Whether Speculative or Not

INTRODUCTION-

In the realm of taxation under the Income Tax Act, the classification of transactions as speculative or non-speculative carries significant implications for businesses and individuals alike. This article aims to demystify these classifications, providing a comprehensive understanding of what constitutes a speculative transaction and what does not. We delve into the nuances of these terms, their tax treatment, and the impact they have on the computation of taxable income. Whether you’re a seasoned investor, a business owner, or simply an individual looking to understand the tax implications of your financial decisions, this article serves as a guide to navigate the complex landscape of speculative and non-speculative transactions under the Income Tax Act.

BRIEF –

The participants of the stock market and broadly be categorised as participants of cash segment or participants of derivative segment.

Cash Segment-

The cash segment in Share Markets refers to the marketplace where actual buying and selling of shares take place. In this segment, traders buy or sell securities such as stocks in exchange for immediate delivery and payment. The transactions are settled on a ‘T+1/2’ basis, which means the settlement of trades (transfer of shares against funds) happens one/two working days as the case may be after the trade day.

There are two types of transactions that can be undertaken in the cash segment:

1. Intraday Trading: In intraday trading, the trader buys and sells the shares within the same trading day. The intention is not to invest but to earn profits by harnessing the movement of stock indices. Therefore, the shares bought are not intended to be held for long term. The trader squares off his position by the end of the trading session.

2. Positional Trading or Investing: In positional trading or investing, the trader buys the shares and holds them for more than one day. They are not necessarily squared off at the end of the trading session. These transactions result in the delivery of shares where the shares are actually transferred to the trader’s demat account. The trader can hold these shares for as long as they want. This is also known as `Delivery Based Trading’.

It’s important to note that the choice between intraday trading and positional trading depends on the trader’s individual strategy, risk appetite, and market understanding. The actions of market participant being Intra Days Trader or a delivery taker also impacts the levy of taxes under the Income Tax Act.

Derivative Segment-

The derivative segment in financial markets refers to the marketplace where derivative contracts are traded. Derivatives are financial instruments whose value is derived from an underlying asset like equities, commodities, or other financial assets.

In the equity and commodity markets, the most common types of derivative contracts are:

1. Futures: These are standardized contracts to buy or sell a particular asset at a predetermined price at a specific future date.

2. Options: These contracts give the buyer the right, but not the obligation, to buy (call option) or sell (put option) an asset at a predetermined price within or at a specific time.

3. Forwards: Similar to futures, these are customized contracts to buy or sell an asset at a predetermined price at a specific future date. However, unlike futures, these are traded over-the-counter (OTC), not on an exchange.

4. Swaps: These are contracts in which two parties agree to exchange cash flows or other variables associated with different investments.

These derivative contracts are used for various purposes, including hedging risk, speculating on future prices, and gaining access to otherwise hard-to-trade assets or markets. The derivative transactions can be undertaken in equity market and or commodity market

Understanding the nature of transactions-

In general parlance transactions of an intraday trader or a trader entering into futures and options transactions are considered to be speculative. However to Income Tax Act does not go by the general believes and has given a very detailed and elaborate definition of which kind of transactions are to be considered as speculative and which are not to be considered as speculative. The definition as per Section 43(5) of the Income Tax Act, 1961 is reproduced as under-

“43(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 scrips:

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; or

(d) an eligible transaction in respect of trading in derivatives referred to in clause (ac) of section 2 of the Securities Contracts (Regulation) Act, 1956 (42 of 1956) carried out in a recognised stock exchange; or

(e) an eligible transaction in respect of trading in commodity derivatives carried out in a recognised stock exchange, which is chargeable to commodities transaction tax under Chapter VII of the Finance Act, 2013 (17 of 2013),

shall not be deemed to be a speculative transaction:

Provided further that for the purposes of clause (e) of the first proviso, in respect of trading in agricultural commodity derivatives, the requirement of chargeability of commodity transaction tax under Chapter VII of the Finance Act, 2013 (17 of 2013) shall not apply.

Explanation 1.—For the purposes of clause (d), the expressions—

(i) "eligible transaction" means any transaction,—

(A) carried out electronically on screen-based systems through a stock broker or sub-broker or such other intermediary registered under section 12 of the Securities and Exchange Board of India Act, 1992 (15 of 1992) in accordance with the provisions of the Securities Contracts (Regulation) Act, 1956 (42 of 1956) or the Securities and Exchange Board of India Act, 1992 (15 of 1992) or the Depositories Act, 1996 (22 of 1996) and the rules, regulations or bye-laws made or directions issued under those Acts or by banks or mutual funds on a recognised stock exchange; and

(B) which is supported by a time stamped contract note issued by such stock broker or sub-broker or such other intermediary to every client indicating in the contract note the unique client identity number allotted under any Act referred to in sub-clause (A) and permanent account number allotted under this Act;

(ii) "recognised stock exchange" means a recognised stock exchange as referred to in clause (f) of section 2 of the Securities Contracts (Regulation) Act, 1956 (42 of 1956) and which fulfils such conditions as may be prescribed and notified by the Central Government for this purpose.

Explanation 2.—For the purposes of clause (e), the expressions—

(i) "commodity derivative" shall have the meaning as assigned to it in Chapter VII of the Finance Act, 2013;

(ii) "eligible transaction" means any transaction,—

(A) carried out electronically on screen-based systems through member or an intermediary, registered under the bye-laws, rules and regulations of the recognised stock exchange for trading in commodity derivative in accordance with the provisions of the Forward Contracts (Regulation) Act, 1952 (74 of 1952) and the rules, regulations or bye-laws made or directions issued under that Act on a recognised stock exchange; and

(B) which is supported by a time stamped contract note issued by such member or intermediary to every client indicating in the contract note, the unique client identity number allotted under the Act, rules, regulations or bye-laws referred to in sub-clause (A), unique trade number and permanent account number allotted under this Act;

(iii) "recognised stock exchange" means a recognised stock exchange as referred to in clause (f) of section 2 of the Securities Contracts (Regulation) Act, 1956 (42 of 1956) and which fulfils such conditions as may be prescribed and notified by the Central Government for this purpose;”

The very essential element to consider is, whether the person has obtained delivery of a particular script or not if the transaction is squared off otherwise by obtaining delivery of a particular script which is the case, in case of a intraday trader trading in cash segment then such transaction shall surely be considered as a speculative transaction.

On the flip side and on the backing of Clause d and e of the provisio to section 43(5) transactions undertaken in equity derivative or commodity derivative segments subject to conditions prescribe there in shall not be considered as speculative weather or not such contract ultimately leads to Physical settlement, meaning thereby that even if the contracts are ultimately cash settled as is the case in majority of the derivative contracts that operate in India the same shall be considered as non-speculative.

The determination of whether a transaction is a speculative one or not has a huge impact on the taxability and setting off of losses under the Income Tax Act and therefore absolute clarity on this matter is extremely essential. We shall in the upcoming Articles cover the issue Carry Forward and setting off of Losses.