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Chartered Accountants1

BOMBAY CHARTERED ACCOUNTANTS SOCIETY

ON

8TH SEPTEMBER 2004

AT

WALCHAND HIRACHAND HALL, IMC MUMBAI

DERIVATIVES &

SPECULATIVE TRANSACTIONS

TAX ASPECTS

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Happenings

Indian Derivatives in Hongkong

Ex- RBI Governor-Mr. Bimal Jalan

Volume on the Bourses

Warren Buffet-www.berkshirehathaway.com

Barring Bank-Nick Leeson

Infosys-9th April, 2003

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Definitions

A Derivative is:

an instrument whose value is derived from thevalue of one or more underlying assets likecommodities, currency, securities, index, etc.

a financial product which is derived fromanother financial product or commodity.

a term having its origin in mathematics, whichrefers to a variable which has been derivedfrom another variable.

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Features & Functions

Features Independent Existence

Dynamic in nature

Zero value at inception

Promise for performance Leverage

Cash settled

Functions Transfer of risk

Price discovery Market completion

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Instruments & Players

Financial Instruments

Index Futures & Options

Stock Futures & Options

Market Players

Speculators-Day and Position Players

Hedgers

Arbitrageurs

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Legal Framework

History and Need

SCRA

Wagering Contracts

Dr. L. C. Gupta Comm.-Regulatory Framework

J. R. Varma Committee-Containment of Risk

SEBI, BSE and NSE

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F & O

Futures-An improvement over Forwards OptionsOption & advance

Call & Put

American & European

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Futures v. Options

Dimensions

Rate of Interest as a consideration

Pricing Process

Exposure

Initial Cost

Degree of Risk of the parties

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Trading Mechanism

Trading commenced in June 2000

SEBI authorized Exchanges

Clearing House-Counter party

Derivative segment

Clearing and Trading Member

Financial guarantee

Deposit and Margins

Index and Stocks-Options & Futures

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Exchange Operations

S & P CNX NIFTY and BSE SENSEX

Standardized Contracts

Trading Units & Minimum value

Screen based trading Three months cycle

Settlement Date-Last Thursday

Initial margin-Determination-Cash equivalent

Mark to Market-Daily Margins

Cash settlement only

Range of Strike Price determination

Transaction Costs

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Accounting Guidelines

Guidance Notes of ICAI

Accounting for Equity Index Futures-December 2000

Accounting for Equity Index Options-June 2002

Accounting for Equity Stock Options-June 2002

Accounting for Equity Index stock/stock Futures-

Options- September 2003, ICAIJ

IAS 39 & IAS 32

FAS 133

AS 11, AS 13 & AS 16

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TAXATION

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General

Whether an asset-Security under SCRA

Whether ind. asset-Cash settled, Rights, Warrant

Whether a cap. asset-S. 2(14)- Property with valu

Head of Income-Relevant factors

Likely concession for commodities

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Business Income

Whether Speculation Business

Applicability of Explanation to S. 73

Treatment of provision for losses

Book Profit Effect of daily settlement

Method of Accounting

Transaction Cost

Valuation at the year end Time of accrual of premium for writer

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Speculative Transaction

S. 43(5)- Speculative transaction means a transaction in which a contract forthe 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 ofraw 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 foractual delivery of goods manufactured by him or merchandise sold by him ; or

(b) A contract in respect of stock 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 memberof a forward market or a stock

exchange in the course of any transaction in the nature ofjobbing or arbitrage to

guard against loss which may in the ordinary course of his business as such

member;

Shall not be deemed to be a speculative transaction

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Speculation Business

Speculative TransactionS.43(5)

S.2(h) of SCRA

Shares & Stocks S. 2(46) of Companies Act

Commodity Nirmal Trading Co. 82 ITR 382 (Cal)

Compound Financials, 67 ITD 304 (Bang.)

ANZ Grindlays Bank, 88 ITD 53 (Del)

Actual Delivery- Lex non cogit ad impossibilia

Difficulties in applying Exceptions

Explanation to S.73 Apollo Tyres, 255 ITR 273 (SC)

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Business Income

Allowance of Provision

Book Profit & Provision for Losses

Mark to Market and accrual

Method of Accounting

Transaction Cost

Valuation of Stock and Fair value accounting

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Capital Gains-General

Underlying Assumptions

Right an asset

Fictional purchase & sale

Merges with a larger asset

Situations

Cash settled

Hedging

Delivery settled

Short-Term Capital Asset Lapse of contract

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Capital Gains-Specific

Future Contracts-Buyer Specific

Future Contracts-Seller Specific

Call Options-Buyer Specific

Call Options-Seller Specific

Put Options-Buyer Specific

Put Options-Seller Specific

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Audit

No Special provisions

Regulatory Requirements

Income Tax Act

Value or Difference

Gross or Net

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SPECULATIVE TRANSACTIONS

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Speculation Business

Speculative transactionS.43(5)

Explanation 2 to S.48

Speculation LossS.73

Explanation to S.73

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Speculative Transactions 43(5)

Contract for sale or purchase

Any commodity including stock & shares

Periodical settlement

Without actual delivery or transfer Exceptions

Hedgingto guard loss on price fluctuations

Dealer or Investor Jobbing or arbitrage

Member of a Forward market or Exchange

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Explanation 2 to S.28

Speculation transactions - business

Distinct and separate business

Separate computation for I T Act

R. Chinnaswamy Chettiar, 96 ITR 353 (Mad.)

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Speculation Business Loss

Restriction on set-off Jaggannath Mahadeo Prasad, 71 ITR 296 (SC)

Profit of Speculation Business only

Any such business

Priority of set-offCir. No. 23 dt. 12.9.1960 - 72(2)

Application to loss as also profit Samba Trading & Invts. 58 TTJ 360(Mum)

Carry forward

Period of 8 succeeding years Bylegal heirs

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Deeming FictionExpl. to S.73

Company assessees

All companies

Shares

Purchase and Sale

Deemed Speculation Business

Exceptions

GTI mainly from specified heads

Banking Company

Loans & Advances Company

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Hedging - I

Requirements Two contracts

Commodities and scrips

Holdings & Contract of delivery

Guard against price fluctuations Purchase- Also sale

Different quality-quantity and value Cir. No. 23D dt. 12.9.1960

Different scrips

Circular 23D

Index F & O

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Hedging - II

Burden of proof

Joseph John, 67 ITR 74 (SC)

Co-relation necessary

Somasundaram Chettiar, 194 ITR 1 (SC)

Independent treatment

Arjan Khimji & Co., 121 ITR 421 (Bom)

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Delivery

Relevance of intention, payment and delivery

Abdul Gani Haji, Habib, 72 ITR 6 (Cal.)

Actual delivery

Blank transfer forms

Mangal Chand Bhanwarlal, 255 ITR 329 (Raj)

Delivery Notes

Davenport & Co., 100 ITR 715 (SC)

Recalled delivery Clayton Commercial, 67 ITD 118 (Del)

Intended delivery

Gandhi Bhandari & Co., 83 ITD 680 (Pune) Pending delivey

Sampath & IyengarNinth Edn.

Judicial controversy

No delivery

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Settlement

Settlement without delivery S.63 of Indian Contract Act

Shantilal (P) Ltd., 144 ITR 57(SC)

Kamani Tubes Ltd., 207 ITR 298 (Bom)

F/E Forward contracts Guard against fluctuation

Badridas Gauridu, 261 ITR 251 (Bom)

Loss in illegal contract

S.C. Kothari, 82 ITR 794 (SC) Nature of deemed profit u/s. 41(1)

Rajputana Trading Co. Ltd. 72 ITR 286 (SC)

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Stray transactions

Concerted activity and efforts

Treatment under the law

Casual Income

Other sources

Capital Gains

Plurality of transactions

Indian Commercial Co., 106 ITR 465 (Bom)

G.P. Birla HUF, 199 ITR 173(Cal)

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Cum-dividend purchase and sale

Dividend and Loss

Effect of S.94(7) and (8)

Effectind. of statutory provisions

Soma Textiles & Ind., 87 ITD 326 (Ahd)

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Arbitrage

Nature of Operations

Whether business

Whether speculation business

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Tax Audit

Applicability

Growmore Exports Ltd., 78 ITD 95 (Mum)

Gross or Net

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Escaping the ExplanationEE

Investment in Shares EE-I

Business of purchase and sale

Relevant factors

Investment Income Mysore Rolling Mills, 105 ITR 405 (Karn)

Venkateshwara Rice & Oil Mills, 154 ITR 756 (AP) VIP Growth Fund Ltd., 95 Taxmann 13 (Delhi)

Kruti Marketing P. Ltd., 118 Taxman 194 (Ahd)

Investment by a dealer in shares/stock broker Kethankumar A.Shah 242ITR 83 (Ker.)

Relevance of books of account Merfin (India) Ltd., 80 ITD 399 (Hyd)

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Relevance of S.70 to S.72 EE-II

Overriding effect

RPG Industries Ltd., 85 ITD 105 (Kol)(TM)

Expl. Over S. 43(5)

C.N.M.P. Inv. (P) Ltd. 78 ITD 297(Del.)

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Lending /Banking company EE-III

Exception to general rule

Parameters

Overriding . 43(5)

C.N.M.P. Inv. (P) Ltd., 78 ITD 297 (Del)

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GTI mainly from EE-IV

Criteria for determination

Relevance of other years

Amrutlal & Co., 212 ITR 540 (Bom)

C iti f GTI EE V

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Composition of GTI EE-V

Mfg (+) Shares(-) O/I (+)

Associated capital markets, ITA No. 1103,

1104, 3051/M/2001 dt.31.03.03 G Bench

Rajan Enterprises, 41 ITD 369(Bom.)

Shares (-) O/I (+)

Eastern Aviation Ind. 208 ITR 1023 (Cal)

Aryasthan Corp Ltd., 253 ITR 401 (Cal)

Park View Properties Ltd. 261 ITR 473 (Cal.) Shares (-) O/I (-)

Sh b i l b i

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Share business - only business

EE -VI

Part to include whole

Arvind Investments Ltd., 192 ITR 365 (Cal)

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In shares of 1 company EE -VII

Purchase & sale - shares of companies

Plural to include singular - GCA

Laxmi Feeds & Exports Ltd. 62 ITD 315(Mum)

Akrosh Inv. & Lea. (P) Ltd. 90 ITD 287(Mum)

IPO Subscriptions

Sri Gopal Jalan & Co. AIR 1964 SC 250

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Losses of a stock broker EE -VIII

Business of purchase and sale of shares

Representative capacity

Application of exception (c) Shri Shrawankumar Agarwal, 249 ITR233(All.).

Same business test Pangal Vittal Nayak,74ITR754(SC)

K.L.Jhunjhunwala, 139ITR371(Cal.)

Nirmallkumar&Co. 161ITR413(Cal.)

Losses of clients unpaid Shah Prataprai Nowpaji 139 ITR 149(AP)

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Business Expenditure EE - IX

Effect on quantum of loss

Common expenditure

Maharashtra Sugar Mils, 82 ITR 452 (SC)

Rajasthan Warehousing Co., 242 ITR 450 (SC)Associated Capital Market Tdg & Inv.s case

Section 14A

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Expl. and Derivatives EE - X

Not a share

Apollo Tyres, 255 ITR 273 (SC)

S. 43(5) does not apply

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Loss on valuation of stock EE - XI

Purchase and sale of share

Associated Capital Markets case

Nirvan Holding Pvt. Ltd., ITA No. 529/M/2001

Prudential Const Co. P. Ltd., 75 ITD 338 (Hyd) Purchase and sale in different years

Sun Dist. & Mining, 68 Taxman 223(Cal.)

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Units and Other Sec. EE - XII

Application to shares only

Apollo Tyres, 255 ITR 273 (SC)

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Objective behind Expl. EE - XIII

Losses by dealing in shares of group

companies

Cir. No. 204 (Para 19.2) dt. 24.07.1976, 110ITR 32(St)

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THANK YOU

AND

GOOD LUCK

Documents

17 Derivatives (1)