares although there is acquisition / transfer of share.

Therefore other aspects of normal loss vis a vis speculative loss are not considered in this write-up.

Deemed speculation:

 According to explanation to section 73 of the Act, in case of certain type of companies business activity of purchase and sale of shares of other companies, though supported by delivery transactions is deemed to be speculative business. Thus, loss arising from purchase and sale of shares (held as stock-in-trade) is deemed to be speculative loss for the purpose of set off in the previous year itself as well as for carry forward and set off in future. Thus, in specified circumstances in case of certain companies such loss is eligible for set-off against only speculation business income.

 Non-applicability to loss arising in case of shares held as capital asset

The deeming provision will not be applicable in case of computation under the head ' Capital gains', when the shares are held as investment and capital asset. In that case loss on transfer of shares of companies will be considered as loss under the head capital gains and not as business loss. However, in case of frequent purchase and sale of shares even if they are held as investment as per books of account of assesses some times Revenue Authorities may try to bring them in the category of business of purchase and sale of shares or adventure in nature of trade as trading activity falling under the head 'Business' and then to apply explanation to section 73.

Shares of companies:

 What is covered by the explanation is business activity of purchase and sale of shares of other companies.

'Share' has not been defined in the Act. Therefore, the term has to be understood as per common understanding vis- a- vis provisions of the Companies Act, 1956. `Share' has been defined in the Companies Act, 1956 in section 2(46) as follows:

(46)  "share" means share in the share capital of a company, and includes stock except where a distinction between stock and share is expressed or implied."

Thus, as per the above meaning share may be a share in capital of a company and there can be different types of shares for example:

A.    equity shares of different face value and types,

B.     preference shares of different types,

C.     stock in capital of company.       

The requirement is that it must represent a share in the capital of any company, which means that it must represent share already allotted and in force (not having been forfeited) which confers rights to dividend, voting rights and right to participate in surplus of company in the event of liquidation of the company.

Share may be of any type of company like a private company, a public company, a listed company or a company whose shares are not listed on any stock exchange.

Mere right to allotment of shares is not share:

An entitlement to allotment of shares is only a right to get shares allotted. This may be by way of 'right entitlement' or 'entitlement for preferential allotment' under any contract or understanding. Thus, if some one purchase and sell right entitlements or sells his rights to allotment of shares in private placement / preferential allotment etc. it will not amount to purchase and sale of shares and therefore deeming provision of explanation shall not be applicable.

Debentures and bonds are not shares:

 Debentures and bonds are instruments used to raise loan / borrowed capital and not share capital. Even in case of debenture that are convertible in to shares, deeming provision shall not be applicable. Purchase and sale of debentures and bonds will not be covered by the explanation to section 73.

 However if debentures were held as stock-in-trade and shares received on conversion are also held as stock-in-trade and then sold the revenue is likely to apply deeming provision in case there is loss. However, it can be argued with force that allotment of share cannot be called as purchase of share in the context of the explanation.

 Shares of co-operative societies is not covered:

 The deeming provisions do not cover shares of co-operative societies. Because co-operative society is not a company within the meaning of the companies Act as well as within the scope of section 73. Therefore, purchase and sale of shares of co-operative societies shall not attract deeming provision.

The society may be of any type like consumer co-operative society, co-operative bank, housing co-operative society etc.

 Units of mutual funds and UTI are not shares of companies:

 Mutual funds issue units to its investors. A mutual fund is not a company. Mutual fund is usually is a trust and its funds are managed by professional managers through Asset Management Company.  There are no voting rights attached to units of mutual fund, as is the case of share of a company or a co-operative society.

 UTI is deemed to be a company under section 32 of the UTI Act and distribution of income to unit holders is deemed to be dividend. However, the deeming provision being a fiction has to be applied for limited purposes.

 Merely because UTI is deemed as company and distribution of income is considered as dividend, it will not make unit of UTI, as a 'share' as there has not been any specific provision to that effect. Thus the supreme court has held, in case of Apollo Tyres Ltd V CIT (2002) 255 ITR 273 (SC)/ 122 Taxman 562 that purchase and sale of units of UTI shall not amount to purchase and sale of shares. Therefore, deeming provision of section 73 shall not apply.

 Similarly units of other mutual funds cannot be called share of a company and purchase and sale of units will not be equated as purchase and sale of shares of other companies.

In this regard it is also worth noting that units and shares are qualitatively different. In case of shares there is right to attend general meeting and exercise voting rights which are in proportion of shares held / amount paid up on shares in case of a poll. However, in case of units of mutual fund generally such rights are not available. 

Detachable warrants / warrants are not covered:

 Instruments like detachable warrants giving right to subscribe shares / debentures in company is not share and therefore purchase and sale of detachable warrants / warrants shall not be hit by the explanation.  

 Shares in "joint stock Company" (before registration) is not covered:

 Shares held in a 'joint stock company' within the meaning of section 566 of companies Act are not shares of a company. However, on registration of such joint stock company under section 574 of the Companies Act, joint stock company gets duly incorporated as a company. Therefore, shares of such incorporated company shall be covered by the explanation to section 73 if they are purchased and sold. 

 Shares allotted cannot be called share purchased:

 If some one make an application or subscribe to the memorandum and articles of association and shares are allotted / issued, it cannot be said that shares have been purchased thought they have been acquired. Therefore, in case shares are acquired by way of application and allotment process and also held as stock-in-trade, it will not be hit by deeming provision.

 Shares allotted on conversion of debentures cannot also be called, as 'shares purchased' therefore on sale of such shares explanation to S. 73 will not be applicable.

 Shares allotted on merger, demerger etc. cannot be called as shares purchased:

 Similarly in case of shares received in the events like merger and demerger of companies, cannot be called as shares purchased. Therefore, even if original shares were purchased and held as stock-in-trade, new shares received on merger, demerger etc. shall not be hit by deeming provision.

 Forfeiture of share is not sale:

 In some circumstances, the company may forfeit shares. Some times in special circumstances like low market price of shares or inability to pay money due one may not pay amount due on allotment / call   and shares may be forfeited by the company. In such circumstances it cannot be said that the shareholder has sold the shares to the company. Therefore, loss arising on forfeiture of shares held, as stock-in-trade shall not be hit by deeming provision.

 Purchase and sale of own share are not covered:

 A company may purchase its own shares for cancellation. However, in some circumstances if a company purchase its own shares and then sell the same, it will not be hit by explanation to section 73 because this explanation is applicable to only purchase and sale of shares of other companies.

 Fall in valuation may not be considered as deemed speculation:

Suppose shares were purchased and are not sold but held has stock-in-trade. On the closing day of the previous year the stock-in-trade of shares is valued and such valuation is lower than cost. Therefore, stock valuation results in loss.  There being no 'purchase and sale', the explanation should not be applied. The fiction is created to keep a check on tax avoidance by way of 'purchase and sale' of shares of other companies. Therefore, unless there is purchase and sale both, the fiction should not be applied. As per purpose of insertion of the explanation the objective is to put a check on claiming loss on purchase and sale of shares of group companies, whose price can be manipulated. Therefore, in case of purchase and sale of shares of companies which are not group companies, whose share price is not amenable to manipulation, this provision should not be applied.