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BOMBAY CHARTERED ACCOUNTANTS SOCIETY ON 8 TH SEPTEMBER 2004 AT WALCHAND HIRACHAND HALL, IMC MUMBAI

DERIVATIVES & SPECULATIVE TRANSACTIONS – TAX ASPECTS. BOMBAY CHARTERED ACCOUNTANTS SOCIETY ON 8 TH SEPTEMBER 2004 AT WALCHAND HIRACHAND HALL, IMC MUMBAI. Happenings. Indian Derivatives in Hongkong Ex- RBI Governor-Mr. Bimal Jalan Volume on the Bourses

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BOMBAY CHARTERED ACCOUNTANTS SOCIETY ON 8 TH SEPTEMBER 2004 AT WALCHAND HIRACHAND HALL, IMC MUMBAI

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  1. DERIVATIVES & SPECULATIVE TRANSACTIONS – TAX ASPECTS BOMBAY CHARTERED ACCOUNTANTS SOCIETY ON 8TH SEPTEMBER 2004 AT WALCHAND HIRACHAND HALL, IMC MUMBAI Pradip Kapasi & Co. Chartered Accountants

  2. 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 Pradip Kapasi & Co. Chartered Accountants

  3. 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. Pradip Kapasi & Co. Chartered Accountants

  4. 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 Pradip Kapasi & Co. Chartered Accountants

  5. Instruments & Players • Financial Instruments • Index Futures & Options • Stock Futures & Options • Market Players • Speculators-Day and Position Players • Hedgers • Arbitrageurs Pradip Kapasi & Co. Chartered Accountants

  6. 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 Pradip Kapasi & Co. Chartered Accountants

  7. F & O • Futures-An improvement over Forwards • Options • Option & advance • Call & Put • American & European Pradip Kapasi & Co. Chartered Accountants

  8. Futures v. Options • Dimensions • Rate of Interest as a consideration • Pricing Process • Exposure • Initial Cost • Degree of Risk of the parties Pradip Kapasi & Co. Chartered Accountants

  9. 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 Pradip Kapasi & Co. Chartered Accountants

  10. 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 Costs Pradip Kapasi & Co. Chartered Accountants

  11. 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 Futures-Options- September 2003, ICAIJ • IAS 39 & IAS 32 • FAS 133 • AS 11, AS 13 & AS 16 Pradip Kapasi & Co. Chartered Accountants

  12. TAXATION Pradip Kapasi & Co. Chartered Accountants

  13. 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 Pradip Kapasi & Co. Chartered Accountants

  14. 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 Pradip Kapasi & Co. Chartered Accountants

  15. 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 Pradip Kapasi & Co. Chartered Accountants

  16. 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) Pradip Kapasi & Co. Chartered Accountants

  17. Business Income • Allowance of Provision • Book Profit & Provision for Losses • Mark to Market and accrual • Method of Accounting • Transaction Cost • Valuation of Stock and Fair value accounting Pradip Kapasi & Co. Chartered Accountants

  18. 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 Pradip Kapasi & Co. Chartered Accountants

  19. 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 Pradip Kapasi & Co. Chartered Accountants

  20. Audit • No Special provisions • Regulatory Requirements • Income Tax Act • Value or Difference • Gross or Net Pradip Kapasi & Co. Chartered Accountants

  21. SPECULATIVE TRANSACTIONS Pradip Kapasi & Co. Chartered Accountants

  22. Speculation Business • Speculative transaction – S.43(5) • Explanation 2 to S.48 • Speculation Loss – S.73 • Explanation to S.73 Pradip Kapasi & Co. Chartered Accountants

  23. 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 Pradip Kapasi & Co. Chartered Accountants

  24. 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.) Pradip Kapasi & Co. Chartered Accountants

  25. 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 Pradip Kapasi & Co. Chartered Accountants

  26. 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 Pradip Kapasi & Co. Chartered Accountants

  27. 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 Pradip Kapasi & Co. Chartered Accountants

  28. 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) Pradip Kapasi & Co. Chartered Accountants

  29. 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 • No delivery • Ramalinga Choodambigal 239 ITR 120 (Mad.) Pradip Kapasi & Co. Chartered Accountants

  30. 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) Pradip Kapasi & Co. Chartered Accountants

  31. 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) Pradip Kapasi & Co. Chartered Accountants

  32. 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) Pradip Kapasi & Co. Chartered Accountants

  33. Arbitrage • Nature of Operations • Whether business • Whether speculation business Pradip Kapasi & Co. Chartered Accountants

  34. Tax Audit • Applicability • Growmore Exports Ltd., 78 ITD 95 (Mum) • Gross or Net Pradip Kapasi & Co. Chartered Accountants

  35. 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) Pradip Kapasi & Co. Chartered Accountants

  36. 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.) Pradip Kapasi & Co. Chartered Accountants

  37. Lending /Banking company EE-III • Exception to general rule • Parameters • Overriding . 43(5) • C.N.M.P. Inv. (P) Ltd., 78 ITD 297 (Del) Pradip Kapasi & Co. Chartered Accountants

  38. GTI ‘mainly’ from EE-IV • Criteria for determination • Relevance of other years • Amrutlal & Co., 212 ITR 540 (Bom) Pradip Kapasi & Co. Chartered Accountants

  39. 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 (-) Pradip Kapasi & Co. Chartered Accountants

  40. Share business - only business EE -VI • Part to include whole • Arvind Investments Ltd., 192 ITR 365 (Cal) Pradip Kapasi & Co. Chartered Accountants

  41. 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 Pradip Kapasi & Co. Chartered Accountants

  42. 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) Pradip Kapasi & Co. Chartered Accountants

  43. 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 Pradip Kapasi & Co. Chartered Accountants

  44. Expl. and Derivatives EE - X • Not a ‘share’ • Apollo Tyres, 255 ITR 273 (SC) • S. 43(5) does not apply Pradip Kapasi & Co. Chartered Accountants

  45. 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.) Pradip Kapasi & Co. Chartered Accountants

  46. Units and Other Sec. EE - XII • Application to shares only • Apollo Tyres, 255 ITR 273 (SC) Pradip Kapasi & Co. Chartered Accountants

  47. 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) Pradip Kapasi & Co. Chartered Accountants

  48. THANK YOU AND GOOD LUCK Pradip Kapasi & Co. Chartered Accountants

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