Understanding Speculation Profit/ loss with latest case laws: Part – II.

Earlier we had discuss the concept of taxation of speculation/ profit loss in detail. The link of the same is given below:

http://taxbymanish.blogspot.com/2014/05/understanding-speculation-profit-loss.html

Given below we provided additional information’s in respect of taxation of speculation/ profit loss.

Section 43(5) v Section Explanation to section 73

Consider the following case

1.Assessee is earning income taxable under the head Profit and gains of business or profession.

2.Assessee incurred loss in share derivative transactions, being transaction of nature specified in Proviso (d) to section 43(5). As per said proviso, losses from such transactions are not loss from speculative transaction.

3.Can assessee set off his loss from share derivative transaction with other business income?

In recent case in CIT v DLF Commercial Developers Ltd (ITA 94/2013),Hon’ble Delhi High Court denied such set off in view of provisions of explanation to section 73. Section 73 contains the provisions for set-off loss from speculative business and carry-forward of the same

. The explanation to section 73 provide as under:-

[Explanation.—Where any part of the business of a company [other than acompany whose gross total income consists mainly of income which ischargeable under the heads "Interest on securities", "Income from house property", "Capital gains" and "Income from other sources"], or a company the principal business of which is the business of banking or the granting of loansand 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 and sale of such shares.]

As per said ruling, share derivative transactions carry the character of speculative transactions for section 73 and any loss arising therefromwill be characterised as loss from speculative business and samecannot be set-off against normal business income

.

As per court section 43(5) defining speculative transaction is only for the purpose defining terms used in section 28 to 41.Section 43(5) has no application over section 73

. This ruling will open Pandora’s box for Share brokers, Share traders and other institution investors, being corporate assesses, if they are showing their sharedealings (cash & Derivative transactions) under the head PGBP i.e they are not falling under exception provided by explanation to section 73 namely, the Gross total income mainly consist of income chargeable under heads “Income from House property”, “Capital Gains” and “Income from other Sources”. Such assessee will not be able to set off loss in share derivative transactions with other business income.

Critical Analysis

 The application of abovementioned ruling will create practical problem inadministration of provisions of Income Tax Act, especially relating to set off and carried forward of losses.

It will lead to situation where Nature of Loss will be determined post setting off with other source of Business income and also nature of loss will be dependent upon the quantum of other business income. The same is illustrated as under:-

A.   Suppose XYZ Ltd having following source of income:-1.Business income  Normal Business Income (Say N) – Rs. 1,00,000 Share Derivative Trading loss (Say S) – Rs. 1,00,000 2.Capital Gain – Rs. 80,000 Computation of Income1.Assessee has Income under two heads – PGBP & capital gains 2.For application of section 73 explanation, one has to determine thecomponents of Gross Total income (GTI) 3.If GTI is consist of Income from house property, Capital gain & Income from other sources, then loss from share transaction is not speculative loss, as per explanation to section 73. 4.Till section 73 explanation application, loss from share derivativetransactions will be treated as non-speculative u/s 43(5), to determineincome under the head PFBP

Income under PGBP

Source N – Rs. 1,00,000Source S–   Rs. 1,00,000 Total -- Rs. NIL

Income under Capital Gain – Rs. 80,000Gross Total Income – Rs. 80,000

Since GTI is mainly consist of income under the head capital gains, loss from share derivative transaction is not speculative loss

Thus nature of loss from share derivative transaction is determine dpost set-off of the same with other business income

B.   Suppose in above example, source N income is Rs. 2,00,000, the GTI will be consist of as under:-1.Income under head PGBPRs. 1000002.Capital Gain-Rs. 80,000Since GTI is not consist of income under the head capital gains, loss of Rs.1,00,000 will be treated as speculative loss and GTI will be recomputed.

Thus nature of loss from share derivative transaction is based onquantum of other business income

C.   Continuing with Example A, suppose in assessment proceedings, income from source N is enhance to Rs. 2,00,000. In that scenario also, the natureof loss from source S will be change to speculative loss from non-speculative loss as claimed by assessee.

FAQ on Speculation Profit/ Loss.

What is the tax that I will have to pay if I am an intra-day trader in the cash and derivatives segment of the equity market? Also, is there any tax slab like Rs 0-2 lakh? Can losses in intra-day trade be carried forward to be offset against profit? For how many years?

Income from intra-day trading in shares is treated as speculative business income as the transaction is settled without delivery. Accordingly, it is charged under the head, ‘Profit and gain of business or profession'. As per Section 43(5) of the Income Tax Act, 1961 speculative transaction means a transaction in which a contract for the purchase or sale of any commodity including stocks and shares is settled otherwise than by the actual delivery or transfer of the commodity or scrips.

However, trading in derivatives, referred to in Section 2(ac) of the Securities Contracts (Regulation) Act, 1956, carried out on a recognised stock exchange is not deemed to be a speculative transaction. Recognised stock exchanges are NSE, BSE, MCX Stock Exchange, and the United Stock Exchange of India. The transaction will be treated as ‘Non-speculative business income'.

In intra-day trading, there is no actual delivery as the shares enter and exit from the trading account on the same date and do not enter the demat account at all. However, if shares are purchased on a particular day and sold next day, it is not treated as ‘Speculative business'. The profit or loss on sale of such shares is taxable as short-term capital gain or business income, as the case may be.

If there is unabsorbed speculation business loss, then such loss can be carried forward to be set off against the subsequent year's income from speculation business. Such loss cannot be carried forward for more than four assessment years (AY) immediately succeeding the AY for which the loss was first computed. Further, loss from trading in derivatives carried out on a recognised stock exchange should not be treated as speculation loss. Unabsorbed non-speculative business loss can be carried forward for eight years to be set off against business income of subsequent years.

Profit from intra-day trading is to be computed as per the normal slab rate applicable. Your tax liability would, thus, depend on your net taxable income.

I am an active trader in the cash and in the futures and options (F&O) segments of the equity market. I generally take delivery of shares for two-three days and sell them. I have huge turnover in this fashion. I had incurred loss in cash trading but made profit in F&O trading. Can I adjust the loss from cash trading with the profit from my F&O trading? As a practice, I show profit and loss of my share trading transactions as ‘Business income' in my account books.

From assessment year (AY) 2006-07 (financial year 2005-06), transactions in derivatives are considered as non-speculative transaction if they satisfy the conditions laid down in Section 43(5) of the Income Tax (IT) Act, 1961. For example, the transaction should be carried out on a recognised stock exchange, the securities transaction tax is paid, and trade is supported by contract note. However, if the conditions laid down in Section 43(5) of the IT Act are not complied with, then such a transaction in derivatives would be treated as speculative transaction.

As per Section 70 of the IT Act, i.e., inter-source adjustment, if the net result of computation for any AY of any source of income falling under any head of income is a loss, then the assessee can set off such loss against his income from any other source of income under the same head. However, inter-source adjustment is not allowed on loss from speculative business, loss from specified business under Section 35 AD of the IT Act, long-term capital loss, and loss from activity of owing and maintaining race horses.

In your case, there is loss from share trading and profit from F&O trading. Therefore, as per Section 70, loss from share trading, i.e., chargeable under the head, ‘Profit and gain of business', can be set off against any source of income under that head, i.e. loss from share trading (non-speculative as delivery is taken) can be set off against profit from F&O, whether considered as speculative or non-speculative profit. However, loss from F&O, if considered as speculative loss by virtue of Section 43 (5) of the IT Act, cannot be set off against profit from share trading. Loss from speculative business, if any, can be set off only against profit from speculative business.

Hope the above small summary on section 73  will help you in getting some relief from the hardship from the ITD. In case you have any further clarification please mail me at taxbymanish@yahoo.com.