Demystifying all the taxation aspect-Traders of shares and Derivatives should know about.
Background
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:
"derivative" includes—
(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