In today’s world , more and more people are toward earning easy money by trading in derivatives. Now, with a plethora of investments avenues, individuals with a high-risk appetite have been venturing into capital markets for quick gains. Futures and options (F&O) trading is preferred by risk-savvy investors with a high risk appetite. So, it is essential to have some knowledge about the F&O mechanism from an investment perspective and the relevant tax implications. Here’s what they are:
There are two broad kinds of instruments in financial market :
– Fundamental instruments are stocks, bonds, etc.
-While derivatives are futures, forwards, options, swaps etc.
Derivatives are financial instruments which derive their value from underlying security .
The underlying security may be shares, bonds, interest on loans, commodity etc.
It is essential for salaried individuals to select the income tax return (ITR) form based on his source of income. F&O trading can be classified as business income or capital gains, depending on certain facts.
F&O -Speculation or Non speculation
As per Section 43(5) of income tax act ,1961 ,any derivatives transaction entered in to any recognized stock exchange is not treated as speculative transaction and Loss in such transaction can be set off against normal business profit.
There is a specific exemption provided in provision (d) of the section.
Had it been a speculative transaction the losses could only be set off against income from speculative transactions and be carried forward for four years.
Business Income vs Capital Gains
There have always been differences between the taxpayer and tax authorities on the classification of F&O income—whether it is business income or income from capital gains—but it entirely depends on certain facts and circumstances:
-Linking commodity derivative transactions with existing business;
-Frequency of the transactions and holding period;
-Volume of transaction; and
-Motive behind the transactions.
In this context, one should note that no single factor is decisive and the effects of all the factors should be considered to determine whether the income is in the nature of business income or capital gains.
So, an investor, who has transacted in derivatives has to independently ascertain the nature of the derivatives transactions and decide accordingly.
F&O Income As Business Income
If income from F&O is considered as business income then it has certain implications.
-Securities transaction tax (STT) and administrative expenses are deductible.
-Losses can be set off against income from business, house property and other sources, but not against one’s salary income.
According to the new rules, unabsorbed losses can be carried forward for eight years and set off against one’s business income.
Since income from derivative trading is considered as normal business income , therefore normal rules as applicable to tax audit as stated in section 44AB will be applicable in case of F&O trading also.
Therefore ,the applicability of tax audit will be as follows in case of F&O trading :
1) In case of the profit from transaction of F&O trading:
-In the case of profit from derivative transaction,tax audit will be applicable if the turnover from such trading exceeds Rs.1 crore.
-Tax audit u/s 44AB read with section 44AD will also be applicable ,if the net profit from such transaction is less than 8% of theturnover from such transactions.
2) In case of Loss from F&O trading:
-In case of loss from derivative trading , since profit &loss in this case is less than 8% of the T/O , therefore tax audit will be applicable u/s 44AB read with section 44AD.
Determination Of Turnover
For derivatives transactions, the following are included in ‘turnover’ for purposes of tax audit under Section 44AB of the Income Tax Act, 1961:
– Total of positive & negative or favourable and unfavourable differences;
– Premium received on sale of options; and
-Difference in respect of reverse trades entered into.
If one makes a profit of 15 lakh (favourable) and books a loss of `13 lakh (unfavourable) in a fiscal from F&O trading, the ‘turnover’ will be 28 lakh (total of favourable and unfavourable differences), there is no need for a tax audit. If the turnover exceeds `1 crore, tax audit is applicable.
F&O Income As Capital Gains
If income from F&O is treated as capital gains then it has certain implications:
– Such gains are usually short-term and taxable at normal slab rates.
– Expenses related to sale or purchase of transactions, such as brokerage, are deductible, but STT is not.
– Short-term capital loss can be set off against any capital gains and carried forward for eight years.
As F&O transactions can be classified either as income from business or capital gains, salaried individuals must first be aware of the form that needs to be filled in . To avoid any further confusion, one should also critically analyse the nature of income from derivatives and list it under the appropriate head.
The due date for filing income tax returns is 31 July, but when income from futures and options is considered as business income and is subject to tax audit, then the due date becomes 30 September.