How Future and Option Derivative Trading Transaction in Shares are Taxed and what are the Audit Requirements?
In the last couple of years there has been a rise in derivative trading i.e. trading in options and futures (F&Os). Many people have interest in stock markets and they casually do intra-day trading or invest in stocks in small amounts, resulting into gains or losses. As they deal in small quantities in a casual manner and the net gain or loss is not very significant compared to their salary, such tax payers, at the time of e-filing of Income Tax Return, often ignore to mention these transactions in their ITR.
What do you mean by F&O Trading?
Derivatives are a kind of trading instrument. They are special contracts whose value derives from an underlying security. Futures and Options (F&O) are two types of derivatives available for the trading in India stock markets.
A futures contract enables investors to buy or sell a stock at a fixed price for delivery on a later date. The call option available on a stock facilitates the investor to buy the common stock (underlying asset) for a fixed price at a later date; on the other hand a put option enables you to sell the common stock.
F&O income to be considered as Business income:
Income arising from the trading of Futures and Options could be treated either as business income or as capital gains. Gains from F&O are not considered capital gains but business income according to Income Tax. Any income or loss that arises from the trading of Futures and Options is to be treated and considered as business income or business loss. It is important to disclose income under the correct head and in correct schedule.
Effects when F&O income is treated as Business Income
- Any expenditure relating to administration is deductible
- Securities Transaction Tax or STT will be deemed to be deductible as well
- Any loss arising from trading of Futures and Options can be offset against any income arising from the taxpayer’s residential property, any other business as well as any other source apart from the taxpayer’s regular salary.
- Any losses that have not been absorbed can be offset against any income the taxpayer receives from any other business, and can be carried ahead for a maximum period of 8 years
- A tax audit will be mandatory if the turnover or income arising from trading of Futures and Options is above and beyond the pre determined limit
Trading in futures & options must be reported as a business unless you have only a few trades (say if only 2-3 trades) in the financial year.
Trading in F&O’s to be treated as non-speculative:
Section 43(5) of the Income Tax Act states that any transactions that take place during Futures and Options trading are deemed to be non speculative transactions. This means than any profits from such trading would be taxed in the same manner as income or profits acquired from the carrying on of any other kind of business.
Applicability of Tax Audit in case of derivative (F&O) Trading:
Since income from F&O 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:
A taxpayer is required to have a tax audit carried out if the sales, turnover or gross receipts of business exceed Rs 1 crore in the financial year. The threshold limit of Rs 1 crore for a tax audit is has increased to Rs 5 crore with effect from AY 2020-21 (FY 2019-20) if the taxpayer’s cash receipts are limited to 5% of the gross receipts or turnover, and if the taxpayer’s cash payments are limited to 5% of the aggregate payments.
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
ITR filing requirements
Any income or loss that arises from the trading of Futures and Options is to be treated and considered as business income or business loss. Therefore, the ITR-4 tax form would be required by the taxpayer to file his or her returns.
Any taxable income that has been acquired from the trading of Futures and Options after any deductions have taken place is taxed as per prescribed income tax slab rates. ITR4 is the form that traders need to file if they are selecting preemptive scheme of tax.
But, for ITR 4 your turnover from F&O trading should not exceed Rs 5 crore or there should not be any losses to carry forward or bring forward from last year.
On the other hand, ITR 3 is meant for self-employed professionals and individuals with business income. Even if you are a salaried person or F&O trading is not your primary business, you have to use ITR 3 or ITR 4 to file your return.
Depending on the requirement to get the accounts audited as per section 44AB & 44AD, the due date for filing the return of income will be as follows:
- If Tax Audit is applicable – Due date will be 30th September of the Assessment Year. For Assessment Year 2020-21 due date of tax audit has been extended to 30th October 2020. Also the assessee has to file the return of income by 30th November 2020.
- If Tax Audit is not applicable – Due date will be 31st July of the Assessment Year. For Assessment Year 2020-21 due date for filing income tax return is 30th November 2020.
Why should I report my F&O transactions?
It should be kept in mind that be it significant or insignificant, gain or loss, a person involved in transaction of F&O’s must disclose it in his/her ITR, provided the total income exceeds the tax-free limit in a financial year. If a person wants to carry forward the unadjusted capital loss, or to bring forward such a loss from the previous year, filing of ITR will be necessary.
Business loss 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 the future, they can only be adjusted from non-speculative income.
Omitting such transactions would not only invite a notice for non-disclosure, but may also attract penal actions due to tax avoidance.
Filing ITR comes with a number of benefits such as claiming deductions, set off and carry forward of losses, avoid interest and penalties on tax liability and so on. It is always considered a prudent action to file one’s income tax return on time. More than any other benefit, being on the right side of law helps. It is recommended to keep the income tax department informed about one’s income and taxability. This communication is only possible when one files their ITR.
Summary of above:
| Type of transaction | Whether tax audit u/s 44AB applicable | Explanation |
| Intraday Trading | Applicable | In the case of profit from derivative transactions, tax audit will be applicable if the turnover from such trading exceeds Rs. 5 crore. i.e. The sum total of favorable trades and the sum total of unfavorable trades must Exceed Rs. 5 Crore in order to get tax audit provisions to get attracted. |
| Future and Options | Applicable | In the case of profit from derivative transactions, tax audit will be applicable if the turnover from such trading exceeds Rs. 5 crore. i.e. The sum total of favorable trades and the sum total of unfavorable trades must Exceed Rs. 5 Crore in order to get tax audit provisions to get attracted. |
| Long term capital gains | Not applicable | NA |
| Short term capital gains | Not applicable | NA |
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