Tax rebate for derivative losses on case-to-case basis

The companies that face losses on account of derivative trades will find it tough to claim tax deductions as the income tax (I-T) department says it will adopt a "case by case" approach in dealing with such claims.

Two days after the Institute of Chartered Accountants of India (ICAI) issued an advisory asking companies to disclose mark-to-market losses on account of complex bets on equities and commodities, an income tax department official said, "If an entity taking a derivatives exposure incurs losses, the question of whether the loss will be allowed as business expenditure or be treated as a speculative transaction will be determined on the basis of individual facts."

Officials said that prima facie it appeared that most derivatives exposures were speculative in nature, therefore would not qualify for tax deductions. A tax consultant countered this view, saying that while forex derivative transactions were largely speculative in nature, the same did not hold true for all transactions.

Dinesh Kanabar, head of tax and regulatory practice, PricewaterhouseCoopers, said clarity was needed on whether tax authorities would allow deductions on mark-to-market losses.

"You cannot have a situation where on the one hand profits are eroded and on the other companies cannot claim tax deductions," he pointed out.

"If these are business losses, then they are allowed for tax deduction. But if the losses are speculative, they will be treated as separate source and have to be set off against speculative gains. Whether the case is speculative in nature will depend on the kind of transaction," added Ved Jain, president, ICAI.

A likely fallout of the case-by-case approach would be greater litigation in such cases where the assessing officer took a view unacceptable to the tax payer.

Income tax officials say the ICAI move is timely and could protect companies from penal proceedings, as many may have hidden losses from derivative transactions under the profit and loss account, without disclosing the speculative nature of deals.

Section 43(5) of the Income Tax Act 1961 defines a speculative transaction as one in which a contract for the purchase or sale of any commodity, including stocks and shares, is periodically or ultimately settled without the actual delivery or transfer of the commodity or scrip.