ACIT vs. Dinesh K. Mehta HUF (ITAT Mumbai)

S. 43(5): Derivatives are speculative transactions if not for bona fide hedging

In respect of AY 2005-06, the assessee, a dealer in shares, entered into transaction of purchases of Nifty Futures, which being a derivative instrument, was settled by payment of differences and not actual delivery of shares. The assessee argued that the transactions were hedging transactions meant to minimize the loss due to fluctuation of price of shares held as stock-in-trade and could not be regarded as speculative transactions u/s 43(5) so as to disallow the loss from being set off against other income. The AO took the view that a derivatives transaction could be regarded as a hedging transaction u/s 43(5)(b) only to the extent of the inventory of shares held by the assessee and that the excess would be regarded as a speculative transaction. As, on the date the Nifty Futures were purchased, the inventory of shares held by the assessee was less that the value of the Futures, the loss was treated as a speculation loss. The CIT (A) allowed the appeal on the ground that the s. 43(5)(d) inserted by FA 2005 w.e.f. 1.4.2006 (which provides that derivatives are not speculation transactions) was clarificatory). On appeal by the Revenue, HELD reversing the CIT (A):

(i) In Shree Capital Services 121 ITD 498 (Kol) it has been held by the Special Bench that the amendment to s. 43(5)(d) is neither clarificatory nor retrospective in operation. Consequently, derivatives can be considered non-speculative u/s 43(5)(b) only to the extent they are for hedging purposes;

(ii) The argument of the assessee that to constitute a hedging transaction u/s 43(5)(b), a transaction need not be in the same 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 is not acceptable. Circular No. 23D dated 12-9-1960 makes it clear that bona fide hedging transactions shall not be regarded as speculative provided that the hedging transactions are up to the amount of his holdings and confined to shares in his holding. The value and volume of hedging transactions should be in equal proportion and the hedging transaction should be in respect of the same scripts held by the assessee;

(iii) If the arguments of the assessee are accepted, it will lead to a situation where all speculative transactions will be claimed as hedging transactions and the purpose behind s. 73 of not permitting set off of speculative loss against business income will become redundant. The fact that in Nifty futures and index futures there cannot be any identification of shares does not change the position in law till the insertion of s. 43(5)(d);

(iv) As the AO has gone by the overall value of inventory without individual script wise tally (though required to be done), the plea of the assessee that the loss in purchase of Nifty Futures should not be considered as speculative to the extent of the value of inventory held by the Assessee on a particular day is acceptable.