Derivatives will also fall within meaning of `commodity'

ITAT, SPECIAL BENCH, KOLKATA

Shree Capital Services Ltd.

v.

ACIT

ITA No. 1294 (Kol) of 2008

July 31, 2009

RELEVANT EXTRACTS:

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5.1. Section 43(5), as it stood during assessment year under consideration, i.e. AY 2004-05, reads as under :-

"5) "speculative transaction" means a transaction in which a contract for the purchase or sale of any commodity, including stocks and shares, is periodically or ultimately settled otherwise than by the actual delivery or transfer of the commodity or scripts:

Provided that for the purposes of this clause-

(a) a contract in respect of raw materials or merchandise entered into by a person in the course of his manufacturing or merchanting business to guard against loss through future price fluctuations in respect of his contracts for actual delivery of goods manufactured by; him or merchandise sold by him; or

(b) 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; or

(c) a contract entered into by a member of a forward market or a stock exchange in the course of any transaction in the nature of jobbing or arbitrage to guard against loss which may arise in the ordinary course of his business as such member."

From the above it is clear that speculative transaction is a transaction in which contract for purchase and sale of any commodity is settled otherwise than by actual delivery. It is not in dispute that in the case of transaction in derivatives, the transaction is always settled otherwise than by actual delivery. However, it was contended by the learned counsel that Sec. 43(5) is applicable only in respect of contract for purchase and sale of commodity. His contention was that the derivative is not a commodity and, therefore, Sec. 43(5) would not be applicable at all. The Ld. Departmental Representative has furnished before us the print out taken from the Website of SEBI explaining the term "derivative", which reads as under :-

"The term "Derivative" indicates that it has no independent value, i.e. its value is entirely 'derived" from the value of the underlying asset. The underlying asset can be securities, commodities, bullion, currency, live stock or anything else. In other words, Derivative means a forward, future, option or any other hybrid contract of pre-determined fixed duration, linked for the purpose of contract fulfillment to the value of a specified real or financial asset or to an index of securities."

From the above it is clear that the derivatives derive its value from the underlying asset. The underlying asset can be securities, commodities, bullion, currency etc. Sec. 2(ac) of the Securities Contracts (Regulation) Act, 1956 also defines the term "derivative" as under :-

"(ac) "derivative" includes-

(A) a security derived from a debt instrument, share, loan, whether secured or unsecured, risk instrument or contract for differences or any other from of security;

5.2. In the appeal under consideration before us, it was fairly admitted by the assessee's counsel that the underlying assets in the derivatives dealt with by the assessee were shares of certain companies. Before interpreting the term "commodity", it would be useful to refer to the decision of Hon'ble Apex Court in the case of CU Vs. B. Suresh (supra) relied upon by the Ld. Departmental Representative, which gives an important guideline for interpreting the words keeping in view the technical advancement. In the case of B. Suresh (supra), the assessee claimed deduction u/s. 80HHC in respect of foreign exchange earned by him by transfer of feature film rights for exploitation outside India. The transfer of right was by way of lease. The same was denied by the department on the ground that there was no sale of any goods or merchandise. The Appellate Tribunal and the High Court held that the assessee was entitled to deduction u/s. 80HHC. On appeal by the department, their Lordships of Hon'ble Apex Court held as under at pages 153 & 154 of the Report :-

"Findings : Two questions arise for determination, namely, whether foreign exchange earned by transfer of feature film rights for exploitation outside India, in the form of lease, is entitled to the benefit of section 80HHC deduction. The same is denied by the Department on the ground that there is no "sale". The other question is whether such "rights" are goods merchandise.

The basic requirement of section 80HHC is earning in foreign exchange and retention of profits for export business. Profits are embedded in the "income" earned. Today the difference between the two is getting blurred with globalization and cross-border transaction. Today with technological advancement one has to change our thinking regarding concepts like goods, merchandise and articles. In the case of B Suresh, the assessee had bought rights of various decoders and had recorded movies on beta-cam-tapes which were transferred as telecasting rights to Star TV for five years (it has a limited life). Hence, such "rights" would certainly fall in the category of articles of trade and commerce, hence merchandise.

On the question as to whether transfer of the said rights by way of lease would attract section 80HHC, we find merit in the contention that under rule 9A and rule 9B, the word "lease" is included in the meaning of the word "sale".

Lastly, we find no infirmity in the judgment of the Bombay High Court in the case of Abdulgafar A. Nadiadwala [2004] 267ITR 488. "[Emphasis supplied]

Thus, their Lordships have held that due to technological advancement, one has to change his thinking about various concepts like goods, merchandise and articles. The above observation would be squarely applicable while interpreting the word "commodity". In Sec. 43(5), the term "commodity" has been given a wide meaning because it is mentioned that any commodity includes stocks and shares. Therefore, even if in common parlance the term "commodity" may not include any stocks and shares, but the legislature for the purpose of sec. 43(5) provided that the term "commodity" would include stocks and shares. This makes the intention of the legislature clear that they used the term "commodity" in a very wide manner. Sec. 43(5) was brought on the Statute decades back when there was no concept of trading in derivatives. Therefore, naturally the Legislative will not mention the word 'derivatives' in Sec. 43(5). However, it has been provided that the term 'commodity' would include stock and shares. Thus the securities represented by stock and shares are included in the term 'commodity'. The derivatives are also securities. Derivative derives its value from the underlying assets. In other words, the underlying assets are represented by derivatives. When the underlying asset of any derivative is share and stock for all practical purposes, the treatment given to such derivatives should be similar to stock and securities. In the case under appeal before us, it is admitted that the underlying asset is shares. Therefore, in our opinion, derivatives will also fall within the meaning of 'commodity' used in Sec. 43(5). We may also mention that Finance Act, 2005 has provided that certain transactions in respect of trading in derivatives shall not be deemed to be speculative transactions within the meaning of Sec. 43(5). If the transaction in derivatives does not fall within the definition of 'speculation transaction' u/s. 43(5), then there was no question of exempting certain type of transaction in derivatives from the scope of speculative transaction u/s. 43(5). If it is held that the transaction in derivatives does not fall in Sec. 43(5), it will make clause (d) and Explanation thereto below Sec. 43(5) introduced by Finance Act, 2005 to be redundant. In furtherance to the above Explanation, the Central Govt, has also framed Rules, i.e. Rules 6DDA and Rule 6DDB. It cannot be presumed that the Government has introduced a clause, i.e. clause (d) as well as Explanation thereto, which was redundant and infructuous.

5.3. In view of above, we hold that the term 'derivatives' in which underlying asset is shares, will fall within the meaning of 'commodity' used in Sec. 43(5) of the Act.