derivatives legal issues

7/30/2019 Derivatives Legal Issues

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Legal Aspects Of Equity and

Derivatives :

Ram Krishna Gupta

CIT Jaipur1,Jaipur


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Brokers Obligations


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Brokers LiabilityClearing Trades can be settled y clearing member OR trading

member can appoint professional clearing memberto settle their payments. PCM take their changesfrom TM

STT Equity Segmenta) Delivery Rs 12500 per 1 crore (on both sale &purchase)b) Jobbing Rs 2500 per crore on sale sidec) F&O segment Rs 1700 per crore on sale side

Membership ChargesOther thancorporate

50 lacs (Capital Market)8 lacs (F&O)

Corporate Rs 125 lacs with minimum net worth of Rs 1 crore


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Margins in Futures

Margin VAR, Exposure Margin, Extreme lossmargin, Mark to Market settlement is doneon daily basis

Mark to MarketSettlement

Is taken by cheque only

VAR andExposureMargin

50% cash & cash equivalent50% in kind

Cashequivalent

FDRs of designated bank + BankGuarantee

In Kind Approved Securities and Govt Bonds


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Penalties

Cross thelimit

1st Default - Rs 10000 and on seconddefault Rs 25000.If broker is unable to pay the requiredmargin or pay in amount then on the

shortage exchange charges .08% on dailybasis. In F&O segment Rs 5000 penalty isimposed on every instance of crossing thelimit.

Penalty onscrip wiseviolation inF&O

segment

If the scrip reaches 95% of Market wideposition then exchange restricts furtherposition built up in the scrip, even if anytakes further position then exchange

imposes a penalty of Rs 5000 minimum perlot or 2% of amount whichever is higher.


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Bank Accounts

Trading member is required to open the following bankaccounts Bank Settlement Account in a designated bank - Exchange uses

this account for taking and giving funds from the tradingmember ( CM and F&O)

For all A/C Separate A?C

Client Account All the cheques from and to the clientsare received and given from this account

Exchange dues account this account is used by theexchange for recovery of expenses from the member

Own Account This is the broker own account fromwhere he can withdraw or use the money from ownpurpose


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Demat A/C -Broker

Capital Market (Equity + Debenture + Warrant) De-mat A/C NSDL

CDSLName of the Demat A/C Pool A/C Exchange deals with this A/C for pay in and payout

purpose Beneficiary A/C from Pool A/C scripts are transferred to this A/C

within 24 hours Penalty A/C F&O Margin Account


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ISSUES

Speculation business Transactions in Derivatives upto A.Y.2005-06

Deemed speculation loss-Expl. To S 73 Rebate for STT Section 88E Upto A.Y.2008-

09

Special benefits under STCG or LTCG Dividend stripping and bonus stripping Section 14A disallowance


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Exp. To sec. 28

Where speculative transactions carried onby an assessee are of such nature as to

constitute a business ,the business(hereinafter referred to as speculationbusiness) shall be deemed to be distinct

and separate from any other business.


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Section 43(5) Speculative Transactions

Speculative transaction means a transaction in

which a contract for sale and purchase of any

commodity, including stocks and shares, is

periodically or ultimately settled otherwise by

actual delivery or transfer of the commodity or

scrip: provided that


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ExceptionsSpeculativeTransactions

Proviso to Section 43(5) (a) Contract in respect ofraw materials

or merchandise in course of business toguard against loss against future pricefluctuation

(b) Contract in respect ofstocks andshares by dealer or investor to guardagainst loss against future price

fluctuation


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Exceptionsspeculativetransactions Cont..

Proviso to Section 43(5) (c) Contract entered into by a member of stock

exchange in the nature of Jobbing Arbitrage

Guard against loss which may arise inordinary course of business as such member

Eligible transactions in derivatives


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Loss on account of transactions inderivatives Speculation loss S.

43(5) Term derivative in which the underlying asset in

shares falls within the meaning of the termcommodity for the purpose of section 43(5); cl.

(d) of proviso to section 43(5) is prospective innature and is effective w.e.f. 1st April, 2006;i.e., asst. year 2006-07 onwards; therefore, losson account of futures and options was rightly

treated as speculative loss for the asst. year.2004-05 under consideration.

Shree Capital Services Ltd vs. ACIT (2009) 28DTR 1 (Kol.) (SB)


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43(5)(a) and (b)

Guard against loss Transaction hedging or notquestion of law, held in

Nuddea Mills Co. Ltd. 171 ITR 169

Departmental circular dt12.09.1960 Pt.1 : Hedging transactions genuine to the

extent of stock of raw materials ormerchandise in hand

Pt 2: Hedging transactions may not identicallyin same commodity Pt 3: Transactions in scripts outside holding

not a hedging


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Exceptionsspeculativetransactions Cont..

43(5)(c) Member of stock exchange

any transaction Jobbing Squaring off without actual delivery

(NSE Circular)

Arbitrage

CM Vs. F&O, NSE Vs. BSE etc. Guard against loss which may arise in the normal

course of business More broader than clause (a) and (b)


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SECTION 73 Losses inspeculation business

1.Any loss, computed in respect of a speculation business2^ carriedon by the assessee, shall not be set off except against profits andgains, if any, of another speculation business.

2.Where for any assessment year any loss computed in respect of aspeculation business has not been wholly set off under sub-section(1), so much of the loss as is not so set off or the whole losswhere the assessee had no income from any other speculation

business shall, subject to the otherprovisions of this Chapter, be carried forward to the followingassessment year, and


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SECTION 73 Losses in speculation business

(i) it shall be set off against the profits and gains, if any, of anyspeculation business carried on by him assessable for thatassessment year; and

(ii) if the loss cannot be wholly so set off, the amount of loss not soset off shall be carried forward to the following assessment year andso on.

(3) In respect of allowance on account of depreciation or capitalexpenditure on scientific research,the provisions of sub-section (2)of section 72 shall apply in relation to speculation business asthey apply in relation to any other business.

(4) No loss shall be carried forward under this section for more thanfour assessment years] immediately succeeding the assessmentyear for which the loss was first computed


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Deemed Speculation Loss-Expl toS 73

[Explanation -Where any part of the business of acompany[other than a company whose gross total incomeconsists mainly of income which is chargeable under the

heads Interest on Securities,Income from HouseProperty, Capital Gainsand Income from otherSources], or a company, the principal business of whichis the business of banking or the granting of loans andadvances)consists in the purchase and sale of shares of

other companies, such company shall, for the purposes ofthe Section be deemed to be carrying on a speculationbusiness to the extent to which the business consists ofthe purchase and sale of such shares.]


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SECTION 14A

[(1)] For the purposes of computing the total income under thisChapter no deduction shall be allowed in respect of expenditureincurred by the assessee in relation to income which does not formpart of the total income under this Act:]

Provided that nothing contained in this section shallempower the Assessing Officer either to reassess under section 147or pass an order enhancing the assessment or reducing a refundalready made or otherwise increasing the liability of the assesseeunder section 154, for any assessment year beginning on or beforethe 1st day of April, 2001.] Ins. by Finance Act, 2001, s. 11(retrospectively w.e.f. 1-4-1962).


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SECTION 14A. [(2) The Assessing Officer shall determine the amount of expenditure

incurred in relation to such income which does not form part of thetotal income under this Act in accordance with such method as maybe prescribed, if the Assessing Officer, having regard to theaccounts of the assessee, is not satisfied with the correctness of theclaim of the assessee in respect of such expenditure in relation toincome which does not form part of the total income under this Act.Ins. by Finance Act, 2002, s. 10 (retrospectively w.e.f. 11-5-2001).

(3) The provisions of sub-section (2) shall also apply in relation to acase where an assessee claims that no expenditure has been

incurred by him in relation to income which does not form part ofthe total income under this Act.] Ins. by Finance Act, 2006, s. 7(w.e.f. 1-4-2007).


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RULE 8D

Method for determining amount of expenditure in

relation to income not includible in total income.

[ (1) Where the Assessing Officer, having regard to theaccounts of the assessee of a previous year, is not satisfiedwith

(a)the correctness of the claim of expenditure made by (heassessee; or (b)the claim made by the assessee that no expenditure has

been incurred, in relation to income which does not formpart ofthe total income under the Act for such previousyear,

he shall determine the amount of expenditure inrelation to such income in accordance with the provisions ofsub-rule (2).


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RULE 8D.

(2) The expenditure in relation to income which does notform pan of the total income shall be the aggregate offollowingamounts,

namely: (i) the amount of expenditure directly relating to income

which does not form pan of total income; (ii) in a case where the assessee has incurred expenditure

by way of interest during the previous year which is notdirectly attributable to any particular income or receipt, anamount computed in accordance with the following

formula, namely : AxB /C

Where


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RULE 8D..

A amount of expenditure by way of interest other than the

amount of interest included in clause (i) incurred during theprevious year;B the average of value of investment, income from which does notor shall not form part of the lotal income, as appearing in thebalance sheet of the assessee, on the first day and the last day ofthe previous year;

C = the average of total assets as appearing in the balance sheet ofthe assessee. on the first day and the last day of the previous year;(iii)an amount equal to one-half percent of the average of the valueof investment, income from which does not or shall not form part ofthe total income, as appearing in the balance sheet of the assessee,on the first day and the last day of the previous year.

(3) For the purposes of this rule, the 'total assets' shall mean, totalassets as appearing in the balance sheet excluding theincrease on account of revaluation of assets but including thedecrease on account of revaluation of assets.


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Section 14A

Godrej & Boyce v. DCIT (Bom.) WP No.758 of 2010 dated 12-08-2010

S.14A Supersedes the principle of law that in the case ofa composite business, expenditure incurred towards tax-free income could not be disallowed and incorporates animplicit theory of apportionment of expenditure betweentaxable and non-taxable income. Once a proximatecause for disallowance is established, which is therelationship of the expenditure with income which doesnot form part of the total income, a disallowance u/s.14A has to be effected.


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Issues for verification-Audit

U/s 88E- Rebate in respect of securities transaction taxForm No. 10DDB & 10 DDC-up to A.Y. 2008-09.

Rebate available u/s 88E(2)

Speculative Loss vs Hedging Loss.

Margin Money (Securies offered in Kind) when volume isvery high.

Penalties.


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SECTION 88E

Rebate in respect of securities transaction tax. Ins. ByFinance Act 2004 w.e.f.1-4-2005 (1) Where the total income of an assessee in a previous year

includes any income, chargeableunder the head "Profit andgains of business or profession", arising from taxablesecuritiestransactions, he shall be entitled to a deduction, from theamount of income-tax on such incomearising from such

transactions, computed in the manner provided in sub-section (2),of an amountequal to the securities transaction tax paid by him inrespect of the taxable securities transactions entered into in thecourse of his business during that previous year

Provided that no deduction under this sub-section shall be

allowed unless the assessee furnishes along with the return ofincome evidence of payment of securities transaction tax in theprescribed form :

SECTION 88E


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Important Decisions-Exp.to73

1. Assessee contended that IOS being positive should betreated as main income.Held:

Loss means negative income

Quantum of both profit (positive income) and loss (negative income) should be compared

Eastern Aviation & Ind. Ltd. v. CIT [208ITR 1023 (Cal)]

2. Facts : IOS 24000/-and loss in share trading

450779/-Held : Loss in share trading being a higher figure, hasto be treated as main business

AryasthanCorporation Ltd v.CIT [253 ITR 401 (Cal)]


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Important Decisions

3. This section comes in Chapter VI which dealswith set off and carry forward of loss

Chapter VI comes into play only after incomeor loss computed under five heads of income

One has to first find out chargeable incomeunder each head & then see applicability of

Chp. VI RajenEnterprises Limited [41 ITD 469

(Mumbai ITAT)]


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Important Decisions

4. Facts :Return of income show Business incomeof 333670/-and OS of 573701/-. Business lossarrived at after setting off loss in share trading

of 898799/-Held :

Eastern Aviation case will apply

Loss in share dealing of to be treatedas negative profit CIT v. Park View Properties PvtLtd [(2003)

261 ITR 473(Cal)]


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Mumbai Special Bench holdsdifferent view

ACIT Vs. Concord Commercials Pvt. Ltd. [94 TTJ 913 (Mum, SB)] Profit from trading in steel, yarn etc. 283.29L Loss in share trading (-)284.26L

Dividend ( from stock) 10.19L HELD GTI consists of mainly of dividend income, chargeable as OS

irrespective of shares held as stock Deeming provision has to be strictly construed

Cir. No. 103 dt. 17thFeb, 1973 interpreted the wordmainly If (IOS+HP+CG) > 50% of GTI, Expl. to S.73 not apply


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History

Introduced w.e.f. 1stApril, 1977 Loss in business of purchase or sale of shares by

companies, other than investment, banking or finance

companies or a Company whose principal business isgranting of loans and advances

Circular no. 204 on Taxation laws

Amendment act 1975 dt. 24thJuly, 1976

-Object of this provision is to curb the device sometimesresorted to by business houses controlling group ofcompanies to manipulate and reduce the taxable incomeof companies under their control


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Favouring assessee

Whether Explanation apply where loss not in abusiness house?

AmanPortfolio (P) Ltd v. DCIT [92 TTJ351(Del)]

No material to show that assessee was a

company controlled by a business house No evidence to prove that transactions weredone to reduce taxable income

Held

loss could not be treated as speculative


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Favouring Revenue

Whether Explanation apply where loss not in a business house?

DCIT Vs. Frontline Capital Securities Ltd 96 TTJ 201(DelITAT)

Rohini Capital Services Ltd 92 ITD 317 (Del) Arvind Investments Ltd Circular Para 19.1

Held SC in Gwalior Rayon Silk Mfg. Co. Ltd 196 ITR 149 held that when

the language used in the section is unambiguous, there is no basisto look at the objective or intention.

Even the Editorial comments in Frontline case reported in TTJ hasraised question on the judgment


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Important Decisions

5KanoriaInvestments (P) Ltd [232 ITR 7]

Fund deployment testan important criteria to determineprincipal business

6Offshore India Ltd [15 ITD 549(Cal ITAT)] Objects in the M/A are not conclusive of the nature of

business carried on by the company

activity which the company actually engages in aloedetermines the nature of its business

If amt invested in money lending business is more thanamt invested in share business, then principal businessshall be deemed to be money lending


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Important Decisions

7 Composition of GTI & not percentageof funds held as investments, material

for considering applicability of Expl. tos.73.

Melville Finvest Ltd vs. JCIT [89 ITD

528 (Hyd)] Similar view held in JCIT v. HaldiaInv.

Ltd. [85 ITD 212 (Kolkata)]


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Important Decisions

8. Recent Conflicting decision KolkataITAT gave a unique way of

determining principal business

DCIT Vs. VenkateshwarInv. & Finance(P) Ltd. [(2004) 92 TTJ 1129 (Cal)] Loss in share dealings in one particular year

cannot be criteria to determine principal

business Will depend on M/A, past history, current andpast years deployment of funds, break up ofincome earned, nature of activities etc.


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Important Decisions

9. Godavari Capital Ltd. Vs. DCIT [273 ITR10 (Hyd)]

Net loss of 9.61 L from non-speculative and profit of

6.61 L from speculative Commission income of 2.30 L & OS of 4.87L

Held

Speculativethere is no loss

Explanation is only for purposes of s.73 &where section doesnt apply, Expln. cannotbe invoked.


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Other Sources IncomeAnalyzed

Interest incomebusiness income or OS Interest income may constitute business income, if investment

yielding int. was done in course of business.

business-Real, substantial & organisedactivity NarainSwadeshiWeaving Mills V. CEPT [26 ITR 765(SC)]

Check

Whether deployment of surplus funds

Advancing loans is part of regular business activityDividend incomewhether business or OSCapital Gainsloss

How does it effect mainly


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Explanation to S.73Summing up

Applies only to corporate assessee

Applicable only on share transactions Not onmutual fund units

Not applicable on loss arising on sale ofinvestments

Deeming provision to be applied strictly within

four corners of law Certain exceptional categoriesGTI mainly consists of income from HP, CG, and OS

Principal business is banking or granting of loans


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Share Brokers

Explanation to section 73loss inpurchase/sale incurred while carrying outbroking business

Eg. Wrong coding, quantity etc.Journal entry passed reversing clienta/c & debit purchaea/c

ParkarSecurities Ltd Vs. DCIT [8 SOT 257(Ahd)]

Held

Explanation not applicable


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Other Issues


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Share Brokers..

SEBI Fees

ITO Vs. Suresh ChandJain [100 ITD 435(MumbaiItat)

Held

turnover charges is also in the nature of the tax,duty, cess or fees payable under a Law

S.43B will apply


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Share Brokers..

SEBI Fees

ITO Vs. Suresh ChandJain [100 ITD 435(MumbaiItat)

Held

turnover charges is also in the nature of the tax,duty, cess or fees payable under a Law

S.43B will apply


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Decisions

Various change like VSAT charges, lease line charges,BOLT Charges, Demat Charges etc. paid to stockexchange services not in the nature of technical.

- DCIT vs angel broking Ltd.

- A.Y. 2005-06, 41 DTR 296 (Mumbai)Capital gain Vs - a - Vs. Business income.

(i) entire investment in share-held asinvestment.

(ii) No. derivation transactions.(iii) No transaction without delivery.

(iv) No barrowed find involved(v) In earlier year, sale of share under the head capital gain.

No Business Income :Management structure & Systerm (P.) Ltd. Vs ITO 4, DTR 426 (Mumbai)


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Section 14A

Godrej & Boyce v. DCIT (Bom.) WP No.758 of 2010 dated 12-08-2010

S.14A Supersedes the principle of law that in the case ofa composite business, expenditure incurred towards tax-free income could not be disallowed and incorporates animplicit theory of apportionment of expenditure betweentaxable and non-taxable income. Once a proximatecause for disallowance is established, which is therelationship of the expenditure with income which doesnot form part of the total income, a disallowance u/s.14A has to be effected.


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