In the last couple of years there has been a rise in derivative trading ie. trading in options and futures. This includes individuals interested in pursuing this on a full time basis and individuals interested in making additional money along with their jobs.
The taxation process ie. filing of income tax for income earned via futures and options can be quite a confusing process for taxpayers. When traders are dealing with Futures and Options for filing taxes, they need to categorize that income as a business income, the exception to that being traders that conduct solely 2-3 trades in the fiscal year. This continues to be the norm for individuals, companies or other legal entities. When a trader reports a transaction as a business income while filing taxes he or she can then claim the expenses from the income of their business. The business income obtained by traders can be further segmented into speculative and non-speculative transactions.
Section 43(5) – Profits & Losses
Under section 43(5) transactions that take place during Futures and Options trading are to be considered non speculative transactions. That is profits obtained from F&O trading would be taxed in the same fashion as profits obtained from any other business transactions. This also implies that taxpayers can claim deductions on tax as they would in any other business, for entities such as electricity, telephone, internet etc. In a scenario where a trader incurs losses on non-speculative income from F&O the losses can be set off against other sources such as rental income. The remainder loss can be carried forward for the next eight years but can solely be set off against non-speculative income ie. tax treatment for speculative and non-speculative transaction varied when loss occurs.
Consequences of treating income as business income
When income or profits obtained from the trading of Futures and Options is treated as business income following consequences take place:
- – Expenditure incurred under administration would be categorized as deductible
- – Securities transaction tax (STT) will also come under the deductible category
- – Losses incurred while trading in futures and options can be utilized to balance income from other sources such as property or any other source except the taxpayer salary
- – On the other hand, losses that have not been absorbed can be carried forward for upto 8 years.
- – In cases where the income from futures and options is above Rs. 1 crore, a tax audit takes place.
Consequences of treating income as capital gain
When income or profits obtained from the trading of futures and options is treated as capital gain, following consequences take place:
- – STT will not come under deductible unlike expenditures in Futures and Options
- – Any losses will be categorized as short term capital loss which can be utilized to balance capital gains earned via other means. Such a loss can be carried forward for upto 8 years.
Calculating Turnover for Futures and Options
While determining the turnover from trading of futures and options, the following factors are taken into consideration:
- – The sum total of favorable trades and the sum total of unfavorable trades
- – Premiums attained over sale of options is also considered
- – The difference in reverse trades that the individual may have incurred
During tax audit determining turnover is quite crucial according to the Section 44AB of the Income Tax Act, 1961. Tax Audits can be considered only if the total turnover amount is above 1 crore after the fiscal year. Example: Let us consider trader A (Future and Options trader) has had the following profit and loss transactions:
- A acquires futures in Company X, that are worth Rs. 10 lakhs and sells them for Rs. 11 lakhs ie. made a profit of Rs. 1 lakh.
- A acquires futures in Company Y, that are worth Rs. 5 lakhs and sells them for Rs. 4.5 lakhs ie. made a loss of Rs. 50,000
- Total Turnover is combination of profit and loss ie. 1,00,000 + 50,000 = 1,50,000
Expenses that traders can claim on Income from Futures and Options
Taxpayers are permitted to claim deductions on the following expenses incurred as they have occurred during the process of business operations.
- – Postage charges
- – Travel and conveyance expenditures
- – Telephone or fax expenses
- – Internet expenses
- – Depreciation on assets utilized for business operations
The income tax return that traders file is correlated to the income bracket they belong to. If the income is being treated by the trader as business income then ITR3 is the form that they would need to file. Schedule BP is the portion where traders are required to report their income and their expenses. ITR4 is the form that traders need to file if they are selecting preemptive scheme of tax. ITR2 is chosen if the trader is treating their income as capital gains wherein the details of income are categorized under Schedule CG. The losses incurred are categorized under Schedule CYLA and Schedule BFLA.
Traders could be dealing with multiple processes such as predicting the stock market, reporting income from intra- day trading, and Futures and Options in tax returns can be quite confusing. However, the rules for reporting trade income in your income tax tend to be fairly uncomplicated and remain consistent over time. Once traders understand the same, they can then file their Futures and Options in ways that can benefit their business.