IN THE INCOME TAX APPELLATE TRIBUNAL

MUMBAI BENCH “D”

Before Shri N.V. Vasudevan (JM) & B. Ramakotaiah (AM)

I.T.A.No. 976/Mum/2009 (Assessment year : 2005-06)

ACIT 12(3) Shri Dinesh K. Mehta HUF

Room No. 121, Aayakar Bhavan 905, Dalamal Towers
M.K. Road Vs. Nariman Point
Mumbai-400 020. Mumbai-400 021.

APPELLANT RESPONDENT

PAN/GIR No. : AACHD8075J

Assessee by : Shri Anant N.Pai

Department by : Shri S.K. Singh

ORDER

PER N.V. VASUDEVAN, JM :-

This is an appeal by the revenue against the order dated

28.11.2008 of learned CIT(A)-XII, Mumbai for A.Y. 2005-06.

2. Ground No.1 raised by the revenue reads as follows :-

On the facts and circumstances of the case and in law, learned
CIT(A) was justified in treating the transactions in derivatives and
futures as business (hedging) transactions and not speculative
transactions and thereby allowing the loss on account of the
transaction in derivatives as business loss instead of speculation
loss.

3. The assessee is a HUF. It is engaged in the business of dealing in

shares and securities. In the profit and loss account, the assessee had
debited loss on account of Nifty hedging transactions of Rs.
1,30,41,270/-. Generally, in transaction of purchases in Nifty Futures,
which is a derivative instrument, there is no actual delivery of shares.
The transaction of purchase at a particular price on a future date is
entered into. On the specified date, the difference between the agreed
price and price prevailing on the specified date is settled and there is no

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actual transaction of purchase of the security. On such settlement there

could be a loss or profit. The assessee explained that the loss had
occurred on account of purchase of Nifty Futures and these transactions
were purely hedging transactions meant to minimize the loss due to
fluctuation of price of shares which the assessee does on delivery basis in
the usual course of business and held by him as stock-in-trade of his
business. They are primarily to be regarded as speculative transactions.
Loss arising on account of speculative transactions cannot be set off
against income from regular business. Speculative transactions have
been defined in section 43(5) of the Act to mean transactions in which,
contract for purchase and sale of any commodity, including stocks and
shares, is periodically or ultimately settled otherwise than by actual
delivery or transfer of commodity or script. There are certain exceptions
to the above definition. Under clause (b) of section 43(5) of the Act, a
contract in respect of stocks and shares entered into by a dealer or
investor therein to guard against loss in his holdings of stocks and
shares through price fluctuations shall not be deemed to be speculative
transactions.

4. According to the Assessing Officer, transaction of derivatives trading

in the form of purchase of Nifty futures was in the nature of speculative
transaction. In this regard the Assessing Officer called for the details of
transactions of purchase of Nifty futures, which resulted in the loss
debited to the profit and loss account. According to the Assessing Officer,
to fall under exception under section 43(5)(b) of the Act, hedging
transactions should be equal to the inventory of the shares held by the
assessee in its business of dealing in shares and securities and only to
this extent, transactions can be said to be hedging transaction which fall
within exception. The Assessing Officer noticed that on the date on which
the assessee entered into transactions of purchase of Nifty futures,
position of inventory of shares held by the assessee on that particular
day was less than the value of purchase of Nifty futures. In this regard,
Assessing Officer has analyzed 38 transactions given by the assessee.

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The Assessing Officer thereafter referred to Circular No. 23 dated

12.9.1960; wherein CBDT had clarified as follows :-

“Hedging sales can be taken to be genuine only to the extent the

total of such transactions does not exceed the ready stock.
Hedging contract is a contract where the person dealing with the
actual commodity ensures himself against the adverse price
fluctuations in that commodity in future. The transaction in the
future market corresponds to an earlier transaction in the ready
market. The future transaction is basically to off-set any loss that
may arise on the earlier transaction.”

The Assessing Officer thereafter referred to certain judicial

pronouncements in the case of M.G. Brothers Vs. CIT, 154 ITR 695 (AP);
Pankaj Oil Mills Vs. CIT, 115 ITR 824 (Guj). The Assessing Officer
thereafter culled out following principles :-

“Thus the basic principles which emerge from the above case laws
are follows :-

(i) the test of whether a Futures transaction is for hedging or

for speculation hinges on whether there already exists a
related commercial position which is exposed to risk of loss
due to price fluctuation. Hedging can be taken to be
genuine only to the extent the total of such transactions
does not exceed the ready stock.
(ii) In the case of pure speculator, as distinguished from a
hedger, futures transaction is a business by itself, as he
has no off-setting commercial position. The assessee would
bear the onus to prove that the forward contract of
purchase entered into by it was to safeguard it against the
loss through future price fluctuations in respect of any
specific contracts of sale for actual delivery of shares.
(iii) The basic material required to identify hedge would be as
under :-

(a) Details of original position and details of delivery and

payment for original position.
(b) Details of the hedging transaction
(c) Details of the final settlement of the transaction.

Analysis of assessee’s arguments and conclusion :

In view of the principles which emerge from discussion of

the above judicial precedents, it is clear that the onus is on the
assessee to prove that the transaction is not speculative, and it is

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a hedging transaction. In discharge of this onus, the assessee has

also to prove that he has in his stock in trade shares which
required to be hedged by taking position in the futures market. To
do this, the assessee has to prove at least that the total value of
his stock exceeds the money invested in purchase of Nifty Futures.
However, in the case of the assessee, as can be seen from the
Table on page No. 2 to 4 of this order, the position of inventory
and the amount of money invested in purchase of Nifty Futures on
that particular day do not bear required relation.”

5. The Assessing Officer thereafter examined the inventory position of

the assessee on various dates on which the assessee entered into
transaction of purchase of Nifty Futures. Wherever the value of
purchases of Nifty Futures were more than the value of inventory, they
were treated as speculative transactions. For example on 17.6.2004, the
value of inventory was Rs. 38.18 lakhs. The value of Nifty purchases
were Rs. 1.49 crores. The loss on this transaction of purchase of Nifty
Futures on settlement was treated as speculation loss by the Assessing
Officer and disallowed. On the above basis and analysis of transactions,
the Assessing Officer arrived at a sum of Rs. 98,66,738/- as the loss on
account of speculative transactions and this loss was not allowed as a
deduction. In respect of the remaining loss the Assessing Officer found
that the value of stock was more than the value of purchase of Nifty
Futures and these transactions were accepted by the Assessing Officer as
Hedging transactions and loss to that extent was allowed as deduction.

6. Before the first appellate authority, the assessee submitted that

under the assessee submitted that under section 43(5) clause (d), which
was introduced w.e.f. 1.4.2006, it has been specifically laid down that
eligible transaction in respect of trading in derivatives are not to be
regarded as speculative transaction. The assessee further submitted that
the Mumbai Bench of the Tribunal in the case of CIT Vs. SSKI Investors
Pvt. Ltd. had taken the view that the aforesaid amendment was
clarificatory and was therefore applicable retrospectively. The assessee
submitted before learned CIT(A) that in view of the aforesaid decision,
loss in question cannot be considered as speculative loss and therefore

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assessee should be allowed to set off the said loss against business
income. Learned CIT(A) accepted this submission of the assessee and
directed the Assessing Officer to treat the loss in question as business
loss and not speculative loss. Aggrieved by the aforesaid order of
learned CIT(A), the revenue has raised ground No. 1 before the Tribunal.

7. At the time of hearing of this appeal, it was brought to our notice

that Special Bench Kolkata in the case of Shree Capital Services Ltd.,
121 ITD 498 (Kol) held that amendment referred to in the earlier para to
section 43(5) is not clarificatory and therefore not retrospective in
operation. In view of the aforesaid decision, the very same basis on
which, learned CIT(A) allowed the claim of the assessee does not survive.
Learned counsel for the assessee, however, submitted under Clause (b)
to section 43(5) assessee’s transaction ought to be considered as a
hedging transactions. In this regard, it was submitted by learned counsel
for the assessee that clause (b) to section 43(5) does not lay down that
the hedging transaction should be in the very same stock and shares
held by the assessee as inventory or that the value of hedging
transactions should be equal to or less than the value of inventory held
by the assessee as a dealer in shares. It was further submitted by him
that in purchase of Nifty futures, or for that matter any form of derivative
trading, it is not possible to link derivatives with any particular script as
the underlying asset is basket of shares comprising of several companies.
It was further submitted that Circular of CBDT referred to by the
Assessing Officer is applicable only in the context of commodities and not
shares.

8. We have considered his submissions. Circular of CBDT dated

12.9.1960 gives a general guideline with regard to different kind of
speculative transactions. Point No. 4 of the aforesaid Circular deals with
hedging transaction in the case of dealer or investor in shares. The same
is as follows :- (it is in the form of question and answer)

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Point No. (iv) : Bonafide hedging transactions by a dealer or

investor in shares should be allowed provided that the hedging
transactions are up to the amount of his holdings even though
these transactions may extend to other types of shares not held by
him.

Board’s decision : the Board are unable to accept this suggestion.

It cannot be accepted that a dealer or investor in stocks or shares
can enter into hedging transactions in script outside his holdings.
The material words in clause (c) of the proviso to Explanation 2 to
section 24(1) are ‘to guard against less in his holdings of stock and
shares through price fluctuations’. Therefore, hedging
transactions having reasonable relations to the value and volume
of the dealer’s or the investor’s holdings are excepted from the
ambit of speculative transactions, but transactions in script
outside his holdings are not.

It is thus clear that the value and volume of a dealer or investor holding
hedging transactions should be in equal proportion and hedging
transactions can never be in excess. It is further a condition that hedging
transaction should be in respect of very same script held by an assessee
as inventory in the business of stocks and shares. In the present case,
the Assessing Officer has not gone by script-wise tally but has gone by
value of overall inventory. To this extent, the Assessing Officer has been
very reasonable. We therefore hold that Circular was very much relevant
and applicable in the case of the assessee.

9. We are also of the view that under clause (b) of section 43(5), the
assessee in the garb of entering hedging transaction cannot seek to enter
into speculative transaction in any stocks or shares other than by one
held by him as inventory in the business of dealing in stocks and shares.
Value of hedging transactions cannot also be more than such inventory.
If arguments sought to be canvassed by the assessee is accepted, then it
will lead to a situation where all speculative transactions will be claimed
as hedging transactions and very purpose behind the provisions of
section 73 of the Act not permitting set off of speculative loss against
business income will become redundant. There is no doubt truth in the
plea of the assessee that Nifty futures and index futures are the only

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available form of derivatives trading through which the assessee could

hedge the value of inventory held by him. In such trading there cannot
be any identification of shares and tally the same with the inventory of
shares held. This aspect has been taken care by the Introduction of
clause (d) of section 43(5) of the Act; therefore, from A.Y. 2006-07, the
assessee may not face this difficulty. But in A.Y. 2005-06 as per the law
as it stands, the claim of the assessee cannot be accepted. We therefore
reverse the order of CIT(A) and restore the order of the Assessing Officer
on this issue.

10. Learned counsel for the assessee, however, submitted that the
Board Circular itself says that only excess of the assessee’s position in
forward market over actual stock held in ready market should be
considered as speculative. For e.g. on 17.6.2004, the inventory of stock
held by the assessee was Rs. 36.18 lakhs and purchases in Nifty Futures
was Rs. 1.49 crores. In Nifty Futures purchase if the assessee incurs loss
on the settlement day, the loss proportionate to the value of inventory i.e.
Rs. 36.18 lakhs should not be considered as speculative loss. To that
extent, the loss should be considered as hedging transaction. We have
already observed that the shares held as inventory and the shares in
which hedging transactions are entered into should be the same. The
Assessing Officer has however gone by overall value of inventory without
individual script wise tally. The plea of the assessee that to the extent of
the value of inventory held by the Assessee on a particular day, the loss
in purchase of Nifty Futures should not be considered as speculative
while working out the loss is an acceptable plea. To this extent, plea of
the assessee is accepted and the Assessing Officer is directed to work out
speculation loss by taking excess of the assessee’s position in forward
market over actual stock in ready market and work out the speculative
loss proportionately. Thus, Ground No. 1 of the revenue is partly allowed.

11. Ground No. 2 raised by the revenue reads as follows :-

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On the facts and circumstances of the case and in law, learned

CIT(A) was justified in reversing the action of the Assessing Officer
of treatment of the short term capital gains of Rs. 16,02,739/- as
income under the head ‘profits and gains from business and
profession’.

12. The assessee declared short term capital gains of Rs. 16,02,739/-.
The Assessing Officer was of the view that since, the assessee was dealer
in shares and was having huge volume of share transactions in such
business, it was hard to believe that the assessee held shares as
investment also, the Assessing Officer therefore treated the short term
capital gain declared by the assessee also as income from business.

13. On appeal by the assessee, learned CIT(A) held that gain in

question was capital gain and not business income for the following
reasons :-

“I have carefully considered the submissions made for the

appellant and the assessment order. It is true that when a dealer
in shares holds shares, the first presumption would be that the
shares held by him constitute stock in trade. But, at the same
time, it is not impossible that there cannot be a situation in which
the assessee, who is dealer in shares also hold some shares as
investment. This proposition is supported by the decision of
Mumbai Tribunal in the case of J.M. Share and Stock Brokers
Ltd., relied by the appellant. As such, I am not inclined to accept
the Assessing Officer’s line of reasoning that a dealer in shares
cannot hold shares as investments. In fact, the very decision relied
by the Assessing Officer in Motilal Oswal has been reversed by the
same Tribunal on rehearing. The fresh decision on rehearing
supports the appellant’s case. An assessee who is a dealer in
shares can also hold shares in investment portfolio by
demarcating the same in his books of accounts has also been
upheld by the Delhi Tribunal in the case of Arjun Kapur Vs. DCIT,
70 ITD 161 (Del) and the Chandigarh Tribunal in Vesta
Investments & Trading Co. P. Ltd. Vs. CIT, 70 ITD 200 (Chd). The
onus will be of course on the assessee to show that the shares
have been correctly so held as investments notwithstanding the
fact that he is a trader in shares. In my view, the manner in which
the assessee holds the shares will determine whether the shares
are investment or stock in trade. Generally, if the volume and
frequency in dealing in shares is large, the period of holding is
low, the conduct of the assessee should point towards that of a
trader. If this also coupled with the use of borrowed capital the

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presumption in favour of trading would be strengthened. The

manner in which the transactions are accounted whether a
trading transaction or as investment would also be a relevant
indicator as this would manifest the intention of the assessee in
dealing with the shares. The role of the assessee as an investor
should be more passive in comparison to that of a dealer, whose
role would be aggressive. The words ‘passive’ means that the role
of the investor would be less in frequency and volume, more use of
own capital and larger period of holding. In short, it is the conduct
of the assessee that should be the determining factor. In the
assessee’s case, its allocation of shares as stock in trade and
investment appears to be justified by its manner in dealing with
the shares. Whereas the shares involved in high frequency in
dealing large volumes etc. have been treated as stock in trade, the
ones in which the period of holding is larger and volume of holding
is small has been demarcated as investments. This method of
accounting has been followed consistently by the assessee and
this lends credibility to the assessee’s allocation of shares as
investments and stock in trade. The Supreme Court in its decision
in the case of Karam Chand Thapar Bros. P. Ltd. Vs. CIT, 82 ITR
899 (sc) has observed that the circumstances that the assessee
has shown particular shares in its books as well as balance sheet
as investments is a relevant factor in deciding whether the shares
are investment or stock in trade. The assessee has reasonably
discharged its onus of showing that it is in dual role of both
investor and dealers of shares by cogent evidence and reasoning.
The Assessing Officer is therefore directed to treat the income of
Rs. 16,02,739/- as income from short term capital gains and not
as business income. This ground of appeal is allowed.

14. Before us, learned DR relied on the order of the Assessing Officer.

15. We are of the view that the order of learned CIT(A) does not call for
any interference. Admittedly, the assessee had treated the shares in
question as investment in his books of accounts. In fact, in A.Y. 2004-
05, the assessee had declared short term capital gain on sale of
investments (shares held as investment) the same was accepted by the
Assessing Officer in assessment u/s. 143(3) of the Act. The Hon'ble
Bombay High Court in the case of CIT Vs. Gopal Purohit, ITA No. 1121 of
2009 dated 6.1.2010 has held that ruling of consistency should apply
when the facts are identical. In view of the acceptance of the assessee’s
stand by the revenue in the past and other circumstances considered by
the learned CIT(A), we see no reason why a different treatment should be

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given in the present assessment year. For the reasons given above, we
uphold the order of learned CIT(A) and dismiss Ground No. 2 raised by
the revenue.

16. In the result, appeal by the revenue is partly allowed.

Order has been pronounced on 30th Day of April, 2010.

Sd/- Sd/-
(B. RAMAKOTAIAH) (N.V. VASUDEVAN)
ACCOUNTANT MEMBER JUDICIAL MEMBER

Dated : 30th April, 2010

Copy to : 1. The Assessee

2. The Respondent
3. The CIT(A)-concerned.
4. The CIT, concerned.
5. The DR concerned, Mumbai
6. Guard File

BY ORDER
True copy

ASSTT. REGISTRAR, ITAT, MUMBAI

PS

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