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Income Tax on transaction in Derivatives, futures and options & its Reporting
Trading in derivatives which may be in shares, currency, commodities, etc has become very common and many people have started participating in it. The online easy accessibility of the trading options has further enabled the momentum in it. With this, emerges the question of its taxation and its reporting in the Income Tax Returns Forms (ITR).
Lot of confusion and doubts prevails over its reporting. All the more, there are some serious confusion as regards to the audit provision applicable to such transactions.
Let us try to understand it all related to F & O Transactions and also related to Intra Day Transactions:
All the taxpayers, be it businessmen or salaried taxpayers or those who are doing it on a time pass basis must ensure its reporting in the ITR Forms.
Non reporting of it has its own consequences. Few taxpayers don’t report it for the reason that there is a loss in the transactions. It may be noted that the department is also using artificial intelligence in its system and it is trying to match the information it has received from the stock exchange with the ITR filed by the taxpayers. From the stock exchange, the department gets the date of purchase and sale and not profit/loss. So, the departmental software just matches the purchase / sales figure and if it is not forming the part of the ITR then the notices may be issued to the taxpayers in such cases. Further, the taxpayers who have incurred loss must check if the audit provision as discussed hereunder in this article is applicable to them or not so as to ensure proper compliance with the law.
Business or Capital Gain Income:
Trading in derivatives is normally considered as “Business Income” unless and until it is used as a hedging tool for capital assets in the form of shares. In normal, for the majority of the investor, the income /loss will be required to be offered as “Business Income” only.
Now, the income arising from trading in Futures and options is considered as normal business income/loss and not a speculative business or loss. Hence, the return filing could be done using either ITR-3 or ITR-4 only. Such taxpayers couldn’t use ITR – 1 & ITR-2 as such.
Deduction Towards Expenses:
While computing the income from F & O, all the expenses incurred for earning such income like consultancy fees, magazine expenses, etc can be claimed as deduction as well. The thump principle of taxation of business income is that “all expenses incurred wholly and exclusively for earning business income are eligible for deduction”. Taxpayers must ensure to maintain proper documents, records, bills, receipt etc in support of its claim All expenses above Rs. 10,00/- must be incurred not in cash but by digital mode only.
It may be noted that the Individual / HUF taxpayer with turnover exceeding Rs. 2 Cr are required to get the books of accounts audited mandatorily. [Only exception is the turnover limit of Rs. 10 Cr if the 95% of the receipt or payment is done in digital mode]. If the turnover is not exceeding Rs. 2 Cr then the audit under the income tax law is not mandatory. However, in such a case, the taxpayers are expected to offer 8% of its turnover (6% for the transaction in digital mode) as profit. If the minimum 8% or 6% is not for taxation then the audit would be mandatory for the taxpayers.
In short, if turnover is not exceeding Rs. 2 Cr there is a presumption of 8% or 6%.
With this in mind, taxpayers dealing in F & O need to first of all compute turnover and check whether it’s profit is exceeding 8% or 6% of the turnover or not. If it has a profit exceeding 8% then there will not be any need for an audit. If it is not then taxpayers need to check whether still it can offer minimum 8% as income in the ITR even though they may not be having such 8% as profit. If the taxpayers agree to offer this 8% as income on notional basis then there will not be any need of audit. However, if the taxpayers don’t wish to offer this 8% or 6% as income then it would be required to get the books audited and would be required to ensure the submission of the audit report.
The important question now arises with regard to the “Turnover”. How to compute the amount of “Turnover” in case of F & O transactions.
For better understanding, one needs to understand that future trading is different from options. Option may include put and call option whereas future is a trading simpliciter without actual delivery.
– 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 premium.
– The turnover in such types of transactions is to be determined as follows:
(i) The total of favourable and unfavorable 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.
In short, the total of profit and loss shall be taken as turnover i.e., aggregate of the differences, whether positive or negative is considered as “turnover”. It makes no difference whether the difference is positive or negative for computing turnover. [For example, a person has a profit of Rs. 3 Lakh & loss of Rs. 7 in F & O. Though there is a net loss of Rs. 4 Lakh in F & O Transactions, Turnover will be considered as Rs. 10 Lakh].
Not a Speculative Transaction
i] Transactions in derivatives are specifically excluded from the category of “Speculative transaction” if the transaction is carried out (a) on a recognized stock exchange (b) the securities transaction tax is paid and (c) trade is supported by contract note. Profit/Loss in derivatives (futures and options) is treated as non-speculative business even though delivery is not there in such transactions.
ii] Profit/loss from such transactions will be considered as normal business income & loss.
No special tax rate (like 15%) is applicable for taxing profit from derivatives transactions & tax rate shall be at normal rates applicable to an Individual.
Loss Carry Forward:
Unabsorbed non-speculative business loss can be carried forward for eight years to be set off against business income of subsequent years.
It may be noted that the filing of the return is also mandatory if the taxpayers wish to have the benefit of a set off of loss in the subsequent year in respect of the loss of the current year. One may note that any unadjusted loss can be carried forward for eight years & can be adjusted against such income in the next years. It may be noted that F&O trading loss is considered a non-speculative loss whereas intra-day stock trading is considered as a speculative loss.
[Speculative loss can be adjusted against speculative income only & any unadjusted speculative losses can be carried forward for 4 years only as against 8 years for other loses]