If all speculative transactions will be claimed as hedging transactions, very purpose behind the provisions of section 73 not permitting set off of speculative loss against business income will become redundant.
CASE LAWS DETAILS
DECIDED BY: ITAT, MUMBAI BENCH `D’, IN THE CASE OF: ACIT Vs. Dinesh K. Mehta (HUF), APPEAL NO: ITA No. 976/Mum/2009, DECIDED ON April 30, 2010
PER N.V. VASUDEVAN, JM :-
This is an appeal by the revenue against the order dated 28.11.2008 of learned CIT(A)-XII, Mumbai for A.Y. 2005-06.
2. Ground No.1 raised by the revenue reads as follows :-
On the facts and circumstances of the case and in law, learned CIT(A) was justified in treating the transactions in derivatives and futures as business (hedging) transactions and not speculative transactions and thereby allowing the loss on account of the transaction in derivatives as business loss instead of speculation loss.
3. The assessee is a HUF. It is engaged in the business of dealing in shares and securities. In the profit and loss account, the assessee had debited loss on account of Nifty hedging transactions of Rs. 1,30,41,270/-. Generally, in transaction of purchases in Nifty Futures, which is a derivative instrument, there is no actual delivery of shares. The transaction of purchase at a particular price on a future date is entered into. On the specified date, the difference between the agreed price and price prevailing on the specified date is settled and there is no Shri Dinesh K. Mehta HUF actual transaction of purchase of the security. On such settlement there could be a loss or profit. The assessee explained that the loss had occurred on account of purchase of Nifty Futures and these transactions were purely hedging transactions meant to minimize the loss due to fluctuation of price of shares which the assessee does on delivery basis in the usual course of business and held by him as stock-in-trade of his business. They are primarily to be regarded as speculative transactions. Loss arising on account of speculative transactions cannot be set off against income from regular business. Speculative transactions have been defined in section 43(5) of the Act to mean transactions in which, contract for purchase and sale of any commodity, including stocks and shares, is periodically or ultimately settled otherwise than by actual delivery or transfer of commodity or script. There are certain exceptions to the above definition. Under clause (b) of section 43(5) of the Act, a contract in respect of stocks and shares entered into by a dealer or investor therein to guard against loss in his holdings of stocks and shares through price fluctuations shall not be deemed to be speculative transactions.
4. According to the Assessing Officer, transaction of derivatives trading in the form of purchase of Nifty futures was in the nature of speculative transaction. In this regard the Assessing Officer called for the details of transactions of purchase of Nifty futures, which resulted in the loss debited to the profit and loss account. According to the Assessing Officer, to fall under exception under section 43(5)(b) of the Act, hedging transactions should be equal to the inventory of the shares held by the assessee in its business of dealing in shares and securities and only to this extent, transactions can be said to be hedging transaction which fall within exception. The Assessing Officer noticed that on the date on which the assessee entered into transactions of purchase of Nifty futures, position of inventory of shares held by the assessee on that particular day was less than the value of purchase of Nifty futures. In this regard, Assessing Officer has analyzed 38 transactions given by the assessee. Shri Dinesh K. Mehta HUF The Assessing Officer thereafter referred to Circular No. 23 dated 12.9.1960; wherein CBDT had clarified as follows:-
“Hedging sales can be taken to be genuine only to the extent the total of such transactions does not exceed the ready stock. Hedging contract is a contract where the person dealing with the actual commodity ensures himself against the adverse price fluctuations in that commodity in future. The transaction in the future market corresponds to an earlier transaction in the ready market. The future transaction is basically to off-set any loss that may arise on the earlier transaction.”
The Assessing Officer thereafter referred to certain judicial pronouncements in the case of M.G. Brothers Vs. CIT, 154 ITR 695 (AP);
Pankaj Oil Mills Vs. CIT, 115 ITR 824 (Guj). The Assessing Officer thereafter culled out following principles :-
“Thus the basic principles which emerge from the above case laws are follows :-
(i) the test of whether a Futures transaction is for hedging or for speculation hinges on whether there already exists a related commercial position which is exposed to risk of loss due to price fluctuation. Hedging can be taken to be genuine only to the extent the total of such transactions does not exceed the ready stock.
(ii) In the case of pure speculator, as distinguished from a hedger, futures transaction is a business by itself, as he has no off-setting commercial position. The assessee would bear the onus to prove that the forward contract of purchase entered into by it was to safeguard it against the loss through future price fluctuations in respect of any specific contracts of sale for actual delivery of shares.
(iii) The basic material required to identify hedge would be as under:-
(a) Details of original position and details of delivery and payment for original position.
(b) Details of the hedging transaction
(c) Details of the final settlement of the transaction. Analysis of assessee’s arguments and conclusion:
In view of the principles which emerge from discussion of the above judicial precedents, it is clear that the onus is on the assessee to prove that the transaction is not speculative, and it is Shri Dinesh K. Mehta HUF a hedging transaction. In discharge of this onus, the assessee has also to prove that he has in his stock in trade shares which required to be hedged by taking position in the futures market. To do this, the assessee has to prove at least that the total value of his stock exceeds the money invested in purchase of Nifty Futures. However, in the case of the assessee, as can be seen from the Table on page No. 2 to 4 of this order, the position of inventory and the amount of money invested in purchase of Nifty Futures on that particular day do not bear required relation.”
5. The Assessing Officer thereafter examined the inventory position of the assessee on various dates on which the assessee entered into transaction of purchase of Nifty Futures. Wherever the value of purchases of Nifty Futures were more than the value of inventory, they were treated as speculative transactions. For example on 17.6.2004, the value of inventory was Rs. 38.18 lakhs. The value of Nifty purchases were Rs. 1.49 crores. The loss on this transaction of purchase of Nifty Futures on settlement was treated as speculation loss by the Assessing Officer and disallowed. On the above basis and analysis of transactions, the Assessing Officer arrived at a sum of Rs. 98,66,738/- as the loss on account of speculative transactions and this loss was not allowed as a deduction. In respect of the remaining loss the Assessing Officer found that the value of stock was more than the value of purchase of Nifty Futures and these transactions were accepted by the Assessing Officer as Hedging transactions and loss to that extent was allowed as deduction.
6. Before the first appellate authority, the assessee submitted that under the assessee submitted that under section 43(5) clause (d), which was introduced w.e.f. 1.4.2006, it has been specifically laid down that eligible transaction in respect of trading in derivatives are not to be regarded as speculative transaction. The assessee further submitted that the Mumbai Bench of the Tribunal in the case of CIT Vs. SSKI Investors Pvt. Ltd. had taken the view that the aforesaid amendment was clarificatory and was therefore applicable retrospectively. The assessee submitted before learned CIT (A) that in view of the aforesaid decision, loss in question cannot be considered as speculative loss and therefore assessee should be allowed to set off the said loss against business income. Learned CIT (A) accepted this submission of the assessee and directed the Assessing Officer to treat the loss in question as business loss and not speculative loss. Aggrieved by the aforesaid order of learned CIT(A), the revenue has raised ground No. 1 before the Tribunal.
7. At the time of hearing of this appeal, it was brought to our notice that Special Bench Kolkata in the case of Shree Capital Services Ltd., 121 ITD 498 (Kol) held that amendment referred to in the earlier para to section 43(5) is not clarificatory and therefore not retrospective in operation. In view of the aforesaid decision, the very same basis on which, learned CIT (A) allowed the claim of the assessee does not survive. Learned counsel for the assessee, however, submitted under Clause (b) to section 43(5) assessee’s transaction ought to be considered as a hedging transactions. In this regard, it was submitted by learned counsel for the assessee that clause (b) to section 43(5) does not lay down that the hedging transaction should be in the very same stock and shares held by the assessee as inventory or that the value of hedging transactions should be equal to or less than the value of inventory held by the assessee as a dealer in shares. It was further submitted by him that in purchase of Nifty futures, or for that matter any form of derivative trading, it is not possible to link derivatives with any particular script as the underlying asset is basket of shares comprising of several companies.
It was further submitted that Circular of CBDT referred to by the Assessing Officer is applicable only in the context of commodities and not shares.
8. We have considered his submissions. Circular of CBDT dated 12.9.1960 gives a general guideline with regard to different kind of speculative transactions. Point No. 4 of the aforesaid Circular deals with hedging transaction in the case of dealer or investor in shares. The same is as follows :-
It is in the form of question and answer) Point No. (iv) : Bonafide hedging transactions by a dealer or investor in shares should be allowed provided that the hedging transactions are up to the amount of his holdings even though these transactions may extend to other types of shares not held by him. Board’s decision : the Board are unable to accept this suggestion. It cannot be accepted that a dealer or investor in stocks or shares can enter into hedging transactions in script outside his holdings. The material words in clause (c) of the proviso to Explanation 2 to section 24(1) are `to guard against less in his holdings of stock and shares through price fluctuations’. Therefore, hedging transactions having reasonable relations to the value and volume of the dealer’s or the investor’s holdings are excepted from the ambit of speculative transactions, but transactions in script outside his holdings are not. It is thus clear that the value and volume of a dealer or investor holding hedging transactions should be in equal proportion and hedging transactions can never be in excess. It is further a condition that hedging transaction should be in respect of very same script held by an assessee as inventory in the business of stocks and shares. In the present case, the Assessing Officer has not gone by script-wise tally but has gone by value of overall inventory. To this extent, the Assessing Officer has been very reasonable. We therefore hold that Circular was very much relevant and applicable in the case of the assessee.
9. We are also of the view that under clause (b) of section 43(5), the assessee in the garb of entering hedging transaction cannot seek to enter into speculative transaction in any stocks or shares other than by one held by him as inventory in the business of dealing in stocks and shares.
Value of hedging transactions cannot also be more than such inventory. If arguments sought to be canvassed by the assessee is accepted, then it will lead to a situation where all speculative transactions will be claimed as hedging transactions and very purpose behind the provisions of section 73 of the Act not permitting set off of speculative loss against business income will become redundant. There is no doubt truth in the plea of the assessee that Nifty futures and index futures are the only available form of derivatives trading through which the assessee could hedge the value of inventory held by him. In such trading there cannot be any identification of shares and tally the same with the inventory of shares held. This aspect has been taken care by the Introduction of clause (d) of section 43(5) of the Act; therefore, from A.Y. 2006-07, the assessee may not face this difficulty. But in A.Y. 2005-06 as per the law as it stands, the claim of the assessee cannot be accepted. We therefore reverse the order of CIT(A) and restore the order of the Assessing Officer on this issue.
10. Learned counsel for the assessee, however, submitted that the Board Circular itself says that only excess of the assessee’s position in forward market over actual stock held in ready market should be considered as speculative. For e.g. on 17.6.2004, the inventory of stock held by the assessee was Rs. 36.18 lakhs and purchases in Nifty Futures was Rs. 1.49 crores. In Nifty Futures purchase if the assessee incurs loss on the settlement day, the loss proportionate to the value of inventory i.e. Rs. 36.18 lakhs should not be considered as speculative loss. To that extent, the loss should be considered as hedging transaction. We have already observed that the shares held as inventory and the shares in which hedging transactions are entered into should be the same. The Assessing Officer has however gone by overall value of inventory without individual script wise tally. The plea of the assessee that to the extent of the value of inventory held by the Assessee on a particular day, the loss in purchase of Nifty Futures should not be considered as speculative while working out the loss is an acceptable plea. To this extent, plea of the assessee is accepted and the Assessing Officer is directed to work out speculation loss by taking excess of the assessee’s position in forward market over actual stock in ready market and work out the speculative loss proportionately. Thus, Ground No. 1 of the revenue is partly allowed.
11. Ground No. 2 raised by the revenue reads as follows :-
On the facts and circumstances of the case and in law, learned CIT(A) was justified in reversing the action of the Assessing Officer of treatment of the short term capital gains of Rs. 16,02,739/- as income under the head `profits and gains from business and profession’.
12. The assessee declared short term capital gains of Rs. 16,02,739/-The Assessing Officer was of the view that since, the assessee was dealer in shares and was having huge volume of share transactions in such business, it was hard to believe that the assessee held shares as investment also, the Assessing Officer therefore treated the short term capital gain declared by the assessee also as income from business.
13. On appeal by the assessee, learned CIT(A) held that gain in question was capital gain and not business income for the following reasons :-
“I have carefully considered the submissions made for the appellant and the assessment order. It is true that when a dealer in shares holds shares, the first presumption would be that the shares held by him constitute stock in trade. But, at the same time, it is not impossible that there cannot be a situation in which the assessee, who is dealer in shares also hold some shares as investment. This proposition is supported by the decision of Mumbai Tribunal in the case of J.M. Share and Stock Brokers Ltd., relied by the appellant. As such, I am not inclined to accept the Assessing Officer’s line of reasoning that a dealer in shares cannot hold shares as investments. In fact, the very decision relied by the Assessing Officer in Motilal Oswal has been reversed by the same Tribunal on rehearing. The fresh decision on rehearing supports the appellant’s case. An assessee who is a dealer in shares can also hold shares in investment portfolio by demarcating the same in his books of accounts has also been upheld by the Delhi Tribunal in the case of Arjun Kapur Vs. DCIT, 70 ITD 161 (Del) and the Chandigarh Tribunal in Vesta Investments & Trading Co. P. Ltd. Vs. CIT, 70 ITD 200 (Chd). The onus will be of course on the assessee to show that the shares have been correctly so held as investments notwithstanding the fact that he is a trader in shares. In my view, the manner in which the assessee holds the shares will determine whether the shares are investment or stock in trade. Generally, if the volume and frequency in dealing in shares is large, the period of holding is low, the conduct of the assessee should point towards that of a trader. If this also coupled with the use of borrowed capital the Shri Dinesh K. Mehta HUF presumption in favor of trading would be strengthened. The manner in which the transactions are accounted whether a trading transaction or as investment would also be a relevant indicator as this would manifest the intention of the assessee in dealing with the shares. The role of the assessee as an investor should be more passive in comparison to that of a dealer, whose role would be aggressive. The words `passive’ means that the role of the investor would be less in frequency and volume, more use of own capital and larger period of holding. In short, it is the conduct of the assessee that should be the determining factor. In the assessee’s case, its allocation of shares as stock in trade and investment appears to be justified by its manner in dealing with the shares. Whereas the shares involved in high frequency in dealing large volumes etc. have been treated as stock in trade, the ones in which the period of holding is larger and volume of holding is small has been demarcated as investments. This method of accounting has been followed consistently by the assessee and this lends credibility to the assessee’s allocation of shares as investments and stock in trade. The Supreme Court in its decision in the case of Karam Chand Thapar Bros. P. Ltd. Vs. CIT, 82 ITR 899 (sc) has observed that the circumstances that the assessee has shown particular shares in its books as well as balance sheet as investments is a relevant factor in deciding whether the shares are investment or stock in trade. The assessee has reasonably discharged its onus of showing that it is in dual role of both investor and dealers of shares by cogent evidence and reasoning. The Assessing Officer is therefore directed to treat the income of Rs. 16,02,739/- as income from short term capital gains and not as business income. This ground of appeal is allowed.
14. Before us, learned DR relied on the order of the Assessing Officer.
15. We are of the view that the order of learned CIT(A) does not call for any interference. Admittedly, the assessee had treated the shares in question as investment in his books of accounts. In fact, in A.Y. 2004- 05, the assessee had declared short term capital gain on sale of investments (shares held as investment) the same was accepted by the Assessing Officer in assessment u/s. 143(3) of the Act. The Hon’ble Bombay High Court in the case of CIT Vs. Gopal Purohit, ITA No. 1121 of 2009 dated 6.1.2010 has held that ruling of consistency should apply when the facts are identical. In view of the acceptance of the assessee’s stand by the revenue in the past and other circumstances considered by the learned CIT(A), we see no reason why a different treatment should be Shri Dinesh K. Mehta HUF given in the present assessment year. For the reasons given above, we uphold the order of learned CIT(A) and dismiss Ground No. 2 raised by the revenue.
16. In the result, appeal by the revenue is partly allowed.