Section 43(5)

Speculative transactions

Scope of definition

Act provides for simple and objective test - ‘Speculation’ in common parlance connotes an intention to speculate, gamble, take a chance or risk. The Act however provides a very simple and objective test for determining whether a transaction is a specu­lative transaction or not. Under this definition, all that has to be found out is whether the contract was periodically or ulti­mately settled by actual delivery, transfer or otherwise. If the goods or commodities in respect of which the contracts were entered into were actually taken delivery of pursuant to the contract, it would not be a speculative transaction, even though the commodity or scrip may be a highly speculative one by its very nature and even though at the time when the contracts were entered into the parties might have had no idea of taking deliv­ery at all. On the other hand, if the contract is settled other­wise than by actual delivery, then it will be a speculative transaction notwithstanding that the nature of the commodity was not one lending itself to possibilities of speculation or that the intention of the parties at the time of entering into the contract might have been to take actual delivery but this inten­tion could not be effectuated for one reason or the other - M.R. Dhawan v. CIT [1979] 119 ITR 412 (Delhi).

‘Contract settled’

‘Contract’ must be enforceable - The ‘contract’ contemplated has to be an enforceable contract and not an unenforceable one by reason of any taint of illegality resulting in its invalidity - CIT v. S.C. Kothari [1971] 82 ITR 794 (SC).

Words should not be construed narrowly - The expression ‘a con­tract is periodically or ultimately settled’ must be construed as ‘the contract is periodically or ultimately determined or con­cluded or disposed of’. The words ‘contract settled’ used in the definition should not be construed in the narrow sense so as to take in only such cases of settlement before the expiry of the due date for the performance of the contract - Thakurlal Shivpra­kash Poddar v. CIT [1979] 116 ITR 190 (MP).

Contract need not be substituted by fresh agreement - The proper meaning to be given to the words ‘a contract. . . settled’ would be ‘a contract determined or concluded or disposed of’; the words do not mean that the contract is to be substituted by a fresh agreement between the parties. - Murlidhar Jhunjhunwalla v. CIT [1969] 73 ITR 727 (Cal.)(App.).

Part settlement of contract is also covered - Section 43(5) is not restricted to a contract where the settlement is only in respect of the entire contract. The word ‘periodically’ makes it clear that it can apply even to a part of a contract. Thus, the provisions can be made applicable where there is a delivery of part of the goods and the other part of the contract is settled otherwise than by actual delivery of goods - CIT v. Aditya Mills Ltd. [1994] 209 ITR 933 (Raj.).

‘Actual delivery’

Delivery must be real as opposed to notional - The words ‘actual delivery’ mean real as opposed to notional delivery. Whether a transaction is speculative in the general sense or under the Contract Act is not relevant for income-tax purposes. A transac­tion which is otherwise speculative would not be a speculative transaction within the meaning of section 43(5) if actual deliv­ery of the commodity or the scrips has taken place; on the other hand, a transaction which is not otherwise speculative in nature may yet be speculative according to this provision if there is no actual delivery of the commodity or the scrips. The provision does not invalidate speculative transactions which are otherwise legal but gives a special meaning to that expression for the purpose of income-tax only. Thus, where the transactions involved mere transfer of delivery notes and not actual delivery of goods, they must be treated as speculative transactions within the meaning of section 43(5) - Davenport & Co. (P.) Ltd. v. CIT [1975] 100 ITR 715 (SC); Nirmal Trading Co. v. CIT [1980] 121 ITR 54 (SC)/Jute Investment Co. Ltd. v. CIT [1980] 121 ITR 56 (SC).

Taking physical delivery of goods by assessee is not the test - On perusal of section 43(5) there is no reference for requirement of actual delivery or transfer of the commodity or the scrips by the assessee or his agent. The emphasis is on settlement of transaction otherwise than by the actual delivery or transfer of the commodity or the scrips. Taking the physical delivery of the goods by the assessee is not the test for determining the speculative transaction in terms of section 43(5) but the test is settlement of the transaction entered into by the assessee or on his behalf otherwise than by actual delivery of the commodity or scrips; where ultimately transaction entered into by the assessee has been settled by the actual delivery of the goods to ultimate buyer, in terms of clause (5) of section 43, the transaction cannot be branded as speculative transactions. Further so long as the nexus between actual delivery of goods and the transaction of sale conducted by the assessee himself or through his agent exists, the actual settlement of account between the assessee and his agent cannot affect the nature of transaction from real to speculative. In such event actual payment or receipt is merely a convenient mode of settling the account, distinct from settling the transaction - Sripal Satyapal v. ITO [2008] 217 CTR (Raj.) 337.

Breach of contract

Breach of contract must be distinguished from settlement of dispute - For the purpose of deciding whether a particular trans­action is a speculative transaction under section 43(5), the transaction falling in the first category, namely, where there is a settlement of the contract, can be regarded as a speculative transaction; a transaction falling in the second category, name­ly, where there is a breach of contract and dispute with regard to damages or compensation for the breach of contract is settled, cannot be regarded as a speculative transaction - CIT v. Dina Lal Gupta [1988] 170 ITR 583 (Raj.)/CIT v. Shantilal (P.) Ltd. [1983] 144 ITR 57 (SC). [See also CIT v. Hans Machoo and Co. [2001] 247 ITR 79 (Delhi)].

Non-delivery must be coupled with settlement of contract - Section 43(5) contemplates a transaction in which a contract for purchase or sale of any commodity is periodically or ultimately settled otherwise than by actual delivery or transfer of the commodity. It is not only actual non-delivery of the goods, but it must be coupled with settlement of contract in a transaction for which payment is made. - CWT v. Shree Bhagpatia Food Industries [1994] 207 ITR 1045 (Raj.).

Damages paid in lieu of refusal to accept goods are not covered - Where the assessee refused to accept the goods purchased by it under a contract and paid the difference between the agreed price and the market price as on the date of refusal, such a payment would amount to a damage for breach of contract, and as such, the transaction could not be treated as a speculative transaction - CIT v. Kamani Tubes Ltd. [1994] 207 ITR 298 (Bom.).

A transaction cannot be treated as a speculative transaction within the meaning of section 43(5), when there is a breach of contract and on a dispute between parties, damages, are awarded as compensation by an arbitration award - Sri Rangavilas Ginning & Oil Mills v. CIT 1995 Tax LR 142 (Mad.).

Hedging transactions

Scope of hedging contracts - Keeping in view Circular No. 23, dated 15-9-1960 and the decision of the Gujarat High Court in Pankaj Oil Mills v. CIT [1978] 115 ITR 824, in the case of a trader, the following position emerges in regard to scope of hedging contracts :

(1)  hedging contracts can be both for purchase and sale;

(2)  in order to be a genuine and valid hedging contract of sale, the total of such transactions should not exceed the total stock of the raw material or merchandise in hand;

(3)  in order to be genuine and valid hedging contract of purchase, there should be an existing forward contract of sale by actual delivery; and

(4)  the hedging contracts need not necessarily be in the same variety of the commodity, they can be in connected commodi­ties, e.g., one type of cotton against another type of cotton - Sopropha S.A., In re [2004] 138 Taxman 75/268 ITR 37 (AAR - New Delhi).

Hedging contracts need not be of identical quality or quantity - The hedging contracts need not be of identical quality/quantity of the goods held in stock - Sopropha S.A., In re [2004] 138 Taxman 75/268 ITR 37 (AAR - New Delhi).

Forward sale transactions are also included - Forward sale trans­actions, though not covered within the meaning of hedging con­tracts as per proviso (a) to section 43(5), are covered within the extended meaning given in Board’s Circular No. 23D, dated 12-9-1960 - [2004] 138 Taxman 75/268 ITR 37 (AAR - New Delhi).

Burden of proof is on assessee - The burden of proof is upon the assessee to show that the transactions are merely hedging transactions within the meaning of proviso (a) to section 43(5). In the absence of any evidence produced on the part of the assessee, the transactions must be held to be speculative transactions - CIT v. Joseph John [1968] 67 ITR 74 (SC).

Correlation must exist between two sets of contracts - The contracts referred to in the latter part of proviso (a) must be contracts for actual delivery of goods sold by the assessee. There need not be co-relation between contract to contract, but there ought to be a co-relation between the contracts spoken to in the first part of proviso (a) and the contracts spoken to in the latter part of that proviso. Unless such co-relation exists between the two sets of contracts, proviso (a) is not attracted. It would therefore be not correct to say that the words ‘contracts for actual delivery of goods’ will take in contracts of purchase - SK. AR. K. AR. Somasundaram Chettiar & Co. v. CIT [1992] 194 ITR 1 (SC).

‘Sold’ cannot be substituted by ‘dealt in’ - The words ‘merchandise sold by him’, occurring in proviso (a) to section 43(5) have to be given their natural or ordinary meaning, and the word ‘sold’ cannot be substituted by the words ‘dealt in’ - CIT v. Agrawal Bros. [1980] 123 ITR 231 (MP).

Assessee must be dealing in relevant goods - Unless it is shown that the hedging contracts entered into by an assessee are contracts, whether for purchase or sale, in respect of raw materials or merchandise which the assessee is dealing in during the course of his business, they are not excluded from the purview of ‘speculative transactions’ under section 43(5). - M.G. Brothers v. CIT [1985] 154 ITR 695 (AP).

Goods covered under forward transactions must have connection with goods dealt with by assessee - To get the benefit of proviso (a) to section 43(5), the raw materials or merchandise in respect of which the forward transactions have been made by a person must have a direct connection with the goods manufactured or merchandise sold by him. - Delhi Flour Mills Co. Ltd. v. CIT [1974] 95 ITR 151 (Delhi).

Hedging contracts and future delivery contracts are independent of each other - Simply because the object of a hedging transaction may be to cover up oneself against a loss on speculation by a compensating transaction on the other side, both these transactions cannot be regarded as inter-connected and each one is independent of the other, and the profit arising from the same has to be considered separately. - CIT v. Arjan Khimji & Co. [1980] 121 ITR 421 (Bom.).

Forward contract to cover future losses is not included - A forward contract of sale in order to guard against loss in forward contracts for purchase would not amount to a hedging contract under proviso (a) to section 43(5), and any loss incurred would have to be treated as a speculation loss - CIT v. Agrawal Bros. [1980] 123 ITR 231 (MP).

In case of UTI’s units - Since units of UTI are not treated as shares either under the Companies Act or under the Unit Trust of India Act, loss incurred by assessee on their sale could not be treated as speculation loss - Apollo Tyres Ltd. v. CIT [2002] 122 Taxman 562 (SC).

Blank transfer of shares - ‘Blank transfer’ of shares as recognised by section 108(1A) of Companies Act, 1956 amounts to ‘actual delivery’ within the meaning of the term used in section 43(5) - CIT v. Mangal Chand Bhanwarlal & Co. [2001] 119 Taxman 614 (Raj.).