Prior to Financial Year 2005–06, transaction in derivatives were considered as speculative transactions for the purpose of determination of tax liability under the Income tax Act. This is in view of section 43(5) of the Income-tax Act which defined speculative transaction as a transaction in which a contract for purchase or sale of any commodity, including stocks and shares, is periodically or ultimately settled otherwise than by the actual delivery or transfer of the commodity or scrips.
Finance Act, 2005 has amended section 43(5) so as to exclude transactions in derivatives carried out in a ―recognized stock exchange‖ for this purpose. This implies that income or loss on derivative transactions which are carried out in a ―recognized stock exchange‖ is not taxed as speculative income or loss. Thus, loss on derivative transactions can be set off against any other income during the year. In case the same cannot be set off, it can be carried forward to subsequent assessment year and set off against any other income of the subsequent year. Such losses can be carried forward for a period of 8 assessment years.
