The Calcutta High Court, in its landmark judgment dated 28 July 2025 in the case of Asian Financial Services Ltd. v. CIT, settled a long-standing controversy regarding the tax treatment of losses incurred from trading in derivatives. The Court categorically held that such losses are business losses and not speculative losses, thereby allowing assessees to set them off against other business income under the Income-tax Act, 1961.
This ruling is significant because it clarifies the interplay between Section 43(5)(d), which excludes exchange-traded derivatives from the ambit of speculative transactions, and the Explanation to Section 73, which deems certain share transactions to be speculative. By emphasizing a strict interpretation of deeming provisions, the Court drew a clear distinction between derivatives and shares, rejecting the Revenue’s attempt to equate the two.
The decision not only provides certainty to taxpayers engaged in derivative trading but also aligns the law with the legislative intent of fostering transparent and regulated market instruments.
Case Overview: Asian Financial Services Ltd v. CIT
Facts
- The assessee (Asian Financial Services Ltd) incurred a loss of ₹3,24,76,185 in trading futures and options (derivatives on shares).
- It sought to set off this loss against other business profits.
- The Assessing Officer treated the loss as speculative under Section 73, disallowed the set-off.
- The CIT (Appeals) allowed the assessee’s appeal, but the Tribunal reversed and sided with the revenue.
Legal Issues
- Is loss from derivative trading a “speculative loss” under Section 73?
- Can such loss be treated as a business loss under Section 43(5)(d) and set off against other business income?
- Does the explanation to Section 73 apply to derivative transactions?
Court’s Analysis & Findings
1. Section 43(5)(d): Derivatives Are Not Speculative
The Court observed that Section 43(5) defines “speculative transaction,” but the proviso—and specifically clause (d)—excludes trading in derivatives on recognised stock exchanges from being treated as speculative. Therefore, losses in such trading are business losses under the Act.
2. Explanation to Section 73 Applies Only to Share Transactions
The explanation to Section 73 deems certain share purchase–sale transactions as speculative, but does not extend that deeming fiction to derivatives, which are distinct from shares both legally and economically.
Calcutta HC emphasized the distinction—derivatives are not shares, and there’s no legislative basis to treat them identically for Section 73 purposes.
3. Set-Off Permitted under Section 70 Unless Otherwise Prohibited
Under Section 70, business losses may be set off against other business income unless there is a specific provision to the contrary. Since the explanation to Section 73 doesn’t apply to derivatives, there is no prohibition on setting off such losses.
4. Statutory and Judicial Reasoning
- Chapter IV-D (Sections 28 to 44DB) deals integrally with business profits and losses; the definition of speculative transaction in Section 43(5) is precise and purpose-bound.
- Deeming provisions must be strictly construed; the explanation under Section 73 refers only to shares, not derivatives.
- The Court relied on Apollo Tyres Ltd v. CIT (SC) regarding mutual fund units—not being shares, so losses on them weren’t deemed speculative—drawing a parallel to derivatives.
Judgment Summary
The Calcutta High Court allowed the appeal, ruling:
- Losses from derivative trading are business losses, not speculative.
- Such losses can be set off against other business income.
- Section 73’s explanation doesn’t apply to derivatives.
- This outcome reflects a logical, coherent interpretation of the Income Tax Act’s scheme.
Comparative Courts’ Positions
| Jurisdiction | Viewpoint |
|---|---|
| Delhi High Court | Held that derivative losses could still fall under the explanation to Section 73 (i.e., speculative), because underlying assets were shares. |
| Calcutta High Court | Distinguished and rejected that view—derivatives are separately treated under Section 43(5)(d); explanation to Section 73 is not applicable. |
| Other Jurisdictions | E.g., Kerala HC also treated derivative losses as business losses eligible for set-off. |
Key Takeaways
- Derivatives ≠ Speculative: By virtue of Section 43(5)(d), derivatives traded on exchanges are not speculative.
- Strict Construction of Deeming Fictions: The explanation to Section 73 applies only to shares—derivatives are excluded.
- Set-Off Allowed: Business losses from derivatives may be set off under Section 70 against other business incomes.
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Divergent Precedents Exist: The Delhi HC and Cal HC differ; Cal HC’s view is now a leading authority, reaffirmed in the 28 July 2025 order.