Everything an F&O trader should know about return filing

For years, F&O traders have been subject to tax audit only because their turnover crossed Rs 10 Crore. But recently the formula for calculating Trading Turnover was updated. Traditionally, the option premium was considered as part of the turnover, often leading to inflated figures that made tax audit mandatory for traders. But now, only positive and negative differences will be taken into account. As a result, turnover from F&O transactions will be significantly lower- which means no tax audit. 

If you are an F&O trader and find it challenging to comprehend the tax implications on your F&O trades, read on for a simplified and comprehensive explanation.

Your gains (losses) from F&O trades must be reported in ITR

Many taxpayers involved in F&O trading often neglect to include their F&O trading information in their tax returns. While this oversight may occur due to lack of awareness, it is crucial to declare all the sources of income. If you fail to disclose, you may receive a notice from the tax department as they now have access to all the stock market transactions carried out by taxpayers. 

In case you have loss from F&O trading, there are tax benefits associated with reporting losses which we will discuss in detail later.

Income Head: Reporting of F&O trading as business income?

As per Section 43(5) of the Income Tax Act, income or loss from F&O is classified as non-speculative business income. Therefore, it is necessary to declare profit/loss from F&O as Business Income under the PGBP head (PGBP Profits & Gains from Business and Profession).

Which ITR to file for reporting F&O income?

Given that F&O Income falls under the category of business income, people having F&O trades must report the profit/loss in ITR-3 form (ITR form designated for people having PGBP Income).

When you file with Cleartax, there is no need to manually select the right ITR form as we auto-select the correct ITR form for you based on your income and other relevant information. 

Taxability of other investments?

In addition to F&O trading, you may also carry out intra-day trading or long-term or short-term investment. However, it is important to note that the taxation rules for each of these activities differ:

• Intra-day trading: must be treated as a separate business from F&O and its income/(loss) should be computed separately.
• If you have a large volume and high frequency of short term trading in equity shares that may be treated as business income or capital gains. Choose a basis wisely and implement it consistently across financial years.
• If you are a long term equity investor or have fewer short-term equity shares, gains from these may be treated as capital gains.

Should F&O traders maintain accounting records?

Once your activity is regarded as a business, there are some additional tax rules that may apply.

In case you are running a business 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 
- turnover exceeds Rs 25 lakhs in any of the 3 preceding years or in the first year in case of a new business. 

If you are an individual who’s doing a business, such as F&O trading, these apply to you as well. Your book keeping will be simpler though. Keeping your trading statements, expense receipts and bank account statements will mostly suffice.

Audit and Return filing

To determine the applicability of Tax Audit, it is important to calculate Trading Turnover.

How to calculate F&O Turnover?

Turnover for F&O Trading = Absolute Profit

Absolute Turnover refers to the sum of positive and negative differences. 

Note: Please note that the calculation for options trading turnover has been updated as per the eighth edition of the guidance note dated 14/08/2022 (applicable from Assessment Year 2022-23). Previously, options trading turnover included "Absolute Profit + Premium on Sale of Options."

Example:
 Aditya buys 100 units of Futures @ Rs 200 and sells at Rs 210. Also buys 200 units of options @ Rs 300 and sells at Rs 290.

This is how his turnover would be determined:

Is Tax Audit applicable for F&O Trading under Section 44AB?

F&O traders commonly get confused about tax audit applicability. Let us break down the tax provisions.
Note: These tax provisions may get overwhelming for some. In which case you can directly skip to the next paragraph where we have discussed the applicability of tax audit.

Section 44AB: Tax Audit: Let us see what this section talks about tax audit

Now that tax audit is dependent on another section, i.e. Section 44AD, let us take a look at the relevant portion.

Tax Audit Applicability for F&O traders

Tax audit applicability for F&O traders is discussed below based on their turnover. From the above tax provisions, we can conclude that tax audit will be applicable only in two cases- 1 and 3 below. 

1. Trading Turnover up to INR 2 Cr
   If the loss or profit from F&O is less than 6% of the Trading Turnover and you've opted out of the presumptive taxation scheme in any of the immediate 5 previous years, and your total income exceeds the basic exemption limit, then Tax Audit will be applicable [Section 44AB(e)]
   On the other hand, if the taxpayer has a profit equal to or greater than 6% of the Trading Turnover, then Tax Audit is not applicable. 
    
2. Trading Turnover between Rs 2 Cr and Rs 10 Cr
   If the Trading Turnover falls within the range of Rs 2 Cr and Rs 10 Cr and the majority of transactions (more than 95%) are carried out digitally, then tax Audit is not required, regardless of whether there is a profit or loss. (Section 44AB) 
    
3. Trading Turnover of more than INR 10 Cr
   Tax Audit is applicable irrespective of the profit or loss [Section 44AB(a)] 

F&O losses – Provisions relating to set off and carry forward

If you have incurred losses in F&O trading, then the primary and most important reason for filing your ITR is to carry forward the losses you have incurred. You can carry forward the F&O losses and offset it against your income in the following 8 years. This will help reduce your tax liability in the following years.
However, the losses can only be adjusted from non-speculative income in the following years.

F&O trading loss is considered a non-speculative loss. Intra-day stock trading is considered as a speculative loss. And it can only be adjusted against speculative income. Unadjusted speculative losses can be carried forward only to the next four years.

Can expenses be claimed by F&O trader?

Yes, you can deduct your business expenses from your F&O income. Also, it is acceptable to claim these expenses when you have incurred loss from F&O.

Ensure that you claim only those expenses which are directly and exclusively related to your business. These may include brokerage fees, broker's commission, subscriptions to trading-related journals, telephone bills, internet costs, consultant charges if you sought professional advice and were charged for it, or the salary of an individual you hired to assist with your business. All of these expenses are eligible for deduction.

It is important to maintain proper records of receipts and bills, and it is advisable to make payment though digital means instead of using cash.

Expenses exceeding Rs 10,000 in cash may not be eligible for deduction. In cases where an expense is both personal and business-related, claim a reasonable portion that can be attributed to the business.

Example 2: 
Aditya works with ABC ltd and has earned a salary of Rs 15 lakh in FY 2017-18. 
Aditya opened a trading account with a brokerage firm by paying Rs 5,000 as enrolment charges.
He has to pay 0.02% as brokerage charges for each F&O trade and paid a total of Rs 98,000 as brokerage charges during the year.
Aditya has telephone expenses for the whole year of Rs 36,000 and a review of his past bills indicates about 50% of his bill is towards his F&O trade. Aditya spends a significant amount of time researching on the internet which help him improve his trading skills. 
His monthly internet bill is Rs 1,200. When Aditya looked up his trading statement he found that he has incurred a loss from F&O aggregating Rs 3 lakhs.
His total turnover being Rs. 30 lakhs (determined on the basis of the method discussed above). Aditya is unsure if he should report his trading activity from F&O or he can ignore it since there is a loss. 
Besides, salary Aditya has Rs 80,000 interest income and Rs 3.5lakhs rental income. Aditya must report his F&O trading as a business.

His F&O expense detail is as follows.

Expenses of F&O Business

Income (loss) from F&O

Total taxable income of Aditya 

                                     * Note: Loss cannot be adjusted from the salary income

Answer:
In the given case, income from business has been declared at Rs -5,400. The presumptive income @ 6% of his turnover is Rs 1.8 lakhs which is more than Rs -5, 400.
Further, the total taxable income is Rs 15 lakhs which are greater than the basic exemption limit of Rs 2.5 lakhs. Thus, tax audit becomes compulsory and filing of balance sheet and profit and loss in the income tax return are mandatory in this case.

Should F&O traders opt for New Tax regime?

F&O traders have the option to pay taxes under the new tax regime outlined in Section 115BAC of the Income Tax Act. Should F&O traders opt for this new tax regime? It is important to consider the following key points under the new tax regime:

- The tax liability will be calculated based on the slab rates introduced in the new tax regime
- F&O Traders will not be allowed to claim deductions under Chapter VI-A like 80C, 80D etc
- Brought forward losses cannot be set off by the trader
- Losses cannot be carried forward to subsequent years
- Filing Form 10IE on the income tax website is mandatory
- Traders engaged in business activities who opt for the new tax regime have an option to go back to the old regime only once in a lifetime. Therefore, if they opt for the new tax regime a second time, they are permanently barred from returning to the old regime.

Frequently Asked Questions (FAQs)

When is tax audit mandatory for F&O trading? 

Tax audit is not mandatory if trading turnover doesn't exceed 2 crore. Tax audit u/s 44AB will be applicable if turnover exceeds 2 crore and the net profit from such transactions is less than 6% of the turnover. Tax Audit u/s 44AB is mandatory if turnover exceeds Rs 10 Crore irrespective of profit or loss declared.

Do I need to pay Advance Tax on my F&O Profits?

F&O income is categorized as is a non-speculative business income and is taxable at normal slab rates. If your expected income for the financial year is more than Rs 10,000, then you will have to pay advance tax in four quarterly installments as per the applicable due date. You may use this advance tax calculator to determine the precise amount of advance tax you need to pay.

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