Speculative Income - Meaning, Taxability, Exceptions

For income tax purposes, the income earned by the taxpayers is categorised under five major heads such as income from salary, income from house property, profits or gains of business/profession (PGBP), income from capital gains, and income from other sources.

Right classification of income plays an important role as the method of computation, deductions, incentives, and tax rates prescribed vary for different heads of income. Let’s quickly test you on this. Would you classify your income from share trading and investment as PGBP income or income from capital gains? The answer seems simple right - Capital Gains! 

Well, not entirely correct. There has always been confusion/litigation regarding the classification of income between PGBP income and income from capital gains in the case of commodities including stocks and shares. 

Various decisions have held that the classification between these two categories of income must depend on the intention of investment and the frequency of transactions. Further, if a transaction is classified as business, it calls for further classification of the income being speculative or non-speculative. This article revolves around understanding what speculative income is and how it is treated distinctly from normal business income.

What is Speculative Income?

Speculative income is income that is not realised until it is earned. Speculative income is earnings dependent/contingent on an occurrence or non-occurrence of a future event. It is an income earned from a business activity in which the taxpayer has a significant risk of losing money is referred to as speculative income. As such the Income Tax Act does not define speculative income. Hence, it is to be interpreted in a general parlance. 

Speculative income is distinct from conventional income in a way that it does not compensate for capital investments or grow net value. In other words, for income to be considered speculative, a taxpayer must be putting capital at risk. The term itself is complicated, and this article will provide you with a detailed guide to speculative income.

You must be thinking about how it makes a difference whether an income is normal business income or it is a speculative business income. The difference lies in the taxability of speculation income separately from normal business income and the time period for which you can carry forward the losses incurred as speculation income. 

What is Speculative Transaction?

A speculative transaction is a transaction of purchase or sale of a commodity including stocks and shares which is settled otherwise than by actual delivery or transfer of the commodity or scrip (Section 43(5) of the Income Tax Act)

Example: In the case of intra-day trading in shares, there is no actual delivery as you buy the shares and sell them from the trading account on the same date and do not receive the actual delivery of shares in the DEMAT account at all. Therefore, actual delivery does not take place. Hence, they are called speculative transactions. Therefore, based on the definition it can be inferred that intra-day trading income is speculative income.

What Are the Exceptions to a Certain Transaction to be Considered as "Speculative"?

Following are certain transactions which have been specifically excluded from being treated as Speculative transactions.

• Hedging contract in respect of raw materials or merchandise

A person may incur a loss in case of future price fluctuations in respect of goods manufactured or merchandise sold by him. To guard himself against such a loss and reduce the risk exposure, he may enter into a contract to hedge himself against the price fluctuations of raw materials or merchandise. Such contracts are not treated as speculative in nature.

• Hedging contract in respect of stocks and shares

To guard against loss due to price fluctuations in stocks and shares a hedge contract entered into by a dealer or investor is not considered as speculative.

• Forward contract

This is a contract entered into by a member of a forward market or stock exchange in the course of any transaction in the nature of jobbing (all transactions are squared off during the same day) or arbitrage (purchase of commodity or security in one market for immediate sale in another market) to guard against loss which may arise in the ordinary course of his business. A forward market is an over-the-counter marketplace that sets the price of a financial instrument or asset for future delivery.

• Trading in derivatives

An eligible transaction (carried out electronically on screen-based systems through a recognized broker as per relevant statutes and which is supported by a time-stamped contract note indicating unique client identity number and PAN) in respect of trading in derivatives referred to in Securities Contracts (Regulation) Act, 1956 and carried out in a recognised stock exchange is known as trading in derivatives and such transaction is out of the purview of the speculative transaction.

• Trading in commodity derivatives

It is an eligible transaction (carried out electronically on screen-based systems through a registered member or intermediary as per relevant statutes and which is supported by a time-stamped contract note indicating unique client identity number, unique trade number and PAN) in respect of trading in commodity derivatives carried out in a recognised association, which is chargeable to commodities transaction tax under Chapter VII of the Finance Act, 2013. Such a transaction is not considered a speculative transaction.

How is Income or Loss from Speculative Business Treated?

• Speculative business to be treated as a distinct business

If a taxpayer is carrying out many businesses along with a speculative business, such speculative business of a taxpayer must be deemed as distinct and separate from any other business carried out by him.

• Treatment of loss from speculative business

Losses from speculative business can be set off only against profits from speculative business. If there is any loss which you cannot set off during that year, it can be carried forward to the next 4 assessment years and set-off only against the speculative income. Further, if depreciation and capital expenditure incurred on scientific research, if any, relates to speculative business then such depreciation/capital expenditure shall be set-off first.