Kerala HC: Derivative Losses Can Offset Business Income

The Kerala High Court recently ruled that losses from derivative trading can be set off against business income, as these transactions are not speculative. This decision involved Dewa Projects Pvt Ltd, which faced a tax issue when its Assessing Officer classified a loss of Rs. 803.03 lakhs from derivative trading as speculative, preventing it from offsetting this loss against business income.

Dewa Projects Pvt Ltd challenged this classification, arguing that derivative transactions are a core part of their business operations and should not be seen as speculative. The court examined the nature of these transactions, noting that derivatives are financial tools used for hedging and managing market risks. Businesses often use them to protect against adverse market movements, not for speculation.

The court referred to the Income Tax Act provisions that distinguish between speculative and non-speculative transactions. Speculative transactions are defined as contracts settled without actual delivery or transfer of goods or stocks. However, derivative transactions are excluded from this under Section 43(5) of the Act, since they are primarily for risk management.

The court emphasized that treating derivative losses as speculative would contradict the purpose of derivatives, which is to protect businesses from market volatility. Such an interpretation could lead to unintended tax consequences for businesses using derivatives for legitimate hedging activities.

As a result, the court ruled in favor of Dewa Projects Pvt Ltd, allowing the company to offset its derivative losses against its business income. This judgment clarifies the tax treatment of derivative transactions and provides relief to businesses using derivatives for risk management. The ruling is expected to positively impact the corporate sector, ensuring businesses are not unfairly penalized for using financial instruments designed to mitigate risks.