BOMBAY CHARTERED ACCOUNTANTS SOCIETY ON 8 TH SEPTEMBER 2004 AT

Pradip Kapasi & Co. Chartered Accountants

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BOMBAY CHARTERED ACCOUNTANTS SOCIETYBOMBAY CHARTERED ACCOUNTANTS SOCIETY

ONON

88THTH SEPTEMBER 2004 SEPTEMBER 2004

ATAT

WALCHAND HIRACHAND HALL, IMC MUMBAIWALCHAND HIRACHAND HALL, IMC MUMBAI

DERIVATIVES &DERIVATIVES &SPECULATIVE TRANSACTIONS SPECULATIVE TRANSACTIONS – – TAX ASPECTSTAX ASPECTS


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HappeningsHappenings

• Indian Derivatives in HongkongIndian Derivatives in Hongkong• Ex- RBI Governor-Mr. Bimal JalanEx- RBI Governor-Mr. Bimal Jalan• Volume on the BoursesVolume on the Bourses

• Warren Buffet-www.berkshirehathaway.comWarren Buffet-www.berkshirehathaway.com• Barring Bank-Nick LeesonBarring Bank-Nick Leeson• Infosys-9Infosys-9thth April, 2003 April, 2003


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DefinitionsDefinitions

A Derivative is:A Derivative is:• an instrument whose value is derived from the an instrument whose value is derived from the

value of one or more underlying assets like value of one or more underlying assets like commodities, currency, securities, index, etc. commodities, currency, securities, index, etc.

• a financial product which is derived from another a financial product which is derived from another financial product or commodity. financial product or commodity.

• a term having its origin in mathematics, which a term having its origin in mathematics, which refers to a variable which has been derived from refers to a variable which has been derived from another variable.another variable.


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Features & FunctionsFeatures & Functions

• FeaturesFeatures Independent ExistenceIndependent Existence Dynamic in natureDynamic in nature Zero value at inceptionZero value at inception Promise for performancePromise for performance LeverageLeverage Cash settled Cash settled

• FunctionsFunctions Transfer of riskTransfer of risk Price discoveryPrice discovery Market completionMarket completion


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Instruments & PlayersInstruments & Players

• Financial InstrumentsFinancial Instruments Index Futures & OptionsIndex Futures & Options Stock Futures & OptionsStock Futures & Options

• Market PlayersMarket Players Speculators-Day and Position PlayersSpeculators-Day and Position Players HedgersHedgers ArbitrageursArbitrageurs


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Legal FrameworkLegal Framework

• History and Need History and Need

• SCRASCRA

• Wagering ContractsWagering Contracts

• Dr. L. C. Gupta Comm.-Regulatory FrameworkDr. L. C. Gupta Comm.-Regulatory Framework

• J. R. Varma Committee-Containment of RiskJ. R. Varma Committee-Containment of Risk

• SEBI, BSE and NSESEBI, BSE and NSE


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F & OF & O

• Futures-An improvement over ForwardsFutures-An improvement over Forwards• OptionsOptions

Option & advance Option & advance Call & PutCall & Put American & EuropeanAmerican & European


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Futures Futures v.v. Options Options

• DimensionsDimensions• Rate of Interest as a considerationRate of Interest as a consideration• Pricing ProcessPricing Process• ExposureExposure• Initial CostInitial Cost• Degree of Risk of the partiesDegree of Risk of the parties


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Trading MechanismTrading Mechanism

• Trading commenced in June 2000Trading commenced in June 2000• SEBI authorized ExchangesSEBI authorized Exchanges• Clearing House-Counter partyClearing House-Counter party• Derivative segmentDerivative segment• Clearing and Trading MemberClearing and Trading Member• Financial guaranteeFinancial guarantee• Deposit and MarginsDeposit and Margins• Index and Stocks-Options & FuturesIndex and Stocks-Options & Futures


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Exchange OperationsExchange Operations

• S & P CNX NIFTY and BSE SENSEXS & P CNX NIFTY and BSE SENSEX• Standardized ContractsStandardized Contracts• Trading Units & Minimum valueTrading Units & Minimum value• Screen based tradingScreen based trading• Three months cycleThree months cycle• Settlement Date-Last ThursdaySettlement Date-Last Thursday• Initial margin-Determination-Cash equivalent Initial margin-Determination-Cash equivalent • Mark to Market-Daily MarginsMark to Market-Daily Margins• Cash settlement onlyCash settlement only• Range of Strike Price determinationRange of Strike Price determination• Transaction CostsTransaction Costs


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Accounting GuidelinesAccounting Guidelines

• Guidance Notes of ICAIGuidance Notes of ICAI Accounting for Equity Index Futures-December 2000Accounting for Equity Index Futures-December 2000 Accounting for Equity Index Options-June 2002Accounting for Equity Index Options-June 2002 Accounting for Equity Stock Options-June 2002Accounting for Equity Stock Options-June 2002 Accounting for Equity Index stock/stock Futures-Options- Accounting for Equity Index stock/stock Futures-Options-

September 2003, ICAIJ September 2003, ICAIJ

• IAS 39 & IAS 32IAS 39 & IAS 32• FAS 133FAS 133• AS 11, AS 13 & AS 16AS 11, AS 13 & AS 16


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TAXATIONTAXATION


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GeneralGeneral

• Whether an asset-Security under SCRAWhether an asset-Security under SCRA

• Whether ind. asset-Cash settled, Rights, Warrants Whether ind. asset-Cash settled, Rights, Warrants

• Whether a cap. asset-S. 2(14)- Property with valueWhether a cap. asset-S. 2(14)- Property with value

• Head of Income-Relevant factorsHead of Income-Relevant factors

• Likely concession for commoditiesLikely concession for commodities


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Business IncomeBusiness Income

• Whether Speculation Business Whether Speculation Business • Applicability of Explanation to S. 73Applicability of Explanation to S. 73• Treatment of provision for lossesTreatment of provision for losses• Book ProfitBook Profit• Effect of daily settlementEffect of daily settlement• Method of AccountingMethod of Accounting• Transaction CostTransaction Cost• Valuation at the year endValuation at the year end• Time of accrual of premium for writerTime of accrual of premium for writer


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Speculative TransactionSpeculative Transaction• S. 43(5)- S. 43(5)- “Speculative transaction” “Speculative transaction” means a transaction in which a contract for the means a transaction in which a contract for the

purchase or sale of any purchase or sale of any commodity, including stocks and sharescommodity, including stocks and shares is periodically or is periodically or ultimately settled otherwise than by the ultimately settled otherwise than by the actual deliveryactual delivery or transfer of the commodity or or transfer of the commodity or scrips:scrips:

Provided that for the purposes of this clause -Provided that for the purposes of this clause -

(a) A contract in respect of (a) A contract in respect of raw materials or merchandiseraw materials or merchandise entered into by a person in entered into by a person in the course of his manufacturing or merchanting business to guard against loss through the course of his manufacturing or merchanting business to guard against loss through future price fluctuations in respect of his future price fluctuations in respect of his contracts for actual deliverycontracts for actual delivery of goods of goods manufactured by him or merchandise sold by him ; ormanufactured 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 (b) A contract in respect of stock and shares entered into by a dealer or investor therein to guard against loss in his to guard against loss in his holdingsholdings of stocks and shares through price fluctuations; or of stocks and shares through price fluctuations; or

(c) A contract entered into by (c) A contract entered into by a membera member of a forward market or a stock exchange in the of a forward market or a stock exchange in the course of any transaction in the nature of course of any transaction in the nature of jobbing or arbitragejobbing or arbitrage to guard against loss to guard against loss which may in the ordinary course of his business as such member;which may in the ordinary course of his business as such member;

Shall not be deemed to be a speculative transaction Shall not be deemed to be a speculative transaction


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Speculation BusinessSpeculation Business

• Speculative Transaction – S.43(5)Speculative Transaction – S.43(5)• S.2(h) of SCRAS.2(h) of SCRA• Shares & StocksShares & Stocks

S. 2(46) of Companies ActS. 2(46) of Companies Act

• CommodityCommodity Nirmal Trading Co. 82 ITR 382 (Cal)Nirmal Trading Co. 82 ITR 382 (Cal) Compound Financials, 67 ITD 304 (Bang.)Compound Financials, 67 ITD 304 (Bang.) ANZ Grindlays Bank, 88 ITD 53 (Del)ANZ Grindlays Bank, 88 ITD 53 (Del)

• Actual Delivery- Actual Delivery- Lex non cogit ad impossibiliaLex non cogit ad impossibilia• Difficulties in applying Exceptions Difficulties in applying Exceptions • Explanation to S.73Explanation to S.73

Apollo Tyres, 255 ITR 273 (SC)Apollo Tyres, 255 ITR 273 (SC)


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Business IncomeBusiness Income

• Allowance of ProvisionAllowance of Provision

• Book Profit & Provision for LossesBook Profit & Provision for Losses

• Mark to Market and accrualMark to Market and accrual

• Method of AccountingMethod of Accounting

• Transaction CostTransaction Cost

• Valuation of Stock and Fair value accountingValuation of Stock and Fair value accounting


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Capital Gains-GeneralCapital Gains-General

• Underlying AssumptionsUnderlying Assumptions Right an assetRight an asset Fictional purchase & saleFictional purchase & sale Merges with a larger assetMerges with a larger asset

• SituationsSituations Cash settled Cash settled Hedging Hedging Delivery settledDelivery settled

• Short-Term Capital AssetShort-Term Capital Asset• Lapse of contractLapse of contract


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Capital Gains-SpecificCapital Gains-Specific

• Future Contracts-Buyer SpecificFuture Contracts-Buyer Specific• Future Contracts-Seller SpecificFuture Contracts-Seller Specific• Call Options-Buyer SpecificCall Options-Buyer Specific• Call Options-Seller SpecificCall Options-Seller Specific• Put Options-Buyer SpecificPut Options-Buyer Specific• Put Options-Seller SpecificPut Options-Seller Specific


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Audit Audit

• No Special provisionsNo Special provisions

• Regulatory RequirementsRegulatory Requirements

• Income Tax ActIncome Tax Act Value or DifferenceValue or Difference Gross or NetGross or Net


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SPECULATIVE TRANSACTIONSSPECULATIVE TRANSACTIONS


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Speculation Business Speculation Business

• Speculative transaction – S.43(5)Speculative transaction – S.43(5)

• Explanation 2 to S.48Explanation 2 to S.48

• Speculation Loss – S.73Speculation Loss – S.73

• Explanation to S.73Explanation to S.73


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Speculative Transaction –s 43(5) Speculative Transaction –s 43(5)

• Contract for sale or purchaseContract for sale or purchase• Any commodity including stock & sharesAny commodity including stock & shares• Periodical settlementPeriodical settlement• Without actual delivery or transferWithout actual delivery or transfer• ExceptionsExceptions

Hedging – to guard loss on price fluctuationsHedging – to guard loss on price fluctuations Dealer or InvestorDealer or Investor

Jobbing or arbitrageJobbing or arbitrage Member of a Forward market or ExchangeMember of a Forward market or Exchange


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Explanation 2 to S.28 Explanation 2 to S.28

• ‘ ‘Speculation transactions’ - ‘business’Speculation transactions’ - ‘business’

• Distinct and separate businessDistinct and separate business

• Separate computation for I T ActSeparate computation for I T Act R. Chinnaswamy Chettiar, 96 ITR 353 (Mad.)R. Chinnaswamy Chettiar, 96 ITR 353 (Mad.)


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Speculation Business Loss Speculation Business Loss

• Restriction on set-offRestriction on set-off Jaggannath Mahadeo Prasad, 71 ITR 296 (SC)Jaggannath Mahadeo Prasad, 71 ITR 296 (SC)

• Profit of Speculation Business onlyProfit of Speculation Business only• Any such businessAny such business• Priority of set-off–Cir. No. 23 dt. 12.9.1960 - 72(2)Priority of set-off–Cir. No. 23 dt. 12.9.1960 - 72(2)• Application to loss as also profitApplication to loss as also profit

Samba Trading & Invts. 58 TTJ 360(Mum)Samba Trading & Invts. 58 TTJ 360(Mum)

• Carry forwardCarry forward• Period of 8 succeeding yearsPeriod of 8 succeeding years• By – legal heirs By – legal heirs


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Deeming Fiction – Expl. to S.73 Deeming Fiction – Expl. to S.73

• Company assesseesCompany assessees All companiesAll companies SharesShares Purchase and SalePurchase and Sale

• Deemed Speculation BusinessDeemed Speculation Business• Exceptions Exceptions

GTI mainly from specified headsGTI mainly from specified heads Banking CompanyBanking Company Loans & Advances Company Loans & Advances Company


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Hedging - I Hedging - I

• RequirementsRequirements Two contractsTwo contracts Commodities and scripsCommodities and scrips Holdings & Contract of deliveryHoldings & Contract of delivery Guard against price fluctuationsGuard against price fluctuations

• Purchase- Also salePurchase- Also sale• Different quality-quantity and valueDifferent quality-quantity and value

Cir. No. 23D dt. 12.9.1960Cir. No. 23D dt. 12.9.1960

• Different scripsDifferent scrips Circular 23DCircular 23D Index F & OIndex F & O


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Hedging - II Hedging - II

• Burden of proofBurden of proof Joseph John, 67 ITR 74 (SC)Joseph John, 67 ITR 74 (SC)

• Co-relation necessaryCo-relation necessary Somasundaram Chettiar, 194 ITR 1 (SC)Somasundaram Chettiar, 194 ITR 1 (SC)

• Independent treatmentIndependent treatment Arjan Khimji & Co., 121 ITR 421 (Bom)Arjan Khimji & Co., 121 ITR 421 (Bom)

•


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DeliveryDelivery

• Relevance of intention, payment and deliveryRelevance of intention, payment and delivery Abdul Gani Haji, Habib, 72 ITR 6 (Cal.)Abdul Gani Haji, Habib, 72 ITR 6 (Cal.)

• Actual deliveryActual delivery Blank transfer formsBlank transfer forms

Mangal Chand Bhanwarlal, 255 ITR 329 (Raj)Mangal Chand Bhanwarlal, 255 ITR 329 (Raj) Delivery NotesDelivery Notes

Davenport & Co., 100 ITR 715 (SC)Davenport & Co., 100 ITR 715 (SC) Recalled deliveryRecalled delivery

Clayton Commercial, 67 ITD 118 (Del)Clayton Commercial, 67 ITD 118 (Del) Intended deliveryIntended delivery

Gandhi Bhandari & Co., 83 ITD 680 (Pune)Gandhi Bhandari & Co., 83 ITD 680 (Pune) Pending deliveyPending delivey

Sampath & Iyengar –Ninth Edn.Sampath & Iyengar –Ninth Edn. Judicial controversyJudicial controversy

No deliveryNo delivery Ramalinga Choodambigal 239 ITR 120 (Mad.)Ramalinga Choodambigal 239 ITR 120 (Mad.)


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Settlement Settlement

• Settlement without deliverySettlement without delivery S.63 of Indian Contract Act S.63 of Indian Contract Act

Shantilal (P) Ltd., 144 ITR 57(SC)Shantilal (P) Ltd., 144 ITR 57(SC)Kamani Tubes Ltd., 207 ITR 298 (Bom)Kamani Tubes Ltd., 207 ITR 298 (Bom)

• F/E Forward contractsF/E Forward contracts Guard against fluctuationGuard against fluctuation

Badridas Gauridu, 261 ITR 251 (Bom)Badridas Gauridu, 261 ITR 251 (Bom)• Loss in illegal contractLoss in illegal contract

S.C. Kothari, 82 ITR 794 (SC)S.C. Kothari, 82 ITR 794 (SC)

• Nature of deemed profit u/s. 41(1)Nature of deemed profit u/s. 41(1) Rajputana Trading Co. Ltd. 72 ITR 286 (SC)Rajputana Trading Co. Ltd. 72 ITR 286 (SC)


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Stray transactions Stray transactions

• Concerted activity and effortsConcerted activity and efforts• Treatment under the lawTreatment under the law

Casual Income Casual Income Other sourcesOther sources Capital GainsCapital Gains

• Plurality of transactionsPlurality of transactions Indian Commercial Co., 106 ITR 465 (Bom)Indian Commercial Co., 106 ITR 465 (Bom) G.P. Birla HUF, 199 ITR 173(Cal)G.P. Birla HUF, 199 ITR 173(Cal)


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Cum-dividend purchase and sale Cum-dividend purchase and sale

• Dividend and LossDividend and Loss• Effect of S.94(7) and (8)Effect of S.94(7) and (8)• Effect – ind. of statutory provisionsEffect – ind. of statutory provisions

Soma Textiles & Ind., 87 ITD 326 (Ahd)Soma Textiles & Ind., 87 ITD 326 (Ahd)


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Arbitrage Arbitrage

• Nature of OperationsNature of Operations• Whether businessWhether business• Whether speculation businessWhether speculation business


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Tax Audit Tax Audit

• Applicability Applicability Growmore Exports Ltd., 78 ITD 95 (Mum)Growmore Exports Ltd., 78 ITD 95 (Mum)

• Gross or Net Gross or Net


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Escaping the Explanation –EEEscaping the Explanation –EE Investment in Shares EE-I Investment in Shares EE-I

• Business of purchase and saleBusiness of purchase and sale• Relevant factorsRelevant factors• Investment IncomeInvestment Income

Mysore Rolling Mills, 105 ITR 405 (Karn)Mysore Rolling Mills, 105 ITR 405 (Karn) Venkateshwara Rice & Oil Mills, 154 ITR 756 (AP)Venkateshwara Rice & Oil Mills, 154 ITR 756 (AP) VIP Growth Fund Ltd., 95 Taxmann 13 (Delhi)VIP Growth Fund Ltd., 95 Taxmann 13 (Delhi) Kruti Marketing P. Ltd., 118 Taxman 194 (Ahd)Kruti Marketing P. Ltd., 118 Taxman 194 (Ahd)

• Investment by a dealer in shares/stock brokerInvestment by a dealer in shares/stock broker Kethankumar A.Shah 242ITR 83 (Ker.)Kethankumar A.Shah 242ITR 83 (Ker.)

• Relevance of books of accountRelevance of books of account Merfin (India) Ltd., 80 ITD 399 (Hyd)Merfin (India) Ltd., 80 ITD 399 (Hyd)


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Relevance of S.70 to S.72 EE-II Relevance of S.70 to S.72 EE-II

• Overriding effectOverriding effect RPG Industries Ltd., 85 ITD 105 (Kol)(TM)RPG Industries Ltd., 85 ITD 105 (Kol)(TM)

• Expl. Over S. 43(5)Expl. Over S. 43(5) C.N.M.P. Inv. (P) Ltd. 78 ITD 297(Del.) C.N.M.P. Inv. (P) Ltd. 78 ITD 297(Del.)


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Lending /Banking company EE-III Lending /Banking company EE-III

• Exception to general ruleException to general rule• ParametersParameters• Overriding . 43(5)Overriding . 43(5)

C.N.M.P. Inv. (P) Ltd., 78 ITD 297 (DelC.N.M.P. Inv. (P) Ltd., 78 ITD 297 (Del))


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GTI ‘mainly’ from EE-IVGTI ‘mainly’ from EE-IV

• Criteria for determinationCriteria for determination• Relevance of other yearsRelevance of other years

Amrutlal & Co., 212 ITR 540 (Bom)Amrutlal & Co., 212 ITR 540 (Bom)


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Composition of GTI EE-VComposition of GTI EE-V

• Mfg (+) Shares(-) O/I (+)Mfg (+) Shares(-) O/I (+) Associated capital markets, ITA No. 1103, 1104, Associated capital markets, ITA No. 1103, 1104,

3051/M/2001 dt.31.03.03 ‘G’ Bench3051/M/2001 dt.31.03.03 ‘G’ Bench Rajan Enterprises, 41 ITD 369(Bom.)Rajan Enterprises, 41 ITD 369(Bom.)

• Shares (-) O/I (+)Shares (-) O/I (+) Eastern Aviation Ind. 208 ITR 1023 (Cal)Eastern Aviation Ind. 208 ITR 1023 (Cal) Aryasthan Corp Ltd., 253 ITR 401 (Cal)Aryasthan Corp Ltd., 253 ITR 401 (Cal) Park View Properties Ltd. 261 ITR 473 (Cal.)Park View Properties Ltd. 261 ITR 473 (Cal.)

• Shares (-) O/I (-)Shares (-) O/I (-)


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Share business - only business EE -Share business - only business EE -VIVI

• Part to include wholePart to include whole Arvind Investments Ltd., 192 ITR 365 (Cal)Arvind Investments Ltd., 192 ITR 365 (Cal)


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In shares of 1 company EE -VIIIn shares of 1 company EE -VII

• Purchase & sale - shares of ‘companies’Purchase & sale - shares of ‘companies’• Plural to include singular - GCAPlural to include singular - GCA

Laxmi Feeds & Exports Ltd. 62 ITD 315(Mum)Laxmi Feeds & Exports Ltd. 62 ITD 315(Mum) Akrosh Inv. & Lea. (P) Ltd. 90 ITD 287(Mum)Akrosh Inv. & Lea. (P) Ltd. 90 ITD 287(Mum)

• IPO SubscriptionsIPO Subscriptions Sri Gopal Jalan & Co. AIR 1964 SC 250Sri Gopal Jalan & Co. AIR 1964 SC 250


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Losses of a stock broker EE -VIIILosses of a stock broker EE -VIII

• Business of purchase and sale of sharesBusiness of purchase and sale of shares• Representative capacityRepresentative capacity• Application of exception (c)Application of exception (c)

Shri Shrawankumar Agarwal, 249 ITR233(All.).Shri Shrawankumar Agarwal, 249 ITR233(All.).

• Same business testSame business test Pangal Vittal Nayak,74ITR754(SC)Pangal Vittal Nayak,74ITR754(SC) K.L.Jhunjhunwala, 139ITR371(Cal.)K.L.Jhunjhunwala, 139ITR371(Cal.) Nirmallkumar&Co. 161ITR413(Cal.)Nirmallkumar&Co. 161ITR413(Cal.)

• Losses of clients unpaidLosses of clients unpaid Shah Prataprai Nowpaji 139 ITR 149(AP)Shah Prataprai Nowpaji 139 ITR 149(AP)


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Business Expenditure EE - IX Business Expenditure EE - IX

• Effect on quantum of lossEffect on quantum of loss• Common expenditureCommon expenditure

Maharashtra Sugar Mils, 82 ITR 452 (SC)Maharashtra Sugar Mils, 82 ITR 452 (SC) Rajasthan Warehousing Co., 242 ITR 450 (SC)Rajasthan Warehousing Co., 242 ITR 450 (SC) Associated Capital Market Tdg & Inv.’s caseAssociated Capital Market Tdg & Inv.’s case Section 14ASection 14A


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Expl. and Derivatives EE - X Expl. and Derivatives EE - X

• Not a ‘share’Not a ‘share’ Apollo Tyres, 255 ITR 273 (SC)Apollo Tyres, 255 ITR 273 (SC)

• S. 43(5) does not applyS. 43(5) does not apply


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Loss on valuation of stock EE - XILoss on valuation of stock EE - XI

• Purchase and sale of sharePurchase and sale of share Associated Capital Market’s caseAssociated Capital Market’s case Nirvan Holding Pvt. Ltd., ITA No. 529/M/2001Nirvan Holding Pvt. Ltd., ITA No. 529/M/2001 Prudential Const Co. P. Ltd., 75 ITD 338 (Hyd)Prudential Const Co. P. Ltd., 75 ITD 338 (Hyd)

• Purchase and sale in different yearsPurchase and sale in different years Sun Dist. & Mining, 68 Taxman 223(Cal.)Sun Dist. & Mining, 68 Taxman 223(Cal.)


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Units and Other Sec. EE - XIIUnits and Other Sec. EE - XII

• Application to shares onlyApplication to shares only Apollo Tyres, 255 ITR 273 (SC)Apollo Tyres, 255 ITR 273 (SC)


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Objective behind Expl. EE - XIII Objective behind Expl. EE - XIII

• Losses by dealing in shares of group Losses by dealing in shares of group companiescompanies Cir. No. 204 (Para 19.2) dt. 24.07.1976, 110 ITR Cir. No. 204 (Para 19.2) dt. 24.07.1976, 110 ITR

32(St)32(St)


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THANK YOUTHANK YOU

AND AND

GOOD LUCKGOOD LUCK

BOMBAY CHARTERED ACCOUNTANTS SOCIETY ON 8 TH SEPTEMBER 2004 AT

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