All about income from derivatives under Income Tax Act
National Stock Exchange (NSE) has become world’s largest derivative exchange for two consecutive years in number of contracts traded. NSE’s capital market segment average turnover witnessed growth of 57% with commencement of year 2020.
However, few traders have knowledge about how these transactions are taxed. Besides, several small traders who have gains or losses from futures & options skip reporting them in their tax return due to which trader can receive a notice from the tax department for non-compliance.
Head of Income for gains and losses from derivative trading
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.
Transactions in the derivative market are treated to be non-speculative transactions as per Section 43(5) and taxed just like any other business income. The expenses incurred for Business would also be allowed to be claimed in the income tax return.
Computation of turnover
The computation of turnover is a very important factor as the applicability of tax audit is determined based on turnover. The Income-tax Act does not contain any provision or guidance for computation of turnover in F&O trading. However, the Guidance Note on Tax Audit issued by the ICAI prescribes the method of determining turnover which shall be as under:
So, if you buy 50 units or 1 lot of Nifty futures at 18000 and sell at 17900, Rs.5,000 (50 x 100) the negative difference or loss on the trade is turnover.
In options, if you buy 100 or 2 lots of Nifty 18000 calls at Rs.20 and sell at Rs.30. Firstly, the favorable difference or profit of Rs 1000 (10 x 100) is the turnover. But premium received on sale also has to be considered turnover, which is Rs 30 x 100 = Rs 3,000. So total turnover on this option trade = 1000 +3000 = Rs 4,000.
The above calculations (points 1 to 3) are fairly simple; the next important thing to decide though is if you want to calculate turnover scrip-wise or trade-wise.
Scrip wise is when you calculate the turnover by collating all trades on the particular contract/scrip for the financial year, calculating average buy/sell value, and then determining the turnover using the above 3 rules with the total profit/loss or favorable/unfavorable difference on this average price.
Trade wise is when you calculate the turnover by summing up the absolute value of profit and loss of every trade done during the year and following the above rules.
Let us understand by following examples
100 Nifty Oct future bought at 18000 and sold at 18100 on 1st Another 100 Nifty Oct future bought at 18100 and sold at 18050 on 28th Oct.
Using scrip wise:
Average Nifty Oct Fut buy: 200 Nifty Buy at 18050
Average Nifty Oct Fut sell: 200 Nifty Sell at 18075
Total profit/loss = 200 x Rs 25 = Profit of Rs 5,000 = Turnover of Nifty Oct Futures
Using trade wise:
100 Nifty Buy at 18000, Sell at 18100, Profit = Rs 10,000
100 Nifty Buy at 18100, Sell at 18050, Loss = Rs 5,000
Turnover of Nifty Oct futures = Rs 10,000 + Rs 5,000 (absolute sum of the loss) =
100 Nifty Oct 18000 puts bought at 200 and sold at 250 on Oct 3rd. Another 100 Nifty Oct 18000 puts bought at 150 and sold at 80.
Using scrip wise:
Average of Nifty Oct 18000 puts buy: 200 puts at 175
Average of Nifty Oct 18000 puts sell: 200 puts at 165
Total profit/loss = 200 x Rs 10 = Loss of Rs 2,000
Total Selling value of options = 200 x Rs 165 = Rs 33,000
Total Turnover for Oct 18000 puts = Rs 2,000 + Rs 33,000 = Rs 35,000
Using trade wise:
100 Nifty Oct puts bought at 200 and sold at 250, Profit = Rs 5,000
Selling value of options =100 x Rs 250 = Rs 25,000
Turnover = Rs 30,000
100 Nifty Oct puts bought at 150 and sold at 80, Loss = Rs 7,000
Selling value of options = 100 x Rs 80 = Rs 8,000
Turnover = Rs 15,000
Total turnover = turnover of (trade 1+trade2) = Rs 45,000
Which of the methods should I follow?
Calculating turnover trade-wise is the most compliant way of determining turnover. The complicated bit calculating trade-wise turnover though is that very few brokers offer trade-wise turnover reports. All brokers provide a P&L with an average buy/sell price, which can be used to calculate scrip-wise turnover. However, one can download all trades done during the year and calculate turnover manually.
Expenses that can be claimed as deductions
The trader may claim the costs incurred directly and solely for the business. Expenses such as brokerage, subscriptions to trade-related journals, phone bills, online costs, consultant costs if you take advice from a paid professional, or the salary of the person you hired to help with your business. However, a proper record of receipts and bills should be maintained.
Tax Audit applicability
As gains and losses from F&O trading are considered as a normal business income, normal provision of the Income Tax Act will apply in this case. Hence, in case turnover from such derivative trading exceeds Rs.10 crore tax audit shall be applicable. Moreover, if a trader has incurred loss or net profit from such transaction is less than 6% of the turnover, tax audit u/s 44AB shall be applicable.
The penalty leviable for non-maintenance of accounting records could go up to Rs 25,000 under Section 271A. Further, a penalty equal to a lower of Rs 1.5 lakhs or 0.5% of gross receipts or turnover can be levied under Section 271B for not getting books audited under Section 44AB.
Treatment of Loss arising in F&O Transactions
The loss arising out of F&O Transactions would be allowed to be set off against all other incomes except Salary Income. If the Loss is not set off against the incomes of the same financial year, then such loss can be carried forward upto 8 years and set off against future business incomes. However, for the loss to be carried forward and set off, the loss should be disclosed in the Income Tax Return and the ITR should be filed before the due date of filing of income.
Any taxable income that has been acquired from the trading of derivatives after deducting expenses is taxed as per prescribed income tax slab rates.