Lately, derivative trading (trading in future and options or F&O on stocks, currencies and commodities) has become a hot topic amongst investors. Unfortunately though, most people have little knowledge about how these trades are taxed. Besides, several small traders who have losses from futures & options skip reporting them in their tax return. If you are an F&O trader and struggling to understand how to tackle your taxes, read on.
Your gains (losses) from F&O trades must be reported: Taxpayers especially those who are salaried but trade in F&O, make the mistake of not reporting these in their tax return. While this may happen due to sheer ignorance; reporting all your sources of income is mandatory. You may receive a notice from the tax department for non-compliance. And as we will see below, reporting losses comes with tax benefits!
Usually F&O trading is reported as a business: Trading in futures & options must be reported as a business, unless you have only a handful of trades in the financial year. Remember this also applies to individuals. You don’t have to be formally incorporated as a company or some legal entity to earn business income. Individuals can have business income too. And have to file ITR-4 to report this income (From FY 16-17, ITR 3 is the new name for ITR-4, so from the said year, ITR-3 needs to be filed for F&O trading income/losses). You may have filed ITR-1 or ITR-2 before but you must check ITR form applicability every year based on each income earned in that year. Reporting an activity as a business means you can claim expenses from earnings of your business.
Expenses that can be claimed by you: The bright spot in filing your return as a business is being able to claim what you’ve spent on it. Sometimes claiming expenses can lead to a business loss and that is ok too. Claim expenses which have been directly and exclusively spent on the business. Brokerage, broker’s commission, subscriptions to journals related to trading, telephone bills, internet costs, consultant charges if you engaged a person or took advice from a professional who charged you. Or salary of a person you hired to help with your business. All of these can be claimed. Remember to maintain proper record of receipts/bills and make sure you are spending via cheques or bank transfers and not in cash. Expenses over Rs 20,000 in cash, may not be allowed to be claimed. If an expense is both personal and business, claim a reasonable portion towards business.
Mixed bag of stock trading/investment: As a stock market expert, you may put your hands in many buckets. Intra-day stock trading or buying shares for short term or longer term. For tax purposes, you must separate out these activities. If you do intra-day trading that 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 a business too. 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 share sales, gains from these may be treated as capital gains. So, in a financial year, you may have several types of business income or may have capital gains income as well.
Keeping accounting records: Once your activity is treated as a business, there are some other tax rules that may apply. Businesses are required to keep accounting records, if their income (in 3 preceding years or in the first year in case of a new business) is more than Rs 1.2lakhs or if turnover is more than Rs 10Lakhs (in 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 shall mostly suffice. From these your profit and loss account and balance is prepared.
From AY 18-19, the limit of Rs. 120,000 has been increased to Rs. 250,000 and Rs. 10,00,000 to 25,00,000.
Audit and Return filing: We know that most taxpayers have to file return by 31st July, but those to whom audit applies, have a return filing due date of 30th September. Audit applies to a business if its turnover exceeds Rs 1 crore. If this is true for you, you’ll have to get your accounts audited via a CA and submit the audit report along with your tax return. If you fail to maintain books of accounts, or do not get an audit done, penalties shall be applicable as per the income tax act. Maximum penalty of Rs 25,000 for not keeping accounting records, and 0.5% of turnover, maximum up to Rs 1.5 lakh for not getting an audit done.
For applicability of tax audit, the turnover limit has been increased to Rs. 2 crores from FY 2016-17 (AY 2017-18).
The other situation when audit becomes compulsory is when you declare your income below 8% of your turnover and your total income exceeds Rs. 250,000 (after setting off F&O loss). Note that F&O loss cannot be set off against salary income.
Tax benefits on losses: The single most important reason to file with F&O trading is to be able to benefit from losses you have incurred. If your business resulted in a loss, don’t worry, report it in your tax return. It can be adjusted from income from remaining heads such as rental income or interest income (cannot be adjusted from salary income). Any unadjusted loss can be carried forward for eight years. However in future they can only be adjusted from non-speculative income. 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 to four years.
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. 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|
|Brokerage enrollment charges||5,000|
|Brokerage charges paid||98,000|
Income (loss) from F&O
Loss from F&O Rs 3,00,000
Less: expenses of F&O Rs 1,35,400
Total F&O loss Rs 4,35,400
Total taxable income of Aditya
Salary Income Rs 15,00,000
Rental income Rs 3,50,000
Interest income Rs 80,000
Non-speculative loss -Rs 4,35,400
Total taxable income Rs 15,00,000
Loss to be carried forward -Rs 5,400 (-4,35,400 + 3,50,000 + 80,000)
In the given case, income from has been declared at Rs. -5,400 which is less than 8% of the total turnover of trading business and the total taxable income is Rs. 15 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.
If you’re trader and want to file your taxes, visit our page on tax filing for traders.