What are speculative transactions and what is their relevance under income-tax laws? The significance of speculative transactions is that losses of a speculation business cannot be set off against any other income.
The normal meaning of the term “speculation” would include all high-risk transactions, including purchase of investments with a view to profiting from price fluctuation. If these meanings were prevalent under our tax laws, almost all our investments in shares would be regarded as speculative transactions. Fortunately, the income-tax definition of speculative transaction is not very wide. It only covers transactions in shares or commodities that are squared up without delivery. For instance, if you buy and sell the shares on the same day, you would not get the delivery of the shares and, therefore, the purchase and sale transactions would be regarded as speculative transactions. Of course, for companies, all share trading transactions are deemed to be speculative transactions, irrespective of whether delivery is involved or not.
Also, there are exclusions from the definition of speculative transaction for hedging transactions and for security derivatives transactions carried out on recognized stock exchanges. These would, therefore, not be regarded as speculative transactions. Of course, commodity derivatives transactions settled without delivery would certainly be regarded as speculative transactions.
The important aspect to remember is that it is only losses of a speculation business which are prohibited from set off and not necessarily all losses from speculative transactions. If speculative transactions are such that they are in the nature of investment and not trading, then such losses are not prohibited from set off, though capital losses can only be set off against capital gains.
If the speculative transactions are part of a business and are in the nature of business transactions, speculative transactions are considered as constituting a separate business, though they may be an integral part of the business. For instance, the situation where you are carrying out arbitrage by buying and selling shares in the physical market without delivery and correspondingly selling and buying futures of the same shares. Though transactions in the physical and future segments are closely related to each other, transactions in the physical segment of buying and selling shares would be regarded as speculative transactions, whereas transactions in the futures segment would not be regarded as speculative transactions. The result is that loss in share transactions in the physical market would not be available for set off against the gains which may be made in respect of the corresponding futures in the same shares and you would, therefore, end up paying income-tax on the gains that you make in the futures market, though your real income is only the net gain after set off of the loss in the physical segment.
All the speculative transactions put together would be regarded as a separate business, though in fact they may not be part of the same business. For instance, you may carry on share day trading and also be carrying on trading in commodity derivatives. Though these are totally unrelated activities and may really be your separate businesses, for the purposes of set off, these would be regarded as one business. Therefore, any losses in share day-trading can be set off against commodity derivatives profit or vice-versa.
What is the logic behind prohibiting such set off of speculation losses against other income? These provisions were introduced decades ago, when it was easy to manipulate the market records and transfer losses from one person to another. In those days, people with substantial income could “purchase” such losses from people who had actually incurred them and who did not have much other income against which such losses could be set off by manipulation of the trading records. Nowadays, with electronic trading on the stock exchanges as the commodity exchanges and strict reporting requirements imposed by stock exchanges on brokers with regard to change of customer codes in transaction records, such manipulation is not possible. Therefore, the logic of such prohibition of set off of speculation losses no longer holds good. Since the issue of set off of speculation losses has been highly controversial and has resulted in substantial litigation, a large amount of litigation could be avoided by doing away with the provision.
Unfortunately, once a provision comes into our tax laws, one rarely finds a review of the provisions to see whether such provisions are still required under changed circumstances. More and more provisions are added, but deletion of provisions is rare. Moreover, though the Direct Taxes Code provided such an opportunity for deletion of a provision no longer required under changed circumstances, the draft of the Direct Taxes Code Bill still retains prohibition on set off of speculation losses. It appears to be a classic case of tax revenue considerations overruling considerations of equity and fairness in tax laws.
Gautam Nayak is a chartered accountant.
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