Under the Income-tax Act, 1961, business losses from speculative transactions can only be set off against business profits from speculative transactions
The Forward Markets Commission (FMC) has finally merged with the Securities and Exchange Board of India (Sebi) on 28 September, with the repeal of the Forward Contracts (Regulation) Act, 1952 (FCRA). Commodity exchanges will therefore now be regulated by Sebi, instead of by FMC. Does this merger have any impact from an income tax perspective for traders in commodity derivatives?
Under the Income-tax Act, 1961, business losses from speculative transactions can only be set off against business profits from speculative transactions. The law contains certain exclusions from the definition of “speculative transaction". Two such exclusions are derivatives transactions carried out on a recognised stock exchange, and commodity derivatives transactions carried out on a recognised association (commodity exchange).
For an association (commodity exchange) to be treated as recognised, it has to be a recognised association under section 2(j) of the Forward Contracts (Regulation) Act, 1952, has to fulfil certain prescribed conditions and has to be notified by the central government under the income-tax Act for the purpose of exclusion from securities transactions. Currently, National Commodity and Derivatives Exchange Ltd (NCDEX), Universal Commodity Exchange Ltd (UCX), Multi Commodity Exchange of India Ltd (MCX), and Ace Derivatives and Commodity Exchange Ltd (ACE) have been notified for this purpose.
By amendment made by the Finance Act, 2015, FCRA was to be repealed from a notified date (now 28 September, 2015). Under the amendment, all recognised associations under FCRA are deemed to be recognised stock exchanges under the Securities Contracts (Regulation) Act, 1956 (SCRA). Therefore, all commodity exchanges approved by FMC under FCRA now become stock exchanges approved under SCRA by Sebi.
Would transactions on such commodity exchanges, which are now stock exchanges, qualify for the exclusion from the definition of speculative transaction after repeal of FCRA? On a bare reading of the exclusion provision, it initially appears that they would not qualify, since the commodity derivatives transactions are now not being carried out on recognised associations under the provisions of FCRA, but on recognised stock exchanges under the provisions of SCRA. This would give rise to a peculiar situation where commodity derivative transactions prior to 28 September would not be speculative, while those after would be.
However, this would not be the correct interpretation. Firstly, one of the principles of interpretation of law is the principle of incorporation by reference. This is when a provision of law is enacted (in this case, the exclusion provision under the income-tax Act), the reference to another law (FCRA) contained in this law (income-tax Act), would have to be understood as referring to that law (FCRA) as it stood when the provision (for exclusion) was enacted, even if that law (FCRA) subsequently undergoes a change or is repealed. Therefore, commodity exchanges, though now regarded as recognised stock exchanges, would still remain approved associations under FCRA, with commodity derivatives traded on them, therefore qualifying for the exclusion, since they also remain notified under the income-tax Act.
Secondly, even commodity derivatives are derivatives as defined under SCRA. In fact, a few years ago, when currency futures were to be introduced, there was a dispute between the regulators on who had the jurisdiction to regulate currency futures. Since currency futures also qualified as derivatives under SCRA, ultimately the role was assigned to Sebi. Therefore, trading in commodity derivatives on a commodity exchange would amount to trading in derivatives on a recognised stock exchange, and would qualify for an exclusion.
Lastly, commodity derivatives transactions continue to attract commodity transaction tax, which is payable only in respect of contracts traded in recognised associations, which indicates that such transactions are still treated as being traded in recognised associations. Consequently, the benefit of the exclusion would still be available for commodity transactions.
In any case, to avoid any possible unintended controversy, the Central Board of Direct Taxes (CBDT) should come out with a clarification, that commodity derivatives transactions would still qualify for exclusion from the definition of speculative transaction, and should amend the law in the next budget accordingly.
One aspect which merits serious consideration is whether there is any need to treat market transactions as speculative at all. Today, share derivatives, currency derivatives and commodity derivatives transactions are all excluded from the ambit of speculative transactions. Only transactions in shares and debt securities squared up on the same day without delivery are regarded as speculative.
The logic for exclusion of derivatives transactions is that there is an audit trail in respect of such transactions, which can prevent manipulation. Such audit trail is available even for transactions in shares and debt securities carried out on the same exchanges. Further, Sebi surveillance is capable of unearthing manipulative transactions, as it has in the case of share prices of lesser known companies being ramped up to create bogus exempt long-term capital gains. Therefore, the logic of the original provision prohibiting set off of speculation loss, i.e. to prevent claiming of losses by market manipulation, no longer holds good.
Exclusion of all market transactions from the definition of speculative transactions would be a significant simplification of law, which the government should seriously consider. This would go a long way in rationalisation of the law, and reducing unnecessary litigation on the subject.
Gautam Nayak is a chartered accountant.
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