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Income Tax Appellate Tribunal, “A”, BENCH MUMBAI
Before: SHRI R.C.SHARMA, AM & SHRI RAM LAL NEGI, JM
O R D E R
PER R.C.SHARMA (A.M): This is an appeal filed by the revenue against the order of CIT(A)- Mumbai, for the assessment year 2009-2010. 2. Rival contentions have been heard and record perused. Facts in brief are that the assessee is engaged in the business of share broking. It is also a member of BSE and NSE and engaged in the business of share broking and dealing in shares. During the course of scrutiny assessment the AO found that the assessee has shown arbitrage income of Rs.28,62,845/- (after deducting arbitrage expenses). The assessee company is requested to submit the bifurcation of arbitrage income segment wise i.e. share trading and derivatives. As per the details filed by the assessee company, the assessee has earned profit of Rs.8,99,70,127/- and incurred loss of Rs.6,01,53,038/- on derivatives and share trading transactions. The assessee company was asked to explain why not the provisions of Explanation to Section 73 of the I.T.Act be invoked in the assessee’s case. Being not satisfied with the assessee’s reply, the loss incurred by the assessee on purchase and sale of shares of Rs.6,01,53,038/- was treated as loss in speculation business and was not allowed to be set off against any other head of income.
By the impugned order, the CIT(A) allowed set off after having the following observations :-
3.3 I have carefully considered the submission of the appellant and remand report given by the Ld. AO on the issues in dispute as well as the rejoinder given by the Ld. AR of the appellant in this case. The remand report reiterated the findings given by the Ld. AO in the assessment order. The Ld. AO has not dealt with the submissions and evidence given by the appellant in the written submission made before me and selectively deals with transactions. Ld. AO in his remand while holding that disallowances has been rightly made and held that the Transactions are not arbitrage Transactions for the following reasons: • The Transactions undertaken are not completely squared off of same quantities of scripts in Cash and F & O. • the Appellant has not established any as to how it has safeguarded its loss while entering into Transactions. • The Transactions in cash Segment are purchase and sale transactions and therefore the provision of section 73 would apply to them and are deemed speculation transactions. • The Transactions entered in the F & 0 segment falls in the exceptional Category of Clause (d) to section 43(5) and are therefore out of the purview of the Speculation Transactions. 3.3.1 I find that the observations of the Ld. AO is not supported by the facts on record as appellant is a member of NSE and BSE since 2002 and its main business involves brokerage / arbitrage / dealing in derivatives etc. The appellant along with the brokerage business, also does arbitrage business and is a known 'Arbitrageurs' in the market. Generally speaking arbitrage is an attempt to profit by exploiting price difference of identical or similar financial instruments on different markets or in different forms which results in risk of less business. Profiting from differences in prices or yields in different markets.
Arbitrageurs' buy a commodity, currency, security or any other financial instrument in one place and immediately sell it at a higher price to ready buyer at another place completing both ends of the transaction usually within a time span. Arbitrage is a risk free transaction because it involves dealings where returns and prices are definite, fixed and known. The simultaneous purchase and sale of an asset in order to profit from a difference in the price. It is a trade that profits by exploiting price differences of identical or similar financial instruments, on different markets or in different forms.
3.3.2. Arbitrage refers to the opportunity of taking advantage between the price difference between two different markets for that same stock or commodity. While Arbitrage is concerned with working with the difference in prices of same shares or other financial instruments / products within two segments of exchange, it may be BSE cash to NSE cash / NSE F&O or NSE Cash to BSE cash / NSE F&O and Spread F&O to F&O. It is also done on Call & Put. Therefore, considering only the loss on the cash segment, but not considering the simultaneous profit incurred in the derivatives segment would result in a view that is absolutely divorced from the facts on record. The appellant being in Arbitrage business, purchased shares in one segment and simultaneously sell the same shares in the other segment and when the price parity reduces, it reverses the transitions which is a normal hedging practice. All the four legs of the transaction have to be consolidated and then only the profit / loss can be derived.
3.3.3. Now coming to specific observation of the Ld. AO in the remand report it is seen that Ld. AO completely ignored the list of shares held as stock in trade as on 31-03-2009 and the reversal position in F & O segment which is exactly the same as that of Stock in Trade. Ld. Aa has not commented upon the position of every month showing the exact opposite position in derivatives segment that of the cash segment of the Appellant company. The Ld. AO has also not considered the position of last Thursday of the month i.e. the settlement period of every month showing the exact opposite position in derivatives that of the cash segment of the Appellant company. Further, the Ld. A has also not verified that the detail summary of Profit versus Loss in the derivatives segment versus cash segment which shall crystallize the Appellant's stand that in arbitrage business being one segment they make a profit and in other segment, i.e. cash segment it incurred loss. All these documents are part of the submission made by the Ld. AR of the appellant. 3.3.4. Normally speaking the activity of Arbitration/ Jobbing is carried out in the following manner:
• The arbitrageur takes a position i.e buy position in a scrip in Cash segment for say 'x' quantity and within fraction of time he simultaneously takes sell position in the same scrip contract in Derivatives segment ( F & 0) for the same or similar (subject to the Lot Size) 'x' quantity.
• There is a difference in price of a security in Cash segment and Derivatives segment which starts reducing towards the expiry of the contract in F&O Segment which is the last Thursday of every month.
• On the expiry day, the closing price is taken and the position in Cash and Derivatives segment is squared off on notional basis.
• The arbitrageur loses in one segment and gains in the other due to exactly opposite positions in both the segments.
• The basic feature of arbitrage is to hedge the buy position in cash segment with a sell position in Derivatives segment in the same security and to earn the differential in the prices in both the segments which starts reducing towards expiry. It is purely hedge position and not any kind of investment.
• The jobber takes a position in liquid scrips with good price movement in anticipation of profit and encashes the profit or loss immediately within a very less time gap in small price difference to earn profits. He takes generally quantitative positions in scrips and the buy-sell price margin is not much.
• While Arbitrage is concerned with working with the difference in prices of same shares or other financial instruments I products within two segments of exchanges such as It may be BSE cash to NSE cash/NSE F&O Or NSE Cash to BSE cash / NSE F&O and Spread F&O to F&O It is also done on Call & Put.
Dimensions of arbitrage / jobbing business can be summarized as under :-
Sometimes the price of a stock in the cash market is lower or higher than it should be, in comparison to its price in the derivatives market. Arbitrageurs exploit these imperfections and inefficiencies to their advantage Arbitrage trade is a low risk trade where simultaneous purchase of securities is done in one market and a corresponding sale is carried out in another market. These are clone when the same securities are being quoted at different prices in two markets. To understand this proposition, let us have an example of XYZ Ltd., suppose the cash market price is Rs 1000 per share, it may be quoting at Rs.1010 in the futures market. An arbitrageur would purchase 100 shares of XYZ Ltd. at Rs 1000 in the cash market and simultaneously, sell 100 shares at Rs.1010 per share in the futures market, thereby gaining Rs.10 per share on the day that the futures contract expires this is because in the Indian markets, there is no delivery of shares in order to settle positions in the derivatives segment as you will see later, the cash and future prices converge on the expiry day, and a trader merely pays or receives the 'difference between his purchase price and the price prevailing in the cash market on the day the contract expires. For now, all one needs to know is that by holding the position i.e. purchase of 100 shares in the cash market at Rs 100 and selling 100 shares in the futures market at Rs 110) until a specific date in the near future (expiry date of the futures contract), one can make a risk free return of Rs 10 per share that have been bought and sold, a net profit of Rs 1000 for taking no risk at all."
The benefits of carrying out the arbitrage can be listed as follows :- i. It is an attempt to profit by exploiting price differences of identical or similar financial instruments, on different markets or in different forms results in risk less business. ii. Profiting front differences in prices or yields in different markets, 'Arbitrageurs' buy a commodity, currency, security or any other financial instrument in one place and immediately sell it at a higher price to a ready buyer at another place completing both ends of the transaction usually within a time span. Arbitrage is a risk-free transaction because it involves dealings were returns and prices are definite, fixed, and known. iii. The simultaneous purchase and sale of an asset: in order to profit from a difference in the price. It is a trade that profits by exploiting price differences of identical or similar financial instruments, on different markets or in different forms. iv. Arbitrage refers to the opportunity of taking advantage between the price difference between two different markets for that same stock or commodity.
A very important and peculiar feature is that the final ultimate position is generally in profit. Le. loss if any in cash segment is always less than the profit in Derivatives segment or vice and versa.
3.3.5. A very important and peculiar feature is that the final ultimate position is generally in profit. Le loss if any in cash segment always less than the profit in Derivatives segment or vice and versa. Therefore, considering only the loss on the cash segment, but not considering the simultaneous profit incurred in the derivatives segment or vice-a-versa would result in a view contrary to the Principles of Arbitrage/Jobbing Business. The Appellant being in Arbitrage business, purchases shares in one segment and simultaneously sell the same shares in the other segment and when the price parity reduces, the transactions is reversed in both the segments which is a normal hedging practice. All the four legs of the transaction have to be consolidated and then only the profit / loss can be derived which is the essential Ingredient of the Arbitrage/Jobbing transactions. It is a matter of fact and record that Ld.AO has considered only one leg of the arbitrage transaction i.e the Transaction of the Cash segment ignoring that the Derivative Segment ( F & 0) i.e the other side of the Transaction.
3.3.6. A bare perusal of the explanation to section 73 revealed that the said Explanation is for the purpose of section 73 of the Act and applies to those company whose business consists of purchase and sale of shares subject to conditions specified therein then only, it shall be deemed to be speculation business to the extent to which the business consists of the purchase and sale of shares. The Appellant has earned profit in one segment and incurred loss in the other segment but overall considering all the aspects, the net is normally' always in profit. Considering the figure of only one segment without offsetting the result of the transactions on the other segment would result in absurdity. If so, the opposite segment transaction should also be considered as a speculation. A script wise summary data for both the segments reflecting profit in one segment vis-a-vis loss in another segment in the same scripts which is a typical phenomenon of arbitrage has been placed on record and verified by the undersigned revealed the exact nature of appellant business. The appellant had submitted summary script wise for four categories namely -- i. Scripts where there was Profit in F&O segment and loss in Cash segment, ii. Scripts where there was Loss in F&O segment and Profit in Cash segment, iii. Scripts where there was profit in both the segments, & iv. Scripts where there was Loss in both the segments 3.3.7. The appellant drew my attention to Page 96 to 101 of the paper Book which gives a summary of the transactions to prove that all the transactions in 'both the segments were peculiar arbitrage transactions. It can be seen that in the end of the year positions in Cash and F & O segment had same exactly opposite positions which is a peculiar feature of an Arbitrage transaction. The time records of transactions in Cash and F & O segments were perused and it is apparent that as soon as a position is taken in cash segment, an equivalent or near to equivalent subject to the lot size, reverse position is taken on F & O segment within a fraction of time in order to capitalize the difference in price in both the segments. The 12 days end of the day position on expiry day of all the F & O settlement where the appellant had opposite position in cash segment and futures segment. (Refer Page Nos. 107 to 184). In a 12 days tentative positions on any day of where appellant had exactly opposite position in cash segment and futures segment. (Refer Page Nos. 185 to 280 of the paper book). Totally there are approximately 240 days of working days in the whole financial and the appellant submitted 24 days break up i.e approximately 10 % over all and an examination of the same revealed the similar status as observed above.
3.3.8. It is a settled position in law that the price of F& 0 contract is derived from its underlying asset in cash segment and there is some difference in the price of F & O contract from the cash market price which gradually reduces towards the expiry which is the last Thursday of every month. Taking an opposite position in F&O market for the position in cash market is actually a hedge position and the arbitrageur earns on net basis is only due to the differential in the prices in both markets. It is accepted by the appellant that there have been certain transactions which have been transacted only in the Cash Segment and No cross positions in the Derivative Segment has been taken or made which is enclosed herewith and marked as Annexure-A. However, Ld. AO failed to appreciate the fact that shares held as stock in trade as on 31-03-2009 and the reversal position in F & 0 segment which is exactly the same as that of Stock in Trade thus shows that even if the transactions in the sheets provided, other than those covered in Annexure "A" above, in clause 11, are settled within the period as reversal has taken place at some time or the other, in either of the segment, which is enclosed as Annexure" 8" to the submissions made by the appellant.
3.3.9. It is a matter of record that even in cash segment appellant has earned a net profit of Rs.7,97,728/- . Thus in the overall Income of 2.86 crores arbitration, the Transactions which exclusively has been made in the Cash Segment there is a profit of Rs. 7.98 lakhs, leaving a Balance of Rs. 2.78 crores of Income where both the corresponding Transactions is done in both the segments i.e Cash as well as Derivative (F & O) Segment. In view of the above, it is clear that transactions are genuine and bona fide Transactions in the nature of Arbitrage/ Jobbing. In the present case, the appellant- had clearly put on record the explanation and the reasons explaining the how the transactions of the arbitration/ Jobbing takes place and the appellant's position Stock in Trade as on 31 st day of March is exactly reverse that of the outstanding as on that day in the F & 0 segment. Importantly, this explanation has not been rebutted I controverted with any cogent material, nor has the A.O looked into the complete transactions as submitted by the appellant. In order to understand the true nature of the transaction in question few transactions are discussed as under:-
Aban Offshore Ltd (Refer-Annexure C)
Transaction of 04-08-2008 The A.O has taken the Transaction of 252 shares executed on 04/08/2008 as one Transaction the facts are as follows; The First Transaction on that day in the Cash segment was 50 Shares Bought at 14.17.31 (Hrs.mins.Sec) Hrs and which was simultaneously Sold in the F & 0 Segment on 14.17.33 Hrs, i.e at the Difference of 02 Seconds.
The Second Transaction on that day in the Cash segment was 50 Shares Bought at 14.19.24 (Hrs.mins.Sec) Hrs and which was simultaneously Sold in the F & 0 Segment on 14.19.32 Hrs. i.e at the Difference of 08 Seconds.
The Third Transaction on that day in the Cash segment was 50 Shares Bought at 14.21.09 (Hrs.mins.Sec) Hrs and which was simultaneously Sold in the F & 0 Segment on 14.21.12 Hrs, i.e at the Difference of 03 Seconds.
The Fourth Transaction on that day in the Cash segment was 50 Shares Bought at 14.23.24 (Hrs.mins.Sec) Hrs and which was simultaneously Sold in the F & 0 Segment on 14.23.02 Hrs, i.e the Transaction was first carried out on F & 0 segment and then on Cash Segment at the Difference of 22 Seconds.
On the Same Day, i.e at 14.17.49 Hrs, the Order for 50 Shares was placed, out of which only 2 shares was received in the Cash Segment, since the order could not be fully executed these 2 shares were sold immediately at 14.18.17 Hrs i.e at ·the difference of just 28 seconds, in the same segment. Please take note that the simultaneous Transaction on F & 0 segment could not be carried out as the Minimum Lot Size of the F & 0 segment in this Script is 50.
Another transaction of Buying of 50 shares in the cash segment was done at 14.21.30 Hrs and the Order for sale was placed in the F & 0 segment at 14.21.31 Hrs. The order for sale did not get executed in the F & 0 segment and therefore the Transaction of the said 50 Shares was immediately reversed in the Cash segment at 14.21.50 Hrs i.e. Within 20 seconds.
Thus overall 252 shares were bought and sold during the Day which the Ld. AO. has considered to be one Transaction but are actually interrelated to the each of the. segment where a Arbitrageur has to take a call in fractions of seconds in respect of his positions. ii. Transactions of 05/08/2008 The AO has taken the Transaction of 20 shares executed on 05/08/2008 as one Transaction facts are narrated as under; In the First Transaction, an Order for 100 Shares was placed at 11.12.28 (Hrs.mins.Sec) Hrs in the BSE Cash Segment, out of which only 10 shares was received, since the order could not be fully executed out of these 1 0 shares, 5 shares each were sold immediately at 11.12.38 Hrs & at 11.12.53 respectively in NSE Cash Segment i.e at the difference of just 10 & 25 seconds respectively at a Marginal Profit in the Different exchange.
The Second Transaction on that day in the Cash segment was 10 shares sold in BSE Cash segment at 11.23.32 (Hrs.mins.Sec) Hrs and simultaneously 10 Shares Bought in the NSE Cash Segment at 11.23.50 (Hrs.mins.Sec), i.e at the Difference of 18 Seconds, on which also the Appellants have earned a marginal profit.
Thus overall 20 shares were bought and sold during the Day which the Ld. AO. has considered to be one Transaction but are actually interrelated to the each of the segment where a Arbitrageur has to take a call in fractions of seconds in respect of his positions. iii. Transactions on 08-08-2008 The AO has taken the Transaction of 197 shares in Cash Segment and 50 script in F & O segment executed on 08/08/2008 as one but independent Transactions each other, however, the correct position is as under; In the First Transaction 50 Shares were sold in the BSE Cash segment at 11.56.15 (Hrs.mins.Sec) Hrs and simultaneously the Said 50 Shares were Bought immediately in the NSE Cash segment at 11.56.31 Hrs i.e. within 16 seconds at no Profit No loss basis.
The Second Transaction on that day in the NSE Cash segment, the Order for 50 shares was placed at 12.01.44 Hrs, out of which only 5 shares was received, since the order could not be fully executed these 5 shares were sold immediately at 12.03.44 Hrs in the BSE Cash segment at a Profit. Please take note that the simultaneous Transaction on F & O segment could not be carried out as the Minimum Lot Size of the F & O segment in this Script is 50.
The Third Transaction on that day in the NSE Cash segment was 10, 1 & 9 Shares Sold at 12.19.17, 12.20.34 & 12.23.38 (Hrs.mins.Sec) Hrs respectively and which was simultaneously Bought in the BSE Cash Segment on 12.19.24, 12.19.42 & 12.19.42 Hrs respectively which was done on a No profit No Loss basis.
The Fourth Transaction on that day in the BSE Cash segment was 10 Shares Bought at 12.26.32 (Hrs.rnins.Sec) Hrs and which was simultaneously sold in the NSE Cash Segment on 12.27.39 Hrs. i.e. at the difference of 07 seconds. The Fifth Transaction on that day in the NSE Cash segment was 10 Shares Sold at 12.28.27 (Hrs.mins.Sec) Hrs and which was simultaneously bought in the BSE Cash Segment on 12.27.48 Hrs. i.e. at the difference of 39 seconds.
The Sixth Transaction on that day in the BSE Cash segment was 10 Shares Sold at 12.34.30 (Hrs.mins.Sec) Hrs and which was simultaneously bought in the NSE Cash Segment on 12.30.32 Hrs. i.e. at the difference of 02 seconds.
The Seventh Transaction on that day in the BSE Cash segment was 50 Shares Bought at 13.35.07 (Hrs.mins.Sec) Hrs and which was simultaneously sold in the F & O Segment on 13.35.09 Hrs, i.e. at the Difference of 02 Seconds.
The Eight Transaction on that day in the F & 0 segment was 50 Shares Bought at 12.02.10 (Hrs.mins.Sec) Hrs and which was simultaneously sold in the BSE Cash Segment on 12.02.44 Hrs, i.e. at the Difference of 34 Seconds.
The Ninth Transaction on that day in the NSE Cash segment was 6 Shares sold at 12.07.23 (Hrs.rnins.Sec) Hrs the same was Bought in the NSE Cash Segment at 12.07.45 Hrs.at a marginal profit. This Transaction was also carried out to understand the nerve and depth of the Script.
The Tenth transaction on that day in BSE Cash segment was the order for Buying of 50 shares was placed at 11.53.51 Hrs and simultaneous the Order for sale was placed in the F & O segment at 11.53.00 Hrs. The order for Buying did not get fully executed in the BSE Cash segment and only 11 shares were received and therefore the Transaction of the Said 11 Shares was immediately reversed in the BSE Cash segment at 11.54.17 Hrs.
The another transaction on that day in BSE Cash segment was the order for Buying of 50 shares was placed at 13.35.00 Hrs and simultaneous the Order for sale was placed in the F & O segment at 13.35.15 Hrs. The order for Buying did not get fully executed in the BSE Cash segment and only 20 shares were received and therefore the Transaction of the Said 20 Shares was immediately reversed in the BSE Cash segment at 13.35.07 Hrs.
Thus overall 197 shares and 50 scripts were bought and sold during the Day in various Segments which the Ld. AO. has considered to be one Transaction but are actually interrelated to the each of the segment where a Arbitrageur has to take a call in fractions of seconds in respect of his positions. iv. Transactions on 28/08/2008 The AO has taken the Transaction of 200 shares executed on 28/08/2008 as one Transaction, the correct position as under; The First Transaction on that day in the Cash segment was 50 Shares Bought at 10.13.03 (Hrs.mins.Sec) Hrs and which was simultaneously Sold in the F & O Segment on 10.12.56 Hrs, i.e. the Transaction was first carried out on F & O Segment and then on Cash Segment at the Difference of 06 Seconds.
The Second Transaction on that day in the Cash segment was 50 Shares Bought at 10.15.02 (Hrs.mins.Sec) Hrs and which was simultaneously Sold in the F & 0 Segment on 10.14.58 Hrs, i.e. the Transaction was first carried out on F & 0 Segment and then on Cash Segment at the Difference of 04 Seconds.
The Third Transaction on that day in the Cash segment was 50 Shares Bought at 10.15.22 (Hrs.mins.Sec) Hrs and which was simultaneously Sold in the F & 0 Segment on 10.15.18 Hrs, i.e. the Transaction was first carried out on F & O Segment and then on Cash Segment at the Difference of 04 Seconds.
The Fourth Transaction on that day in the Cash segment was 50 Shares Bought at 10.17.33 (Hrs.mins.Sec) Hrs and which was simultaneously Sold in the F & 0 Segment on 10.17.23 Hrs, i.e the Transaction was first carried out on F & 0 Segment and then on cash Segment at the Difference of 10 Seconds.
Thus overall 200 shares were bought and sold during the Day which the Ld. AO has considered to be one Transaction but are actually interrelated to the each of the segment where a Arbitrageur has to take a call in fractions of seconds in respect of his positions.
V. Transactions on 06-11-2008 The AO has taken the Transaction of 257 shares executed in Cash Segment and 350 scripts in F & a Segment on 06/11/2008 as one, but independent transactions, the details are as under; The First Transaction on that day in the Cash segment was 50 Shares Bought at 10.08.56 (Hrs.mins.Sec) Hrs and which was simultaneously Sold in the F & a Segment on 10.08.52 Hrs, i.e. the Transaction was first carried out on F & a segment and then on Cash Segment at the Difference of 04 Seconds.
The Second Transaction on that day in the Cash segment was 50 Shares Bought at 10.09.30 (Hrs.mins.Sec) Hrs and which was simultaneously Sold in the F & a Segment on 10.09.50 Hrs, i.e at the Difference of 20 Seconds.
The Third Transaction on that day in the Cash segment was 50 Shares Bought at 10.10.08 (Hrs.mins.Sec) Hrs and which was simultaneously Sold in the F & a Segment on 10.09.53 Hrs, i.e the Transaction was first carried out on F & a segment and then on Cash Segment at the Difference of 17 Seconds.
The Fourth Transaction on that day in the Cash segment ~as 50 Shares Bought at 10.10.43 (Hrs.mins.Sec) Hrs and which was simultaneously Sold in the F & a Segment on 10.10.50 Hrs, i.e at the Difference of 07 Seconds.
The Fifth Transaction on that day in the Cash segment was 50 Shares Bought at 10.21.39 (Hrs.mins.Sec) Hrs and which was simultaneously Sold in the F & a Segment on 10.21.31 Hrs, i.e the Transaction was' first carried out on F & a segment and then on Cash Segment at the Difference of 08 Seconds.
The Sixth Transaction on that day in the Cash segment was 50 Shares Sold at 12.49.46 (Hrs.mins.Sec) Hrs and which was simultaneously Bought in the F & O segment on 12.21.39 Hrs, i.e the Transaction was first carried out on F & O segment and then on Cash Segment at the Difference of 07 Seconds.
The Seventh Transaction on that day in the Cash segment was 50 Shares Sold at 12.53.36 (Hrs.mins.Sec) Hrs and which was simultaneously Bought in the F & O Segment on 12.53.31 Hrs, i.e the Transaction was first carried out on F & O segment and then on Cash Segment at the Difference of 05 Seconds.
The Eight Transaction on that day in the Cash segment was 50 Shares Sold at 13.02.20 (Hrs.mins.Sec) Hrs and which was simultaneously Bought in the F & O Segment on 13.02.18 Hrs, i.e the Transaction was first carried out on F & O segment and then on Cash Segment at the Difference of 02 Seconds.
The Ninth Transaction on that day in the Cash segment was 50 Shares Sold at 13.03.21 (Hrs.mins.Sec) Hrs and which was simultaneously Bought in the F & O Segment on 13.03.18 Hrs, i.e the Transaction was first carried out on F & O segment and then on Cash Segment at the Difference of 03 Seconds.
The Tenth Transaction on that day in the Cash segment was 50 Shares Sold at 14.37.42 (Hrs.mins.Sec) Hrs and which was simultaneously Bought in the F & O Segment on 14.37.39 Hrs, i.e the Transaction was first carried out on F & O segment and then on Cash Segment at the Difference of 03 Seconds.
On the Same Day, i.e. at 10.18.39 Hrs, the Order for 50 Shares was placed, out of which only 1 share was received in the Cash Segment, since the order could not be fully executed that 1 share was sold at 12.53.13 Hrs in the Same segment. Please take note that the simultaneous Transaction on F & O segment could not be carried out as the Minimum Lot Size of the F & O segment in this Script is 50. The another Transaction on that day in the Cash segment was 6 Shares Bought at 13.06.09 (Hrs.mins.Sec) Hrs and 1, 2, 2 & 1 shares respectively were Sold in the Same Segment on at 12.54.11, 12.56.11, 12.56.48 & 12.57.12 Hrs respectively, i.e. the Transaction was first carried out for sale and then for Buy in the same segment. These transactions in smaller quantities were carried out to understand the nerve and depth of the market.
Another transaction of Buying of 50 scripts in the F & O segment was done at 13.02.35 Hrs and the Order for sale was placed in the Cash segment at 13.02.45 Hrs. The order or sale did not get executed in the Cash segment and therefore the Transaction of the said 50 Shares was immediately reversed in the F & 0 segment at 13.02.50 Hrs i.e. within 05 seconds.
Another transaction of Buying of 50 scripts in the F & O segment was done at 14.37.43 Hrs and the order for sale did not get executed in the Cash segment and therefore the Transaction of the Said 50 Shares was immediately reversed in the F & O segment at 14.38.00 Hrs i.e. within 23 seconds.
Thus overall 257 shares and 350 scripts were bought and sold during the Day which the Ld. AO has considered to be one and independent Transactions but are actually interrelated to the each of the segment where a Arbitrageur has to take a call in fractions of seconds in respect of his positions.
If the loss on cash segment is considered without considering the simultaneous profit incurred in derivatives segment or vice versa would result in a view that is absolutely divorced from the facts and contrary to the principles of arbitrage/jobbing business. The appellant who is in arbitrage business purchases shares in one segment and simultaneously sell the same shares in the other segment and when the price parity reduces, the transactions is reversed in both the segments which is a normal hedging practice. All the four legs of the transaction have to be consolidated arid then only the profit / loss can be derived which is the essential ingredient of the Arbitrage/Jobbing transactions.
In the present case, if the transaction only in one segment, i.e. to say cash segment is considered, then it is seen that the appellant earned a net profit of Rs.7,97,728/-. Thus, in the overall income of 2.86 crores arbitration, the transactions which exclusively has been made in the cash segment, there is a profit of RS.7.98 lacs, leaving a balance of Rs. 2.78 crores of Income where both the corresponding transactions is done in both the segments, i.e. cash as well as derivative (F & 0) segment. In view of this, the appellant submitted that if transaction which has been exclusively made in cash segment, corresponding transaction in derivative is deemed speculation transaction. Thus, the appellant submitted that a net profit of Rs.7,97,728/- has been earned and thus, Expln. To Sec. 73 is not applicable in the, appellant's case. 3.3.10. The transaction of the appellant when examined as per the details on record revealed that these are pure arbitrage and jobbing transactions, Ld. AO failed to appreciate the essence of arbitrage as it does not necessarily have a vis-a-vis position after each transaction. In cash segment the marketable lot is 1 and in derivatives segment the marketable lot can be 50/100/200 etc depending on the script. In view the above, the additions made by Ld. AO cannot be sustained on facts of the appellant's case as it is carrying out the arbitrage activity and the transaction under reference cannot be looked independently of the Transaction undertaken in the other segment or exchange. Without prejudice even if the profits from Arbitrage Transaction is to be considered as speculative in nature be set-off against the alleged loss from cash segment need to be allowed before arriving at a net profit from the similarly placed transactions. It is only thereafter that profit and loss so arrived can be further taken up for carry forward and set of as per the extant provisions of section 73 of the Act. Further, I find that Explanation to section 73 is not applicable to the Arbitrage/Jobbing Transaction as the said Explanation requires that the entire transactions pertaining to Shares & Securities of the assessee need to be considered before arriving at the profit or loss. The Explanation states that for the purpose of section 73 of the Act, the business of the company consisting of purchase and sale of shares shall be deemed to be speculation business to the extent to which the business consists of the purchase and sale of shares in case the condition as specified therein are met. The Appellant in this case has earned profit in one segment and incurred loss in the other segment but considering the overall picture, i.e. all the aspects of the Arbitrage Activity, the net is normally always in profit. Considering the figure of only one segment without offsetting the result of the transactions in the other segment would result in absurdity.
3.3.11 From the foregoing discussion it is clear that that the arbitrage activity cannot be broken up and one limb of the said activity i.e., purchase and sale of shares in the cash segment be considered to be speculation as per explanation and the other limb i.e, sale and purchase of stock futures in the F & O segment be considered to be normal business activity, especially when the appellant company are not indulging in trading activity but-are. engaged in the business of arbitrage operations. Further my findings are supported by the following judicial decisions:-
In case of Arion Commercial Pvt Ltd, 0/Kol/2011, it is held that "trading of shares which is done by delivery transactions are not hit by Section 43(5) as speculation. Similarly, derivative transaction in shares profit/loss is also not hit by Section 43(5) of the Income Tax Act, which deals about speculation transaction. As such, both profit loss from all the share delivery transactions & derivative transactions are having the same meaning, so far as, section 43(5) of the Income Tax Act is concerned. It is further held that, once the transactions done by delivery as well as the transactions of den vat Ives are not hit by Section 43(5) of the Act, the aggregation of the share trading loss and profit from derivative transactions should be done before the application of explanation to section 73 of the Income Tax Act is applicable. b. In case of Shree Capital Services Ltd Vs ACIT, ITA No. 1294(Kol) of 2008, the Hon. ITAT, Kolkata, has held that F & 0 shall be treated in same line with cash and vice versa. c. In case of DCIT vs Loknath Saraf Securities Ltd , ITA No. 695/Kol/2008, the Hon. IT AT has held that different treatment of transactions in a composite business, cannot be said to be different business. d. In case of Chirag Tanna Vs ACIT, ITA No. 4227/Mum/2010, the Hon. ITAT has held that, derivatives transactions entered into by the assessee at the recognized stock exchanges are to be treated as covered by the exclusion clause set out in Sec. 43(5)(d) of the act and also the arbitrage 1 jobbing transactions carried out by the assessee are not speculative transactions. e. In case of ITO Vs Arena textiles & Industries Ltd, ITA No. 1019/Kol/2011, the Hon. Ko!kata ITAT has held that, trading of a share which is done by delivery transactions are not hit by sec. 43(5) as speculation. Also, derivatives transactions in shares profit/loss is also not hit by sec. 43(5), which deals about speculative transactions. The transactions done by delivery as well as the transactions of derivatives are not hit by sec. 43(5), it is considered that the aggregation of share trading loss and profit from derivatives should be done before the application of Explanation of Sec. 73 of the I T Act is applicable.
Thus, from the above its evident that, arbitrage/jobbing transactions are non-speculative transactions and Sec. 73 is not applicable to the case of the appellant.
3.3.12 Without prejudice to my above stated findings that arbitrage/jobbing transactions are non-speculative transactions and Sec. 73 is not applicable to the case of the appellant as well as provisions of Explanation to section 73 are not applicable to the appellant case in view of finings of the Hon'ble jurisdictional High Court in the case of Darshan Securities(. Supra), even if it is held that the transaction are speculative than also profit of the F&O transaction are to be adjusted against the losses of cash transactions in view of decision of Arion Commercial Pvt Ltd. (supra) wherein it was held that trading of shares which is done by delivery transactions are not hit by Section 43(5) as speculation. Similarly, derivative transaction in shares profit/loss is also not hit by Section 43(5) of the Income Tax Act, which deals about speculation transaction. As such, both profit loss from all the share delivery transactions & derivative transactions are having the same meaning, so far as, section 43(5) of the Income is concerned. It is further held that, once the transactions done by delivery as well as transactions of derivatives are not hit by Section 43(5) of the Act, the aggregation of the share trading loss and profit from derivative transactions should be done before the application of explanation to section 73 of the Income Tax Act is applicable. As is evident from the extant provisions of the section 43(5) of the Act, that none of the transactions are speculative in nature and that they are all hedge transactions between the two segments. If at all one segment of the transaction is to be considered as speculative then, the opposite segment transaction should also be considered as a speculative , here again the loss in the cash segment need to be allowed as a set off against the derivative profit considering both are speculative in nature. Similar issue was also involved in the case of M/s. Arena Textiles & Industries ltd., Kolkata in for A.Y. 2008-09 before the Hon'ble ITAT, Kolkata. The grounds of appeal raised by the Revenue were as under :-
1. Whether on the facts and circumstances of the case and settled legal position, the Ld. CIT(A) is justified in holding that transactions in derivatives are not hit by section 43(5) of the I.T.Act.
2. Whether on the facts and circumstances of the case and settled legal position, the Ld. CIT(A) was justified on facts and in law in deleting the disallowance and addition of Rs.28,95,42,845/- treated as deemed speculation loss by the AO.
3. Whether on the facts and circumstances of the case and settled legal position, the Ld. CIT(A) is justified in holding that delivery- based share transactions does not fall in the ambit of Explanation to section 73 of the I.T.Act.
The Hon'ble ITAT after considering rival submissions has observed as under:-
• After hearing the rival submissions and on careful perusal of materials available on record, we are of the view that trading of shares which is done by delivery transactions are not hit by Section 43(5) as speculation. Similarly, derivative transaction in 9 shares profit/loss is also not hit by Sec.43(5) of the I.T Act, which deals about speculation transaction. As such, both profit/loss from all the share delivery transactions and derivative transactions are having the same meaning, so far as Sec.43(5) of the I. T Act is concerned.
• When once we held that the transactions done by delivery as well as the transactions of derivatives are not hit by Sec. 43(5) of the Act it is in our considered view that the aggregation of the share trading loss and profit from derivative transactions should be done before the application" of the Explanation to Sec. 73 of the I. T Act is applicable.
Thus, Hon'ble ITAT in this case has held that aggregation of share trading loss and profit from derivative transaction should be done before the application of Explanation to Section 73 of the I.T.Act is applicable.
This position is further supported by the Hon'ble Delhi High Court's Judgement in the case of CIT v/s DLF Commercial Developers Ltd. [ITA No. 94/2013 vide order dated 11.07.2013] wherein it has been held that Derivatives which derive their value from the underlying shares & securities cannot be exempted from the mischief of Explanation to Section 73 and are therefore to be considered as Speculative in nature. The Hcn'ble Delhi High Court has held as under:-
"9. In this context, it would be instructive to notice that in Rajashree Sugars and Chemicals Ltd (supra), the Madras High Court noticed, rather dramatically, that - .. 'Derivatives are time bombs and financial weapons of mass destruction' said Warren Buffett, one of the world's greatest investors, who overtook Microsoft Maestro in 2008 to become the richest man in the world and who is known as the 'Sage of Omaha or Oracle of Omaha'. Derivatives, according to him, can push companies on to a spiral that can lead to a corporate melt down .... The High Court then, after examining the nature and characteristics of derivatives transactions, observed that:
5. What are these 'derivatives' which have gained such a great deal of notoriety? In simple terms, derivatives are financial instruments whose values depend on the value of other underlying financial instruments. The International Accounting Standard (IAS) 39, defines derivatives" as follows:
A derivative is a financial instrument:
(a) whose value changes in response to the change in a specified interest rate, security price, commodity price, foreign exchange rate, index of prices or rates, a credit rating or credit index, or similar variable (sometimes called the 'underlying'); (b) that requires no initial net investment or little initial net investment relative to other types of contracts that have a similar response to changes in market conditions; and (c) that is settled at a future date.
Actually, derivatives are assets, whose values are derived from values of underlying assets. These underlying assets can be commodities, metals, energy resources, and financial assets such as shares, bonds, and foreign currencies. "
It is no doubt, tempting to hold that since the expression "derivatives" is defined only in Section 43 (5) and since it excludes such transactions from the odium of speculative transactions, and further that since that has not been excluded from Section 73, yet, the Court would be doing violence to Parliamentary intendment. This is because a definition enacted for only a restricted purpose or objective should not be applied to achieve other ends or purposes.
Doing so would be contrary to the statute. Thus contextual application of a definition or term is stressed; wherever the context and setting of a provision indicates an intention that an expression defined in some other place in the enactment, cannot be applied, that intent prevails, regardless of whether standard exclusionary terms (such as "unless the context otherwise requires") are used. In The Vanguard Fire & General Insurance Co. Ltd.. Madras v. M/s. Fraser And Ross & Anr AIR 1960 SC 971 it was held that:
"It is well settled that all statutory definitions or abbreviations must be read subject to the qualification variously expressed in the definition clauses which created them and it may be that even where the definition is exhaustive inasmuch as the word defined is said to mean a certain thing, it is possible for the word to have a somewhat different meaning in different sections of the Act depending upon the subject or the context. That is why all definitions in statutes generally begin with the qualifying words similar to the words used in the present case, namely, unless there is anything repugnant in the subject or context. Therefore in finding out the meaning of the word " insurer " in various sections of the Act, the meaning to be ordinarily given to it is that given in the definition clause. But this is not inflexible and there may be sections in the Act where the meaning may have to be departed from on account of the subject or context in which the word has been used and that will be giving effect to the opening sentence in the definition section, namely, unless there is anything repugnant in the subject or context. In view of this qualification, the court has not only to look at the words but also to look at the context, the collocation and the object of such words relating to such matter and interpret the meaning intended to be conveyed by the use of the words under the circumstances. "
Similarly, in N.K. Jain and Ors. v C.K. Shah and Ors. AIR 1991 SC 1289, it was held that:
"4. The subject matter and the context in which a particular word is used are of great importance and it is axiomatic that the object underlying the Act must always be kept in view in construing the context in which a particular word is used.
The stated objective of Section 73- apparent from the tenor of its language is to deny speculative businesses the benefit of carry forward of losses. Explanation to Section 73 (4) has been enacted to clarify beyond any shadow of doubt that share business of certain types or classes of companies are deemed to be speculative. That in another part of the statute, which deals with computation of business income, derivatives are excluded from the definition of speculative transactions, only underlines that such exclusion is limited for the purpose of those provisions or sections. To borrow the Madras High Court's expression, -derivatives are assets, whose values are derived from values of underlying assets; in the present case, by all accounts the derivatives are based on stocks and shares, which fall squarely within the explanation to Section 73 (4). Therefore, it is idle to contend that derivatives do not fall within that provision, when the underlying asset itself does not qualify for the benefit, as they (derivatives – once removed from it and entirely dependent on stocks and shares, for determination of their value).
In the light of the above discussion, it is held that the Tribunal erred in law in holding that the assessee was entitled to carry forward its losses; the question framed is answered in favour of the revenue and against the assessee. The appeal is therefore allowed there shall be no order as to ..” Therefore, the Hon'ble Delhi High Court has categorically observed that the provisions of Section 73 of the Act would be applicable even in the case of derivatives to the extent they are backed by stock and shares. Therefore, if the AO invoked the provision of the explanation of Sec. 73, the entire transaction of the appellant become speculative for this purpose as per Delhi High Court and the appellant is entitled for the set off which will make the addition nullified as made by the AO. 3.3.13. In view of the foregoing discussion wherein in both circumstances of treating the transactions as speculative or non speculative, the set off has to be allowed, the addition made by the Ld. AO cannot be sustained both on facts and circumstances of the appellant's case, the same are accordingly deleted. This ground of appeal is allowed.”
4. Against the above order of CIT(A), assessee is in further appeal before us.
5. We have considered rival contentions and carefully gone through the orders of authorities below as well as judicial pronouncements relied on by ld. CIT(A) while coming to the conclusion that Explanation to Section 73 of the Act would not be applicable in the case of derivatives to the extent they are backed by stock and shares. Therefore, if the AO invoked the provision of the explanation of Section 73, the entire transaction of the assessee become speculative for this purpose. This view of CIT(A) is supported by Hon’ble Delhi High Court in the case of DLF Commercial Developers Ltd., order dated 11-7- 2013. We found that in the instant case the assessee being in the arbitrage business, purchased shares in one segment and simultaneously sales the other shares and other segments and when the price parity reduces, the transactions is reversed in both the segments which is a normal hedging practice. All the four legs of the transaction have to be consolidated and then only the profit/loss can be derived which is the essential ingredient of the Arbitrage/Jobbing transactions. However, in the instant case, the AO has considered only one leg of the arbitrage transaction i.e. the transaction of the cash segment ignoring that the derivative segment (F&O) i.e. the other side of transaction. We found that assessee has earned profit in one of the segment and incurred loss in the other segment but overall considering all the aspects, the net is always in profit. Considering the figure of only one segment without offsetting the result of the transactions on the other segment would result in absurdity.