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Transcript
DERIVATIVES &
SPECULATIVE TRANSACTIONS
– TAX ASPECTS
BOMBAY CHARTERED ACCOUNTANTS SOCIETY
ON
8TH SEPTEMBER 2004
AT
WALCHAND HIRACHAND HALL, IMC MUMBAI
Pradip Kapasi & Co.
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1
Happenings
• Indian Derivatives in Hongkong
• Ex- RBI Governor-Mr. Bimal Jalan
• Volume on the Bourses
• Warren Buffet-www.berkshirehathaway.com
• Barring Bank-Nick Leeson
• Infosys-9th April, 2003
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2
Definitions
A Derivative is:
• an instrument whose value is derived from the
value of one or more underlying assets like
commodities, currency, securities, index, etc.
• a financial product which is derived from
another financial product or commodity.
• a term having its origin in mathematics, which
refers to a variable which has been derived
from another variable.
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Features & Functions
• Features






Independent Existence
Dynamic in nature
Zero value at inception
Promise for performance
Leverage
Cash settled
• Functions
 Transfer of risk
 Price discovery
 Market completion
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Instruments & Players
• Financial Instruments
 Index Futures & Options
 Stock Futures & Options
• Market Players
 Speculators-Day and Position Players
 Hedgers
 Arbitrageurs
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Legal Framework
• History and Need
• SCRA
• Wagering Contracts
• Dr. L. C. Gupta Comm.-Regulatory Framework
• J. R. Varma Committee-Containment of Risk
• SEBI, BSE and NSE
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F&O
• Futures-An improvement over Forwards
• Options
 Option & advance
 Call & Put
 American & European
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Futures
•
•
•
•
•
•
v.
Options
Dimensions
Rate of Interest as a consideration
Pricing Process
Exposure
Initial Cost
Degree of Risk of the parties
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Trading Mechanism
•
•
•
•
•
•
•
•
Trading commenced in June 2000
SEBI authorized Exchanges
Clearing House-Counter party
Derivative segment
Clearing and Trading Member
Financial guarantee
Deposit and Margins
Index and Stocks-Options & Futures
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Exchange Operations
•
•
•
•
•
•
•
•
•
•
•
S & P CNX NIFTY and BSE SENSEX
Standardized Contracts
Trading Units & Minimum value
Screen based trading
Three months cycle
Settlement Date-Last Thursday
Initial margin-Determination-Cash equivalent
Mark to Market-Daily Margins
Cash settlement only
Range of Strike Price determination
Transaction CostsPradip Kapasi & Co.
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Accounting Guidelines
• Guidance Notes of ICAI
Accounting for Equity Index Futures-December 2000
 Accounting for Equity Index Options-June 2002
 Accounting for Equity Stock Options-June 2002
 Accounting for Equity Index stock/stock FuturesOptionsSeptember 2003, ICAIJ

• IAS 39 & IAS 32
• FAS 133
• AS 11, AS 13 & AS 16
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11
TAXATION
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General
• Whether an asset-Security under SCRA
• Whether ind. asset-Cash settled, Rights, Warrants
• Whether a cap. asset-S. 2(14)- Property with value
• Head of Income-Relevant factors
• Likely concession for commodities
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Business Income
•
•
•
•
•
•
•
•
•
Whether Speculation Business
Applicability of Explanation to S. 73
Treatment of provision for losses
Book Profit
Effect of daily settlement
Method of Accounting
Transaction Cost
Valuation at the year end
Time of accrual of premium for writer
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Speculative Transaction
•
S. 43(5)- “Speculative transaction” means a transaction in which a contract for
the purchase or sale of any commodity, including stocks and shares is
periodically or ultimately settled otherwise than by the actual delivery or
transfer of the commodity or scrips:
Provided that for the purposes of this clause (a) A contract in respect of raw materials or merchandise entered into by a
person in the course of his manufacturing or merchanting business to guard
against loss through future price fluctuations in respect of his contracts for
actual delivery of goods manufactured by him or merchandise sold by him ; or
(b) A contract in respect of stock and shares entered into by a dealer or investor
therein to guard against loss in his holdings of stocks and shares through price
fluctuations; or
(c) A contract entered into by a member of a forward market or a stock
exchange in the course of any transaction in the nature of jobbing or arbitrage to
guard against loss which may in the ordinary course of his business as such
member;
Shall not be deemed to be a speculative transaction
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Speculation Business
• Speculative Transaction – S.43(5)
• S.2(h) of SCRA
• Shares & Stocks
 S. 2(46) of Companies Act
• Commodity
 Nirmal Trading Co. 82 ITR 382 (Cal)
 Compound Financials, 67 ITD 304 (Bang.)
 ANZ Grindlays Bank, 88 ITD 53 (Del)
• Actual Delivery- Lex non cogit ad impossibilia
• Difficulties in applying Exceptions
• Explanation to S.73
 Apollo Tyres, 255 ITR 273 (SC)
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Business Income
• Allowance of Provision
• Book Profit & Provision for Losses
• Mark to Market and accrual
• Method of Accounting
• Transaction Cost
• Valuation of StockPradip
and
Fair value accounting
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Capital Gains-General
•
Underlying Assumptions
 Right an asset
 Fictional purchase & sale
 Merges with a larger asset
•
Situations
 Cash settled
 Hedging
 Delivery settled
• Short-Term Capital Asset
• Lapse of contract
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Capital Gains-Specific
•
•
•
•
•
•
Future Contracts-Buyer Specific
Future Contracts-Seller Specific
Call Options-Buyer Specific
Call Options-Seller Specific
Put Options-Buyer Specific
Put Options-Seller Specific
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Audit
• No Special provisions
• Regulatory Requirements
• Income Tax Act
 Value or Difference
 Gross or Net
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SPECULATIVE TRANSACTIONS
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Speculation Business
• Speculative transaction – S.43(5)
• Explanation 2 to S.48
• Speculation Loss – S.73
• Explanation to S.73
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Speculative Transaction –s 43(5)
•
•
•
•
•
Contract for sale or purchase
Any commodity including stock & shares
Periodical settlement
Without actual delivery or transfer
Exceptions
 Hedging – to guard loss on price fluctuations

Dealer or Investor
 Jobbing or arbitrage
 Member of a Forward market or Exchange
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Explanation 2 to S.28
• ‘Speculation transactions’ - ‘business’
• Distinct and separate business
• Separate computation for I T Act
 R. Chinnaswamy Chettiar, 96 ITR 353 (Mad.)
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Speculation Business Loss
• Restriction on set-off
•
•
•
•
 Jaggannath Mahadeo Prasad, 71 ITR 296 (SC)
Profit of Speculation Business only
Any such business
Priority of set-off–Cir. No. 23 dt. 12.9.1960 - 72(2)
Application to loss as also profit
 Samba Trading & Invts. 58 TTJ 360(Mum)
• Carry forward
• Period of 8 succeeding years
• By – legal heirs
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Deeming Fiction – Expl. to S.73
• Company assessees
 All companies
 Shares
 Purchase and Sale
• Deemed Speculation Business
• Exceptions
 GTI mainly from specified heads
 Banking Company
 Loans & Advances Company
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Hedging - I
•
Requirements




Two contracts
Commodities and scrips
Holdings & Contract of delivery
Guard against price fluctuations
• Purchase- Also sale
• Different quality-quantity and value
 Cir. No. 23D dt. 12.9.1960
• Different scrips
 Circular 23D
 Index F & O
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Hedging - II
• Burden of proof
 Joseph John, 67 ITR 74 (SC)
• Co-relation necessary
 Somasundaram Chettiar, 194 ITR 1 (SC)
• Independent treatment
 Arjan Khimji & Co., 121 ITR 421 (Bom)
•
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Delivery
•
•
Relevance of intention, payment and delivery
 Abdul Gani Haji, Habib, 72 ITR 6 (Cal.)
Actual delivery
 Blank transfer forms
 Mangal Chand Bhanwarlal, 255 ITR 329 (Raj)
 Delivery Notes
 Davenport & Co., 100 ITR 715 (SC)
 Recalled delivery
 Clayton Commercial, 67 ITD 118 (Del)
 Intended delivery
 Gandhi Bhandari & Co., 83 ITD 680 (Pune)
 Pending delivey
 Sampath & Iyengar –Ninth Edn.
 Judicial controversy
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 No delivery
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Settlement
• Settlement without delivery
 S.63 of Indian Contract Act
Shantilal (P) Ltd., 144 ITR 57(SC)
Kamani Tubes Ltd., 207 ITR 298 (Bom)
• F/E Forward contracts
 Guard against fluctuation
Badridas Gauridu, 261 ITR 251 (Bom)
• Loss in illegal contract
 S.C. Kothari, 82 ITR 794 (SC)
• Nature of deemed profit u/s. 41(1)
 Rajputana Trading Co. Ltd. 72 ITR 286 (SC)
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Stray transactions
• Concerted activity and efforts
• Treatment under the law
 Casual Income
 Other sources
 Capital Gains
• Plurality of transactions
 Indian Commercial Co., 106 ITR 465 (Bom)
 G.P. Birla HUF, 199 ITR 173(Cal)
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Cum-dividend purchase and sale
• Dividend and Loss
• Effect of S.94(7) and (8)
• Effect – ind. of statutory provisions
 Soma Textiles & Ind., 87 ITD 326 (Ahd)
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Arbitrage
• Nature of Operations
• Whether business
• Whether speculation business
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Tax Audit
• Applicability
 Growmore Exports Ltd., 78 ITD 95 (Mum)
• Gross or Net
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Escaping the Explanation –EE
Investment in Shares
EE-I
• Business of purchase and sale
• Relevant factors
• Investment Income




Mysore Rolling Mills, 105 ITR 405 (Karn)
Venkateshwara Rice & Oil Mills, 154 ITR 756 (AP)
VIP Growth Fund Ltd., 95 Taxmann 13 (Delhi)
Kruti Marketing P. Ltd., 118 Taxman 194 (Ahd)
• Investment by a dealer in shares/stock broker
 Kethankumar A.Shah 242ITR 83 (Ker.)
• Relevance of books of account
 Merfin (India) Ltd., 80 ITD 399 (Hyd)
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Relevance of S.70 to S.72 EE-II
• Overriding effect
 RPG Industries Ltd., 85 ITD 105 (Kol)(TM)
• Expl. Over S. 43(5)
 C.N.M.P. Inv. (P) Ltd. 78 ITD 297(Del.)
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Lending /Banking company EE-III
• Exception to general rule
• Parameters
• Overriding . 43(5)
 C.N.M.P. Inv. (P) Ltd., 78 ITD 297 (Del)
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GTI ‘mainly’ from
EE-IV
• Criteria for determination
• Relevance of other years
 Amrutlal & Co., 212 ITR 540 (Bom)
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Composition of GTI
EE-V
• Mfg (+) Shares(-) O/I (+)
 Associated capital markets, ITA No. 1103,
1104, 3051/M/2001 dt.31.03.03 ‘G’ Bench
 Rajan Enterprises, 41 ITD 369(Bom.)
• Shares (-) O/I (+)
 Eastern Aviation Ind. 208 ITR 1023 (Cal)
 Aryasthan Corp Ltd., 253 ITR 401 (Cal)
 Park View Properties Ltd. 261 ITR 473 (Cal.)
• Shares (-) O/I (-)
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Share business - only business
EE -VI
• Part to include whole
 Arvind Investments Ltd., 192 ITR 365 (Cal)
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In shares of 1 company EE -VII
• Purchase & sale - shares of ‘companies’
• Plural to include singular - GCA
 Laxmi Feeds & Exports Ltd. 62 ITD 315(Mum)
 Akrosh Inv. & Lea. (P) Ltd. 90 ITD 287(Mum)
• IPO Subscriptions
 Sri Gopal Jalan & Co. AIR 1964 SC 250
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Losses of a stock broker EE -VIII
• Business of purchase and sale of shares
• Representative capacity
• Application of exception (c)
 Shri Shrawankumar Agarwal, 249 ITR233(All.).
• Same business test
 Pangal Vittal Nayak,74ITR754(SC)
 K.L.Jhunjhunwala, 139ITR371(Cal.)
 Nirmallkumar&Co. 161ITR413(Cal.)
• Losses of clients unpaid
 Shah Prataprai Nowpaji 139 ITR 149(AP)
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Business Expenditure EE - IX
• Effect on quantum of loss
• Common expenditure
 Maharashtra Sugar Mils, 82 ITR 452 (SC)
 Rajasthan Warehousing Co., 242 ITR 450 (SC)
 Associated Capital Market Tdg & Inv.’s case
 Section 14A
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Expl. and Derivatives
EE - X
• Not a ‘share’
 Apollo Tyres, 255 ITR 273 (SC)
• S. 43(5) does not apply
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Loss on valuation of stock EE - XI
• Purchase and sale of share
 Associated Capital Market’s case
 Nirvan Holding Pvt. Ltd., ITA No. 529/M/2001
 Prudential Const Co. P. Ltd., 75 ITD 338 (Hyd)
• Purchase and sale in different years
 Sun Dist. & Mining, 68 Taxman 223(Cal.)
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Units and Other Sec.
EE - XII
• Application to shares only
 Apollo Tyres, 255 ITR 273 (SC)
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Objective behind Expl.
EE - XIII
• Losses by dealing in shares of group
companies
 Cir. No. 204 (Para 19.2) dt. 24.07.1976, 110
ITR 32(St)
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THANK YOU
AND
GOOD LUCK
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48