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Deputy Commissioner of Income Tax, Company Circle-V (3) Chennai Versus M/s. Rajkumar Impex Pvt. Ltd.

2015 (9) TMI 497 - ITAT CHENNAI

Forward contracts in respect of forex transactions entered into by the assessee with the banks - whether will not fall under the definition of speculative transaction and holding that assessee is entitled to claim such loss as business loss as held by CIT(A) - Held that:- Forex transactions entered into by the assessee are not derivative transactions. However, it was held that transactions considered for determining the business loss from derivative transactions cannot be more than the total exp .....

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to follow the decision of this Tribunal in the case of Majestic Exports (2015 (7) TMI 936 - ITAT CHENNAI ) and recompute the business loss in line with the order of the Tribunal, after calling for details from the assessee and giving opportunity of being heard - Decided partly in favour of revenue for statistical purposes. - I.T.A.No.518/Mds/2014 - Dated:- 26-8-2015 - SHRI CHANDRA POOJARI AND SHRI CHALLA NAGENDRA PRASAD, JJ. For The Appellant : Dr. U.Anjaneyalu, CIT For The Respondent : Mr. B.Ra .....

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ssessee is entitled to claim such loss as business loss. 2. Counsel for the assessee submits that the issue in appeal has been decided by the co-ordinate Bench in various cases holding that loss incurred on account of forward contracts is business loss and contracts entered into by the assessee with the banks to hedge against any loss arising due to fluctuation in foreign currency is business loss and such transactions are not speculative transactions. Counsel for the assessee places reliance on .....

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re Kumar & Co. Vs. DCIT (2 SOT 769) 9) DCIT Vs. Intergold (I) Ltd., (124 TTJ (Mum) 337) 10)Rajashree Sugars & Chemicals Vs. Axis Bank Ltd. in appeal Nos.1926 & 1927 of 2008 dt.14.10.2008 11) IVF Advisors P.Ltd. Vs. ACIT in ITA No.4798/Mum/2012 dt.13.02.2015 12) SCM Garments P.Ltd. Vs. DCIT in ITA No. 1645/Mds/2013 dt. 27.02.2015 13) S.P. Apparels Ltd. Vs DCIT in ITA No.1327/Mds/2014 dt. 17.04.2015 14) DCIT Vs. AVT MC Comic Ingredients Ltd. in ITA No. 2170/Mds/2013 3. Departmental Rep .....

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,82,32,979/- on account of forex loss hedging contending that income of loss from forward contracts entered into by the assessee is loss incurred in speculation business, therefore he did not allow set off of such loss against business income but was allowed to be carried forward for set off as per section 73 of the Act. The Assessing Officer observed in the assessment order as under:- 4.7.2 Having regard to the fact that assessee has cancelled 96% of forward contracts entered into by the assess .....

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nsidering the submissions of the assessee and contentions of the Assessing Officer and following the decision of Calcutta High Court in the case of CIT Vs. Soorajmull Nagarmull (129 ITR 169), Bombay High Court in the case of CIT Vs. Badridas Gauridu P.Ltd. (261 ITR 256) and the decision of co-ordinate Bench in the case of Cotton Blossoms in ITA No.2032/Mds/2012 dated 21.2.2013 held that various contracts entered into by the assessee will not fall under the definition of speculative transaction a .....

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nts from foreign buyers in foreign currencies are received through the State Bank of India. During the year under consideration the assessee entered into many forex derivative contracts including six structured contracts. These are stated to be called as Exotic Cross Currency Option contracts. In respect of one of the structured contracts with State Bank of India on various dates, the assessee incurred huge losses to the extent of Rs. 4,30,44,915/- and the assessee claimed the said loss as busin .....

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sing Officer treated the speculation loss not allowable to set off against business income of the assessee. Against this, the assessee carried the matter in appeal before the Commissioner of Income Tax (Appeals). The Commissioner of Income Tax (Appeals) confirmed the view of the Assessing Officer. Aggrieved, the assessee is in appeal before us. 4. The ld. Authorised Representative for assessee submitted that derivatives had been excluded from the definition of speculative business u/s.43(5) by s .....

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ge. He submitted that foreign currency or any currency is neither commodity nor shares. The Sale of Goods Act, specifically excludes cash from the definition of goods. Besides, no person other than authorized dealers and money changers are allowed in India to trade in foreign currency, much less speculate. Section 8 of the Foreign Exchange Regulations Act, 1973, provides that except with prior general or special permission of the RBI, no person other than an authorized dealer shall purchase, acq .....

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enting the export contracts, the assessee had entered into forward contract with the banks. In some cases, the export could not be executed and the assessee had to pay certain expenses. These expenses the assessee claimed by way of expenditure towards business and the transaction can be stated to be in speculation as to cover under sub-section (5) of Section 43 of the Act. 5. The ld. Authorised Representative for assessee relied on the order of the Co-ordinate Bench in the case of M/s. Cotton Bl .....

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rdinate Bench, Delhi in the case of Munjal Showa Ltd vs. DCIT, 94 TTJ 227, dated 26th June, 2003 wherein it was held that Profit on cancellation of forward contract in foreign currency entered into for safeguarding against loss by fluctuation in foreign currency for purchase of plant and machinery with loan obtained in foreign currency is capital receipt and not speculative profit. 5.2 The ld. Authorised Representative for assessee relied on the judgment in the case of CIT vs. Badridas Gauridu ( .....

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ined to mean a transaction in which a contract for the purchase or sale of a commodity is settled otherwise than by the actual delivery or transfer of such commodity. However, as stated above, the assessee was not a dealer in foreign exchange. The assessee was an exporter of cotton. In order to hedge against losses, the assessee had booked foreign exchange in the forward market with the bank. However, the export contracts entered into by the assessee for export of cotton in some cases failed. In .....

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ough diamonds and exporting cut and polished ones, profits from cancellation of forward contracts in foreign exchange entered into with a view to minimize risk were integral part of assessee s exports profits eligible for deduction u/s.80HHC and Expln.(baa) had no application . 5.4 The ld. Authorised Representative for assessee relied on the order of the Co-Ordinate Bench, Mumbai in the case of DCIT vs. Intergold (I) Ltd, 124 TTJ 337, wherein it was held that Profits on cancellation forward exch .....

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O. A. Nos.251 &252 of 2008 and others dated 14th October, 2008 wherein it was held that The above sequence of events would show that the transaction in question, from its very nature, cannot be termed as a wager. We have seen in paragraph-55 above that three tests are to be satisfied if a contract is to be termed as a wager. The first test is that there must be two persons holding opposite views touching a future uncertain event. The second test is that one of those parties is to win and the .....

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ng and vice versa. Therefore both parties cannot be taken to be winners or losers in absolute terms. Even if we take for the sake of argument that the first two tests are satisfied in this case, the third test is certainly not satisfied in the case on hand. Both the parties definitely have an actual interest in the rate of exchange hitting a high or low. This is because of the fact that the very intention of the transaction is to hedge an underlying exposure. It is like a contract of insurance, .....

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rmulae itself was named after them, as Black-Scholes Model. The application of the model, led to the award of the Nobel in Economics. The derivatives prices are determined by feeding certain inputs into this model. These inputs are (i) stock price of the underlying asset (ii) amount of time until expiration (iii) strike price of the option (iv) volatality of the underlying asset (how much it moves up or down during a given period) (v) risk free rate of return (usually the interest rate paid by G .....

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ians (or Portfolio Managers) evaluate the price of these derivatives. Hence they cannot be termed as wagers Two of the earliest circulars so issued by the Reserve Bank of India, were A. D (M. A. Series) Circular Nos. 21 and 26 dated 23.12.1994. They were issued in exercise of the power conferred under Section 73(3) of the Foreign Exchange (Regulation) Act, 1973, permitting authorised dealers (of foreign exchange) to offer forward cover to resident customers in any currency of their choice. Norma .....

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tter currency is also a permitted currency and is actively traded in the market, if the customer wished to hedge against a third currency instead of the rupee. Customers will ordinarily require forward cover facilities for the foreign currency in which their receivables or payables are denominated, against the Indian rupee. If for any reason, customers wish to hedge them against a third currency instead of the rupee, authorised dealers may provide forward sale or purchase facilities as appropria .....

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of the above circular show that it is not necessary for the Customers to seek forward cover facilities for the foreign currency in which their receivables or payables are denominated, against the Indian rupee. If for any reason, customers wished to hedge them against a third currency instead of the rupee, authorised dealers were permitted by this circular to provide forward sale or purchase facilities as appropriate, in the currency of the receivables or payables against the third currency provi .....

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held that 7.4 Considering the relevant provisions of the relevant Acts, discussed herein above in the light of Hon ble Madras High Court and the answers given to frequently asked questions by the SEBI and the incorporation of exchange traded currency derivative from August, 2008, there remain no iota of doubt that the transaction of the assessee cannot be treated as speculative transaction. We have also gone through the copies of the contract notes incorporated in the paper book filed before us. .....

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of the judicial discussion herein above, we have no hesitation in setting aside the order of Ld. CIT(A). Appeal filed by the assessee is accordingly allowed . 5.7 The ld. Authorised Representative also placed reliance on the order of the Co-ordinate Bench, Madras in the case of M/s. SCM Garments (P) Ltd vs. DCIT, in ITA No.1645/Mds/2013 and ITA No.2275/Mds/2014, dated 27.02.2015 wherein it was held that We have heard the rival submissions and carefully perused the material on record and case la .....

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ion is by way of hedging . Hedging transactions are entered in order to protect against the loss due to compensatory price movement. It protects an asset or liability against fluctuation in foreign exchange rate. One of the tools for hedging the forex risk is by way of foreign currency derivatives. Section 45 of the Reserve Bank India Act, 1949 defines derivative as a financial instrument whose value depends on the value of the underlying exposures. In the case before us, the underlying exposure .....

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ver, the assessee is not compelled to buy or sell, if the spot market prices are favorable or not favorable. The cost of this option is called Option Premium . Upon the payment of the same, the exporter is hedged against adverse currency movement and also not liable to loose in case of favorable currency movement. Therefore, it is apparent in the case of the assessee that the assessee had entered into Options Contract (derivative) with the bank in order to hedge its foreign exchange risk. In the .....

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essee before us, the following facts emerge and the legal issues involved are discussed and summarized herein below:- (i) The assessee has entered into forex derivative transactions only in order to contain the foreign currency fluctuation risk. (ii) Thus, the loss on account forex derivative transactions are directly attributable to the normal business of the assessee. (iii) The loss incurred by the assessee is realistic and not notional. (iv) Only money changers and banks are allowed to trade .....

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nstructions issued by CBDT Instruction No.03/2010 dated 23.03.2010 has recognized the loss out of forex derivatives on actual settlement/conclusion of contracts as allowable business loss, however they have directed the Revenue to examine whether the transactions would fall U/s. 43(5)(d) of the Act, and if so to treat the same as non-speculative transaction. By the above directions, it appears that though the CBDT has recognized the loss arising out of forex derivatives on actual settlement of t .....

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f service is very limited. (ix) In the present case the assessee has taken a hedging position to the extent of ₹ 1.05 crores and USD ₹ 3 crores during the period 2007-2009 based on the RBI guidelines. The guidelines permitted hedging to the extent of last three years annual average turnover, or current year s actual export turnover whichever is higher. Where exact amount of underline transaction was not ascertainable according to RBI guidelines, the contracts could be booked on the b .....

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e has entered into foreign currency derivative contract adequate enough to cover the overall exposures of foreign currency, the contention of the Revenue that the proportion of the loss in derivatives is eight times more than the loss from currency fluctuation does not have any merits. (xii) The forex derivative transactions transacted by the assessee are through nationalized banks in compliance with the RBI regulations. These regulations permit the assessee to enter into such derivative transac .....

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it any bank under its umbrella to entertain its client in any separate business of forex derivative transactions. Permission is granted only for the clients of the bank to hedge on foreign exchange in order to minimize the risk of the foreign currency exposure arising out of import and export trade. (xiv) The Hon ble jurisdictional Madras High Court in the case M/s.Rajashree sugars and chemicals Ltd Vs. Axis Bank Ltd., in O. A Nos.251 & 252 of 2008 in C.S.No.240 of 2008 O. A. Nos.526 & 5 .....

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tives. Thus to sum up in the present case before us, the assessee is an exporter of garments who has entered into forex derivative transactions through its bankers with a view to effectively hedge its foreign currency risk. Therefore, these forex derivative transactions have a close proximity or rather incidental to the export business of the assessee, which cannot be considered as speculative. Moreover in the case of the assessee foreign currency contracts cannot be treated as wagering contract .....

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R. B. I regulations is quiet substantial in order to justify the forex derivative transactions made by the assessee through Government recognized channel, otherwise the RBI would not have entertained these transactions and would have restrained the banks from entering into such transaction with its clients. Thus considering the totality of the facts and circumstance of the case and the decisions relied upon herein above, we allow the grounds raised by the assessee s on this issue for all the thr .....

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Foreign Exchange is not a commodity and therefore it was outside the purview of Section 43 (5). (ii) Derivative contracts entered into by the assessee have a direct underlying currency exposure on account of export proceeds receivable by the assessee. (iii) The decision to go for cross currency option contract was a decision purely to hedge the currency exposure of the assessee and he prays that both the appeals may be allowed. 6. On the other hand, the Departmental Representative submitted that .....

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tock exchange from the ambit of speculative transaction. This clearly excludes derivatives trading through stock exchanges and conversely there cannot be any exclusion without an earlier inclusion. Unless it was the intention of the legislature that trading derivatives are included in commodity, they would not have specifically excluded trading through stock exchange under Section 43(5)(d) of the Act. Therefore, it was evident that derivatives will form part of commodity mentioned u/s.43(5). He .....

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ich Legislature made it effective i.e.1.4.2006 - Held Yes - Whether term derivatives in which underlying assets is shares, would fall within meaning of commodity used in section 43(5) - Held, yes - whether, therefore, where assessee suffered a loss on account of futures and options, i.e., a form of derivatives, in which underlying asset was shares, said loss was rightly disallowed by revenue authorities by invoking provisions of section 43(5)- Held yes . 6.1 Further, ld. Departmental Representat .....

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tive transactions carried on by the assessee during assessment year 2003-04 were speculative transactions covered under section 43(5) of the Act and ,the loss incurred in those transactions was liable to be treated as speculative loss and not business loss. 6.2 A perusal of the above judgements and averments contained therein, it was evident that the derivative transactions are included in the meaning of commodities and in these cases the transactions were held as speculative transactions before .....

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exchange. Therefore, forex derivatives are clearly commodities as understood in business parlance. Further till the liberalization of Indian economy undertaken in 1991 foreign exchange was treated as scarce commodity and was not available for trade or purchase by individuals. It was only in mid 2000, that the Government and Reserve Bank of India allowed the trading in foreign currency. It was much later, in 2007, that the State Bank of India come out with a scheme for trading in foreign currency .....

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ts have nothing to do with overall forex earnings of the assessee either in US Dollars or Japanese Yen. The assessee s account is debited or credited on settlement date given in the contract based on the currency movements upto maturity date. In this derivative contracts assessee can neither deliver US dollars nor Japanese Yen from the export earnings. The assessee can derive a profit or loss based on the currency movement ie. Japanese Yen Vs. US Dollars. Therefore, the claim of the assessee tha .....

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ssment order would clearly indicate that the assessee was only having a speculative bet on the currency movement between US Dollars and Japanese Yen. All these transactions based on currency movements between US Dollar and Japanese Yen on maturity date/knock of date mentioned in the contract has resulted in huge losses to the assessee as shown in-the copy of the ledger account. Further it may be noticed that the assessee s export bills for the past four years did not have a single exports in Jap .....

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n exporter of garments. Export bills or receivables of the assessee cannot be linked to the derivative transactions. b) By entering into a currency derivative transaction the assessee is clearly taking a speculative bet on the movement of Japanese Yen with US Dollars during a fixed period. These transactions are clearly a speculative bet on the currency which are in the nature of a wager contract. c) The forex derivative transactions are not settled by actual delivery of foreign exchange but onl .....

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nsactions entered into by the banks are not within the four corners of law. e) An analysis of the complex derivative transactions entered into by the assessee does not correlate to their trade exposure. In these derivatives the assessee had undertaken the risk of buying dollars and selling Japanese Yen, when the company was never a buyer of Dollars nor did they ever have any Japanese Yen assets. These derivative transactions were complex leveraged structures which were sold by the bankers to the .....

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incorporated in the Contract Note. Similarly the declaration of the exposure given in the second page of the Contract Note The size and tenor of the above transaction is not in excess of the underlying exposure in Balance Sheet is a_statement made in the contract note which is devoid of any merit. Neither the bank nor the assessee has analysed or stated any specific underlying exposure or balance sheet exposure of the assessee in the derivative transaction. If there was a real underlying exposur .....

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hat the derivate transactions have only increased the risk to the assessee and not reduced the risk like as a hedge . 6.4 The Ld. Departmental Representative further submitted that the Assessing Officer has considered all the arguments but forward by the assessee and has passed a detailed assessment order and the Commissioner of Income Tax (Appeals) confirmed the view of the Assessing Officer. He placed reliance on the order of the Tribunal in the case of Shri Vinodkumar Diamonds, (P) Ltd. vs. A .....

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ulative transaction as held by revenue - Whether, where a contract for purchase or sale of commodity is periodically or ultimately settled otherwise than by actual delivery, same would fall within speculative transaction - Held, yes - Whether for hedging transactions it is necessary that commodity in respect of which forward transactions have been made by assessee must have a direct connection with goods manufactured or sold by assessee - Held, yes - Whether, where assessee was dealing in diamon .....

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oreign currency was treated as a commodity and transactions including cancellation of foreign currency forward contracts which was settled otherwise than the actual delivery will be treated as speculative transaction. The derivative transaction entered into by the assesses are without hedge, underlying and there cannot be any delivery against derivative transactions. The principle laid down in the above judgement will squarely apply in the case of the assessee. The claim of the assessee s deriva .....

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. The assessee s export bills in the last 4 years have permitted him to enter into derivative transactions with the bank. However, the assessee s decision to enter into separate cross currency derivative transactions were a separate activity to obtain speculative profit based on the currency movements ie. US Dollar Vs. Japanese Yen during a particular period. In other words US Dollar and Japanese Yen were mere dices on the gambling table. The movement of Japanese Yen Vs. US Dollar went against a .....

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loss in this transaction. The assessee claimed it as business loss. According to the Assessing Officer this loss was not business loss and it is a speculative loss and this transaction is speculative in nature as such the loss incurred on this transaction cannot be set off against business income of the assessee. According to the ld. Authorised Representative for assessee, the derivative transaction cannot fall under sec.73. Explanation to sec.73 creates a deeming fiction by which among the ass .....

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ivery does not come under the purview of the said section. Similarly, as per clause (d) of sec.43(5), derivative transaction in shares is also not speculation transaction as defined in the said section. Therefore, both profit/loss from all the share delivery transactions and derivative transactions are having the same meaning, so far as sec.43(5) of the Act is concerned. Again, in view of the fact that both delivery transactions and derivative transactions are nonspeculative as far as sec.43(5) .....

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her the assessee s case is hit by the deeming provision of Explanation to Sec. 73 of the Act, the aggregate of the business profit / loss has to be worked out based on the non-speculative profits; either it is from share delivery or from share derivative. 8. From the above, it is concluded that both trading of shares and derivative transactions are not coming under the purview of Section 43(5) of the Act which provides definition of speculative transaction exclusively for purposes of section 28 .....

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or derivative transaction. 8.1 Now, this view has been taken by Co-Ordinate, Chennai in the case M/s. Aishwarya & Co P. Ltd in ITA No.860/Mds/2014, dated 29.05.2015, wherein they followed the judgment of the Calcutta High Court in the case of M/s. Baljit Securities Pvt. Ltd. (88 CCH 313) wherein held as under:- Clause (d) of Section 43(5) became effective with effect from 1st April, 2006. Therefore, prior to 1st April, 2006 any transaction in which a contract for the purchase or sale of any .....

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d only have been set off against profits arising out of speculative transaction. In the present case, the assessee, as already indicated, has been dealing in shares where delivery was in fact taken and also in shares where delivery was not ultimately taken. In other words, the assessee has been dealing in actual selling and buying of shares as also dealing in shares only for the purpose of settling the transaction otherwise than by actual delivery. The question arise whether the losses arising o .....

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s chargeable under the heads interest on securities , or a company the principal business of which is the bu9siness of banking or the granting of loans and advances) consists in the purchase and sale of shares of other companies, such company shall, for the purposes of this section, be deemed to be carrying on a speculation business to the extent to which the business consists of the purchase. In order to resolve the issue before us, the section has to be read in the manner as follows: Explanati .....

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.. … … … … …. … … …) consist in the purchase and sale of shares of other companies, such company shall, for the purposes of this section, be deemed to be carrying on a speculation business to the extent to which the business consists of the purchase and sale of such shares. It would, thus, appear that where an assessee, being the company, besides dealing in other things also deals in purchase and sale of shares of other companies, the asse .....

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on. There was, as such, no bar in setting off the loss arising out of derivatives from the income arising out of buying and selling of shares. This is what the learned Tribunal has done. 9. From the above decision of the Calcutta High Court in the case of Baljit Securities Pvt. Ltd. cited supra, the issue stands covered in favour of the assessee. However, we make it clear that total transaction considered for determining this business loss from derivative transactions cannot be more than the tot .....

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