Stockbrokers who have been taking advantage of the ambiguity in the Income Tax Act rules to reduce their tax payouts could be in for a rude shock.

The Bombay high court has ruled that brokers cannot set off losses in the trading business against their other income and that these losses can only be neutralised against gains from the same business.

In the past few years, many brokers had misinterpreted the language of a circular, issued by the Central Board of Direct Taxes in 1976. This circular, which has to be read in conjunction with Section 76 of the Income Tax Act, deals with carry forward and setting off of losses from speculative business.

The ambiguity in the law existed because of paragraph 19.2 that read, "The objective of this provision is to curb the device sometimes resorted to by business houses controlling groups of companies to manipulate and reduce the taxable income of companies under their control."

Some brokers, however, interpreted it otherwise. That is, since they were not a part of any business house, they would set off their losses against other income, including brokerage income.

"This interpretation of the circular is wrong and there are nearly a hundred such cases, where brokers and non-banking finance companies have resorted to Circular 204 and avoided paying taxes," said R B Upadhyay, senior I-T advocate, who represented the case in which this ruling came.

The court on March 20 upheld the order passed by the Mumbai Income Tax Appellate Tribunal against an NBFC, Prasad Agents. The company had gone to the court with a view that I-T officials were not right in disallowing their speculative loss of over Rs 600,000 to be set off against their operational income.

The argument was that since the NBFC did not have any group companies and the transactions were not done to manipulate and reduce the taxable income of the companies under their control, the I-T department should allow them to neutralise it against other income.

According to Upadhyay, the court observed that paragraph 19.1 of the CBDT circular did not refer to group of companies. It simply referred to firms dealing with shares. This implied that the circular also included cases of standalone companies, which were in the speculative business of stock trading.

Speculative transaction is a contract for the purchase or sale of any commodity, including stocks that are periodically or ultimately settled. This is either done by giving the actual delivery or transferring the commodity or scrips.

Traders can carry forward their speculative losses for four years during which they can adjust it against their speculative gains, thereby saving 15 percent short-term capital gains tax.

Tax authorities consider speculative businesses as different from normal businesses. Brokers involved in propriety trades are advised to maintain separate trading and investment accounts.