Section 73 of the Income-tax Act prohibits set-off of losses of speculation business except against profits and gains of another speculation business. The Explanation to section 73 extends the meaning of speculation business for the purposes of such set-off, by deeming any part of the business of a company which consists in the purchase and sale of shares of other companies to be a speculation business.
There are however two exceptions to this deeming fiction — one is for a company whose gross total income consists mainly of income which is chargeable under the heads ‘Interest on Securities’, ‘Income from House Property’, ‘Capital Gains’ and ‘Income from Other Sources’ and the second is for a company the principal business of which is the business of banking or the granting of loans and advances.
The Explanation to section 73 reads as under:
“Where any part of the business of a company (other than a company whose gross total income consists mainly of income which is chargeable under the heads ‘Interest on Securities’, ‘Income from House Property’, ‘Capital Gains’ and ‘Income from Other Sources’, or a company the principal business of which is the business of banking or the granting of loans and advances) consists in the purchase and sale of shares of other companies, such company shall, for the purposes of this section, be deemed to be carried on a speculation business to the extent to which the business consists of the purchase and sale of such shares.”
Two issues have arisen before the Courts, in the context of the first fiction, above, as to how the composition of the gross total income is to be looked at for the purpose of considering the applicability of this Explanation. One issue has been as to how negative income (loss) has to be considered — whether in absolute terms ignoring the negative sign, or to be taken as lower than a positive figure, for determining the majority composition of the gross total income. The second issue has arisen as to whether, for considering the applicability of this Explanation, the deemed speculation business loss is to be set off first against the other business profits, and only the net business income after such set-off is to be considered as ‘included’ in the gross total income and that it is such net business income, so included, that is to be compared with the income from the other heads of income to determine the composition of the gross total income. Naturally, the income under the other heads of income shall gain a higher share in composition of the gross total income where the business income is first set off against the losses of the deemed speculation business.
Considering the second issue, the Calcutta High Court has taken the view that for considering the applicability of the Explanation, the share trading loss is not to be set off against other business profits by adopting the ratio of its earlier decisions in the context of the first issue, the Bombay High Court has held that only the net business income after setting off the share trading loss against other business profits is to be considered as included in the gross total income.
Park View Properties’ case
The issue first came up before the Calcutta High Court in the case of CIT v. Park View Properties P. Ltd., 261 ITR 473.
In this case, the assessee-company had incurred a loss of Rs.8,98,799 in share trading, and had other business profits of Rs.12,32,469, the net business profits being Rs.3,33,670. The assessee had income from other sources and dividend income (which was taxable at that point of time) of Rs.5,73,701. The gross total income, determined after set-off of the share trading loss, was therefore Rs.9,07,371.
The Assessing Officer denied the benefit of the exception to the Explanation to section 73, denying set-off of share dealing loss on the ground that such losses were to be deemed as the loss of a speculation business, on application of the said Explanation. The Commissioner (Appeals) allowed the appeal of the assessee, holding that the main source of income of the assessee consisted of income from interest on securities and income from house property. The Tribunal upheld the order of the Commissioner (Appeals), allowing set-off of the share trading business loss without treating the same as a speculation loss.
The Calcutta High Court noted that the Tribunal had allowed the benefit of the exception to the Explanation to section 73 by setting off the share trading loss against the profits of other business for the purposes of determining whether the said Explanation was applicable or not. The Court did not approve the approach of the Tribunal. According to the Calcutta High Court, in order to ascertain whether an assessee would be covered by the Explanation to section 73, it had to be first examined whether the assessee came within the exception provided to the Explanation. This, according to the Court, was to be done by taking into consideration only the business profits, excluding the share trading loss, as could be gathered from the expression ‘gross total income consists mainly of income chargeable under the heads . . . . .’ used in the Explanation that was clear and unambiguous, and reflected the intention of the Legislature.
The Calcutta High Court noted that while computing the gross total income, loss was also to be taken into account, since loss was treated as a negative profit. The Calcutta High Court noted that in the case of Eastern Aviation and Industries Ltd. v. CIT, 208 ITR 1023, the Calcutta High Court had held that the explanation to section 73 could be applied before the principle of deduction was applied, namely, after computing the gross total income.
Applying this principle, the Court observed that if the loss in the share dealing account of Rs.8,98,799 was treated as a negative profit, then definitely the income from other sources and dividend income of Rs.5,73,701 was lower. Therefore, according to the Calcutta High Court, the main income consisted of the business of share trading, which was the main object of the assessee. The Calcutta High Court expressed the view that the business income computed after setting of the loss in share trading of Rs.3,33,670 did not represent the business income, since it was arrived at after applying the benefit of the explanation to section 73, namely, setting off the speculative income.
The Calcutta High Court therefore held that the case did not fall within the exception in the explanation to section 73, and the loss incurred on share trading was to be treated as speculation loss and could not be set off against other income.
Darshan Securities’ case
The issue again recently came up before the Bombay High Court in the case of CIT v. Darshan Securities Pvt. Ltd., (ITA No. 2886 of 2009, dated 2-2-2012 — available on www. itatonline.org).
In this case, the assessee had an income from service charges of Rs.2,25,04,588, and share trading loss of Rs.2,23,32,127, besides a taxable dividend income of Rs.4,79,325. The assessee claimed that in computing the gross total income for the purposes of the Explanation to section 73, the share trading loss had to be first adjusted against the income from service charges.
The Assessing Officer disallowed the set-off of the share trading loss, holding it to be a speculation loss. The Commissioner (Appeals) accepted the assessee’s claim that the case of the company was covered by the first exception to the said Explanation to section 73, as did the Tribunal.
On behalf of the Revenue, it was argued before the Bombay High Court that in computing the gross total income for the purposes of the Explanation to section 73, income under the heads of profits and gains of business or profession must be ignored. Alternatively, it was urged that where the income from business included a loss in trading of shares, such loss should not be allowed to be set off against income from any other source under the head of profits and gains of business or profession.
The Bombay High Court analysed the provisions of section 73 and the Explanation thereto. It noted that the Explanation to section 73 was a deeming fiction applying only to a company and extending only for the purposes of that section. It noted that the bracketed portion of the Explanation carved out an exception.
The Bombay High Court noted that ordinarily income which arose from one source, which fell under the head of profits and gains of business or profession could be set off against the loss, which arose from another source under the same head. Section 73(1) however set up a bar to setting off a loss which arose in respect of a speculation business against the profits and gains of any other business. Consequently, such speculation loss could be set off only against the profits and gains of another speculation business.
According to the Bombay High Court, the explanation provided a deeming fiction of when a company is deemed to be carrying on a speculation business. If the Department’s submissions were accepted, it would lead to an incongruous situation, where in determining as to whether a company was carrying on a speculation business within the meaning of the explanation, section 73(1) would be applied in the first instance. According to the Bombay High Court, this would not be permissible as a matter of statutory interpretation, as the explanation was designed to define a situation where the company was deemed to carry on speculation business. It is only thereafter that section 73(1) can apply. Applying the provisions of section 73(1) to determine whether a company was carrying on speculation business would reverse the order of application, which was impermissible and not contemplated by Parliament.
The Bombay High Court observed that in order to determine whether the exception carved out by the Explanation applied, the Legislature had first mandated a computation of the gross total income. Further, the words ‘consists mainly’ were indicative of the fact that the Legislature had in its contemplation that the gross total income consisted predominantly of income from the 4 heads referred to therein. Obviously, according to the Bombay High Court, in computing the gross total income, the normal provisions of the Act must be applied, and it was only thereafter that it had to be determined as to whether the gross total income so computed consisted mainly of income which was chargeable under the heads referred to in the Explanation.
The Bombay High Court followed the ratio of its earlier decisions in the cases of CIT v. Hero Textiles and Trading Ltd. , (ITA No. 296 of 2001 dated 29-1-2008) and CIT v. Maansi Trading Pvt. Ltd., (ITA No. 47 for 2001 dated 29-1-2008). It also noted that it had dismissed Notice of Motion No. 1921 of 2007 in ITA (Lodging) No. 852 of 2007 for condonation of delay against the Tribunal Special Bench decision in the case of Concord Commercial Pvt. Ltd., which decision had been followed by the Tribunal in this case.
The Bombay High Court therefore held that since the net business income of Rs.1,72,461 was less than the dividend income of Rs.4,79,325, the assessee was covered by the exception carved out in the Explanation to section 73, and would not be deemed to be carrying on a speculation business for the purposes of section 73(1).
Observations
The Calcutta High Court seems to have placed reliance on its decision in the case of Eastern Aviation and Industries Ltd. (supra) in arriving at its conclusion. In particular, it followed the view taken in that case that negative profits are also income and are to be considered in the absolute sense (ignoring the positive or negative signs) for the purpose of the exception carved out in explanation to section 73(1). The Calcutta High Court, however, failed to appreciate that Eastern Aviation’s case dealt with a situation where there was a negative speculation income and negative share trading income, but no other profits from any other business. The question of set-off of share trading loss against any other business profit, therefore, did not arise for consideration in that case. In that case, the gross total income itself also was a negative figure. The reliance placed on the ratio of that decision, therefore, seems to have been misplaced.
Even assuming that the ratio of Eastern Aviation’s case that even negative incomes should be considered in the absolute sense were correct, what needs to be considered is the net position of the income under each head of income, and not the net position of each source of income. In Darshan Securities’ case, the net position of the income under the head business or profession was a positive figure, which was lower than the income under the head ‘Income from Other Sources’. Therefore, even applying Eastern Aviation’s case, the ratio of Darshan Securities’ case seems justified.
As rightly observed by the Bombay High Court, one cannot start with a presumption that the explanation applies and that the loss is a loss from speculation business for determining whether the explanation applies. One would therefore have to compute the gross total income without applying the explanation for finding out the applicability of the explanation. In doing so, one would have to apply the normal provisions for computation of gross total income ignoring the explanation to section 73, i.e., by setting off the share trading loss against other business profits, which would normally have been the position in the absence of the explanation. It is only then if it is determined that the explanation applies, as the case falls outside the exception to the explanation, that the prohibition on set-off of the loss would apply.
The view taken by the Bombay High Court that the share trading loss is to be set off against other business income for determining whether explanation to section 73 applies, is therefore the better view of the matter.
