Identifying yourself as a trader or an investor is the first step to assess your income under correct head of income and computation of tax liability and filing your income tax returns.
This issue has always been debatable issue wherein originally instruction No. 1827 dtd. Aug,21 1989 was released by CBDT. Numerous judicial pronouncements and government were still unable to clear this highly debatable issue. After 18 years of original instruction, Circular no. 4/2007 was issued wherein clarification regarding criteria to classify it as trading or investment was released. Despite that, it leads to huge litigation since it was difficult to prove the intention acquiring share/securities. Hence, the income tax department brought in clarity in classifying yourself as a trader or an investor (equity delivery trades) through the circular no. 6/2016.
“As per above mentioned Circular, an individual can decide on his own to either show his stock investments as capital gains or as a business income (trading) irrespective of the period of holding of the listed shares and securities. However, if the stance once taken, the taxpayer will have to continue with the same in the subsequent years.”
In this article, we will be discussing only about trading in shares and derivatives.
What are derivatives??
According to sec 2 of the income tax Act, 1961:
(A) a security derived from a debt instrument, share, loan, whether secured or unsecured, risk instrument or contract for differences or any other form of security;
(B)a contract which derives its value from the prices, or index of prices, of underlying securities;
(C) commodity derivatives; and
(D) such other instruments as may be declared by the Central Government to be derivatives;
The most popular derivatives are futures and options.
Futures is a contract to buy or sale an underlying asset on a specified date at a pre-determined price. On expiry of contract, futures are executed by delivering the underlying asset or through payment.
Options is a contract same as future, except in option, one party of the contract has an option (right).
Intra-day trading deals with buying and selling of stocks on the same day, during the trading hours such that all positions are closed before the market closes for the trading day.
Is it a business income or capital gain?
Trading in intra-day of shares and futures & options are considered as a business and resulting income/loss shall be taxed under the head PGBP under the Income tax Act.
Read below to know whether it is speculative or non-speculative business.
Determination of business from Derivatives/ Intra-day as speculative or non-speculative
According to sec 43(5) of income tax Act, 1961, "speculative transaction" means a transaction in which a contract for the 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:
Provided that for the purposes of this clause—
(d) an eligible transaction in respect of trading in derivatives referred to in clause (ac) of section 2 of the Securities Contracts (Regulation) Act, 1956 (42 of 1956) carried out in a recognised stock exchange; or
(e) an eligible transaction in respect of trading in commodity derivatives carried out in a recognized stock exchange, which is chargeable to commodities transaction tax under Chapter VII of the Finance Act, 2013 (17 of 2013),
shall not be deemed to be a speculative transaction.
[Explanation 1].- For the purposes of [clause (d)], the expressions—
(i) “eligible transaction” means any transaction, —
(A) carried out electronically on screen-based systems through a stock broker or sub-broker or such other intermediary registered under section 12 of the Securities and Exchange Board of India Act, 1992 (15 of 1992) in accordance with the provisions of the Securities Contracts (Regulation) Act, 1956 (42 of 1956) or the Securities and Exchange Board of India Act, 1992 (15 of 1992) or the Depositories Act, 1996 (22 of 1996) and the rules, regulations or bye-laws made or directions issued under those Acts or by banks or mutual funds on a recognized stock exchange; and
(B) which is supported by a time stamped contract note issued by such stock broker or sub-broker or such other intermediary to every client indicating in the contract note the unique client identity number allotted under any Act referred to in sub-clause (A) and permanent account number allotted under this Act;
(ii) “recognized stock exchange” means a recognized stock exchange as referred to in clause (f) of section 2 of the Securities Contracts (Regulation) Act, 1956 (42 of 1956) and which fulfils such conditions as may be prescribed and notified by the Central Government for this purpose;
[Explanation 2.—For the purposes of clause (e), the expressions—
(i) “commodity derivative” shall have the meaning as assigned to it in Chapter VII of the Finance Act, 2013
On the basis of above, we can say Intra-day trading of shares shall be termed as Speculative business and trading in derivatives/commodity derivatives which are traded on recognized stock exchange is non-speculative business as per proviso inserted.
Hence, we can Summaries it as follows:-
1. Speculative business
As per section 43(5) of the Income Tax Act, 1961, profits earned by trading equity or stocks for intraday or non-delivery is categorized under speculative business income.
Currency trading is also considered as speculative since there is no STT (unless you are using currency derivatives to hedge.
2. Non-speculative business
Income from trading futures & options on recognized exchanges (equity, commodity) is categorized under non-speculative business income as per section 43(5) of the Income Tax Act, 1961.
Maintenance of Books of Accounts
As given in sec 44AA(2) of the Income tax Act,
Every person, being an individual and HUF, carrying on business or profession shall,—
(i) if his income from business or profession exceeds two lakh fifty thousand rupees or his total sales, turnover or gross receipts, as the case may be, in business or profession exceed or exceeds twenty-five lakh rupees in any one of the three years immediately preceding the previous year; or
(ii) where the business or profession is newly set up in any previous year, if his income from business or profession is likely to exceed two lakh fifty thousand rupees or his total sales, turnover or gross receipts, as the case may be, in business or profession are or is likely to exceed twenty-five lakh rupees, during such previous year; or
keep and maintain such books of account and other documents as may enable the Assessing Officer to compute his total income in accordance with the provisions of this Act:
In simple words, In case you are running a business ( such as F&O trading)in the capacity of an individual or a HUF, the requirement to maintain accounting records would arise if your income exceeds Rs 2.5 lakhs or gross receipts exceeds Rs 25 lakhs in any of the 3 preceding years or in the first year in case of a new business.
Your book keeping will be simpler though. Keeping your trading books which automatically get maintained for you by the broker where you trade, expense receipts which you can claim(discussed below) and bank account statements shall mostly suffice. From these your profit and loss account and balance sheet are prepared.
However in case of non-compliance the penalty leviable for non-maintenance of accounting records could go upto Rs 25,000 under Section 271A.
Methodology of Calculation of Turnover
As per Guidance note issued by ICAI on Tax Audit u/s 44AB of the Income tax Act, 1961,
Such transactions are completed without the delivery of shares or securities. These are also squared up by payment of differences. The contract notes are issued for the full value of the asset purchased or sold but entries in the books of account are made only for the differences. The transactions may be squared up any time on or before the striking date. The buyer of the option pays the premia.
The turnover in such types of transactions is to be determined as follows:
(i) The total of favourable and unfavourable differences shall be taken as turnover.
(ii) Premium received on sale of options is also to be included in turnover.
(iii) In respect of any reverse trades entered, the difference thereon, should also form part of the turnover.
If we summaries the above with examples: -
Speculative transactions (intraday equity trading)
For all speculative transactions, aggregate or absolute sum of both positive and negative differences from trades is to be considered as a turnover.
So if you buy 100 shares of Reliance at 800 in the morning and sell at 820 by afternoon, you make a profit or positive difference of Rs 2000, this Rs.2000 can be considered as turnover for this trade.
Non-speculative transactions (Futures and options)
For all non-speculative transactions, the article says that turnover to be determined as follows –
The total of favourable and unfavourable differences shall be taken as turnover
Premium received on sale of options is also to be included in turnover
In respect of any reverse trades entered, the difference thereon should also form part of the turnover.
So if you buy 25 units or 1 lot of Nifty futures at 8000 and sell at 7900, Rs.2500 (25 x 100) the negative difference or loss on the trade is turnover.
In options, if you buy 100 or 4 lots of Nifty 8200 calls at Rs.20 and sell at Rs.30. Firstly, the favourable difference or profit of Rs 1000 (10 x 100) is the turnover. But premium received on sale also has to be considered turnover, which is Rs 30 x 100 = Rs 3000. So total turnover on this option trade = 1000 +3000 = Rs 4000
Treatment of Expenses against the F& O Income
Expenses such as Brokerage, Broker Commission, Interest paid for the borrowed capital, Subscriptions to journals related to trading, Telephone bills, internet cost, Consultancy charges if you have engaged any person, salary paid if any, Depreciation on any asset used for the business or profession.
Applicability of Tax Audit
As Per Section 44AB of income tax Act, Every person,—
(a) carrying on business shall, if his total sales, turnover or gross receipts, as the case may be, in business exceed or exceeds one crore rupees in any previous year:
Provided that in the case of a person whose—
(a) aggregate of all amounts received including amount received for sales, turnover or gross receipts during the previous year, in cash, does not exceed five per cent of the said amount; and
(b) aggregate of all payments made including amount incurred for expenditure, in cash, during the previous year does not exceed five per cent of the said payment,
this clause shall have effect as if for the words "one crore rupees", the words "five crore rupees" had been substituted; or
get his accounts of such previous year audited by an accountant before the specified date and furnish by that date the report of such audit in the prescribed form duly signed and verified by such accountant and setting forth such particulars as may be prescribed.
Hence, since all the payments including expenditure and amount received in case of only derivative trading business are only through other than cash, hence audit u/s 44AB shall be applicable only if turnover as computed above exceeds Rs. 5 crores.
Presumptive taxation scheme under Income tax Act
As per Section 44AD of the Act which states that: -
(1) In the case of an eligible assessee, a sum equal to eight per cent of the total turnover or gross receipts of the assessee in the previous year on account of such business or, as the case may be, a sum higher than the aforesaid sum claimed to have been earned by the eligible assessee, shall be deemed to be the profits and gains of such business chargeable to tax under the head "Profits and gains of business or profession" :
Provided that this sub-section shall have effect as if for the words "eight per cent", the words "six per cent" had been substituted, in respect of the amount of total turnover or gross receipts which is received by an account payee cheque or an account payee bank draft or use of electronic clearing system through a bank account during the previous year.
(4) Where an eligible assessee declares profit for any previous year in accordance with the provisions of this section and he declares profit less than 8% or 6% as the case may be for any of the five assessment years relevant to the previous year succeeding such previous year, he shall not be eligible to claim the benefit of the provisions of this section for five assessment years subsequent to the assessment year relevant to the previous year.
(5) An eligible assessee who declares profit less than 8% or 6% as the case may be and whose total income exceeds the basic exemption limit, shall be required to keep and maintain such books of account and other documents as required and get them audited and furnish a report of such audit as required under section 44AB.
Explanation.—For the purposes of this section,—
(a) "eligible assessee" means,—
(i) an individual, Hindu undivided family or a partnership firm, who is a resident, but not a limited liability partnership firm.
Provisions relating to filing of Income Tax Return for F&O trading income
Since income from F&O trading is to be treated as business income, therefore an individual filing return with F&O trading income has to file ITR in form ITR 3.
Depending on the requirement to get the accounts audited as per section 44AB & 44AD, the due date for filing the return of income will be as follows:
If Tax Audit is applicable: Due date will be 30th September of the Assessment Year.
If Tax Audit is not applicable: Due date will be 31st July of the Assessment Year.
Offsetting Loss from F&O transactions
As per section 72 and 73 of Income tax Act, Speculative (Intraday equity) loss can be offset only against speculative gain and can’t be offset with non-speculative (F&O) gains, but speculative gains can be offset with non-speculative losses.
Let’s understand this with an example: -
If Mr. A incurs speculative (intraday equity) loss of Rs.100,000/- for a year, and a non-speculative profit of Rs 100,000/-, then you cannot set-off each other and avail the benefit of off-setting. Mr. A would still have to pay taxes on Rs 100,000/- from non-speculative profit.
Mr. A can carry forward speculative loss of Rs.100,000/-, which he can set-off against any future (up to 4 years) speculative gains.
But if Mr.A had a speculative gain of Rs 100,000/- and non-speculative loss of Rs 100,000/- they can offset each other, and hence tax in the above example would be only on the salary of Rs 500,000/-.
Carry forward & and set off of Loss from F&O transactions
Speculative losses can be carried forward for 4 years and can be set-off only against any speculative gains you make in that period.
Non-speculative losses can be set-off against any other business income except salary income the same year. So they can be set-off against bank interest income, rental income, capital gains, but only in the same year.
You carry forward non-speculative losses to the next 8 years; however, do remember carried forward non-speculative losses can be set-off only against any non-speculative gains made in that period.
Bonus Tip - Tax-loss harvesting?
Towards the end of a financial year, you might have realized profits and unrealized losses. If you let it be, you will end up paying taxes on realized profits and carrying forward your unrealized losses to next year. This would mean a higher tax outgo immediately, and hence any interest that you could have earned on that capital which goes away as taxes.
You can very easily postpone this tax outgo by booking the unrealized loss, and immediately getting back on the same trade. By booking the loss, the tax liability for the financial year would reduce.
· Income derived from derivates or intraday trading of futures and options are considered to be non-speculative income by definition.
· Since it is not a normal business income, computation of turnover in case of F&O transaction or intraday trading has ben guided by Guidance note issued by ICAI on Tax Audit.
· While calculating the turnover the total of favorable and unfavorable is to be taken. It makes no difference whether the difference is positive or negative; it is aggregated to the turnover in either way.
· Tax audit for any business is required, when the turnover exceeds Rs 1crore (or Rs 5 crore with effect from AY 2020-21 (FY 2019-20) if the taxpayer’s cash receipts are limited to 5% of the gross receipts or turnover, and if the taxpayer’s cash payments are limited to 5% of the aggregate payments.) in a financial year.
· Further, a tax payer having turnover up to 2crore can opt for presumptive taxation scheme under Sec 44AD.
· Tax audit under Section 44AB also becomes mandatory for taxpayers who opt for presumptive scheme of taxation, yet declare an income lower than the presumptive income(8%/6% in case of 100% electronic transactions) and such income (after setting of F & O losses or other business losses if any) exceeds the maximum amount not chargeable to tax i.e. Rs 2.5 lakhs.
· Penalty equal to lower of Rs 1.5 lakhs or 0.5% of gross receipts or turnover can be levied under Section 271B for not getting books audited under Section 44AB.
· For Setoff & carry forward of loss from non speculative or normal business, Inter head adjustment as per Section 70 and intra head adjustment except salary as per section71 is allowed & the remaining loss can be carry forward as per section 72 for 8 years and set off only against business income only, provided return for loss filed on or before the due date provided under section 139.