The absence of a separate provision for taxing income or loss arising from futures or options contract in the Income Tax Act on the lines of the US Internal Revenue Code is likely to come in the way of the successful take-off of derivatives trading on July 2.
Another factor which is acting as an impediment is that stock index futures and options contracts are not yet classified as hedging transactions under the Income Tax Act.
If derivative transactions cannot be treated as hedge transactions, they automatically fall into the speculative transactions category which are treated differently, say market sources.
Speculative transactions are treated separately from normal business transactions in as much losses suffered in speculative transactions cannot be adjusted against other income earned. This is going to be a major dampener for institutions to take active participation in this segment.
Vineet Bhatnagar, managing director, Refco-Sify Securities, said: "Institutional players who plan to use derivative instruments for hedging their portfolios would have hesitation if the accounting treatment of hedging profits and losses is not clear to them. We require guidelines where hedging as an activity need to be acknowledged. Any hedging profits and losses need to be viewed in conjunction with the effect of the market movement on the underlying portfolio itself."
Kamlesh Vikamsey, central council member, Institute of Chartered Accountants of India, added: "There is an urgent need to amend the Income Tax Act whereby transactions in stock index futures and options are treated as hedging transactions so that the profits and losses arising from these deals can be set off against normal business income."
Section 43 (5) of the Income Tax Act, which deals with speculative transactions, distinguishes them from hedging, jobbing and arbitrage.
The normal test for speculation is settlement of transactions without actual delivery. Although hedging, jobbing and arbitrage do not result in physical delivery, these transactions are categorised as normal business deals and therefore treated on par with normal business transactions.
The clear disadvantage to speculative transactions in taxation is that the loss on speculation cannot be set off or adjusted from normal income and can be set off only against speculation income earned during that year or future years.
Another aspect which needs amendment is the explanation given in proviso (b) of Section 43 (5) of the Income Tax Act. This deals with "a contract in respect of stocks and shares" and not a contract in "stock index". Since transactions in "stock index" are not mentioned in clause (b) of the Act, gain or losses in stock index futures contracts can be considered as speculative.
Although the Securities Contract Regulation Act considers stock index as security, unless this necessary amendment is made in clause (b) of Section 43 (5), stock index futures contracts will result in speculative profit or losses.
