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Derivative Transaction


Last updated: 14 September 2009

Court :
Kolkata ITAT

Brief :
Derivatives transactions having underlying asset as shares are covered under section 43(5) prior to the amendment (effective from AY 2006-07) exempting derivatives from the definition of ‘speculative transaction’

Citation :
Shree Capital Services Ltd. v. ACIT (2009-TIOL-542-ITAT-KOL-SB)

Facts of the case


 The taxpayer company was engaged in business of financing and
investments in shares and securities. During the year the taxpayer
suffered the loss amounting to INR 925,065 on account of futures
and options. The Assessing Officer (AO) treated the same as
speculation loss as per section 43(5) of the Act.


Contentions of the taxpayer


 The derivative transactions entered into in the form of futures and
options were not covered under the provisions of section 43(5) of
the Act. Hence, the said transactions cannot be considered as
speculative transactions.
 

 The amendment to section 43(5) of the Act was clarificatory in
nature and hence is retrospective in operation.

Contentions of the tax department


 As per the meaning given on the website of Security Exchange
Board of India (SEBI) the 'Derivatives' gets its colour from the
underlying security and the underlying security can be either
commodity or stock and in either case it will fall within the ambit of
section 43(5) of the Act.


 The term 'commodity' is wider and, therefore, the derivatives would
fall within the term 'commodity' used in section 43(5) of the Act.


 Clause (d) in section 43(5) of the Act was introduced with effect
from 1 April 2006, providing that the derivatives transaction would
not be treated as speculative transaction. Accordingly, transactions
in derivatives before this amendment would be covered under
section 43(5) of the Act.


 It was evident from the memorandum explaining the insertion of the
relevant clause in the Finance Act that the insertion of clause (d)
under section 43(5) of the Act was prospectively and not
retrospectively.


Issues before the Tribunal


 Whether the derivative transaction falls within the meaning of
speculative transaction under section 43(5) of the Act?


 Whether clause (d) of section 43(5), introduced by Finance Act,
2005 with effect from 1 April 2006 was clarificatory in nature and
therefore, applies retrospectively?


Ruling of the Special Bench


Whether Derivatives falls within the ambit of section 43(5) of the Act
prior to the amendment


 The term ‘commodity’ has been given a wide meaning and it has
been mentioned that any commodity includes stocks and shares.
Thus, the securities represented by stock and shares were also
included in the term ‘commodity’. The derivatives are also securities
which derives its value from the underlying assets.


 In other words, the underlying assets were represented by
derivatives and since in the current case it was not disputed that the
underlying asset was shares, the Special Bench held that the
derivatives will also fall within the meaning of 'commodity' used in
section 43(5) of the Act.


Applicability of the amendment to section 43(5) of the Act


 The Finance Act 2005 had amended provisions of section 43(5) of
the Act to provide that certain transactions in respect of trading in
derivatives shall not be deemed to be speculative transactions.The Special Bench also observed that if it was held that the
transaction in derivatives does not fall in section 43(5) of the Act, it
will make clause (d) and explanation thereto below section 43(5) as
introduced by the Finance Act, 2005 to be redundant. It cannot be
presumed that the Government has introduced a clause as well as
explanation thereto, which was redundant and infructuous.


 Further it was observed that the Legislature had made the
amendment to section 43(5) because of the technological
advancement introduced by the stock markets resulting in more
transparency in the dealings. Therefore, the circumstances under
which amendment was brought into existence do not lead to the
inference that it was retrospective in nature.


 Accordingly, it was held that clause (d) of Section 43(5) was
prospective in nature and will be applicable from assessment year
2006-07 onwards.

 
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