DETERMINATION OF TURNOVER IN CASE OF TRADING OF SHARES EITHER ON SPECULATION OR NON-SPECULATION BASIS
1. Preamble:
1.1 The broad legal positions are as follows- Dealing in shares whether Investment or Business
Dealing in shares can result either in “Business income” (chargeable as Profits & Gains of Business or Profession chargeable under section 28 of the Income Tax Act, 1961) or “Capital Gains” (chargeable under Sec.45 of the Act). Thus, dealings in shares could either be in the course of business – chargeable as Business Income, OR for the purpose of investment – chargeable as Capital Gains. Classification into Business Income and Capital Gains depends on facts & circumstances of each case. However, as a very broad guideline, as held in many cases, it can be said that – ordinarily, the purchase and sale of shares with the motive of earning a profit, would result in transaction being in the nature of trade, but where the object of investment in shares of a company is to derive income by way of dividend etc., then the profit accruing by sale of shares will yield capital gains and not revenue gains (business income).
2. This article deals with the situation where trading in shares have been considered as business income
3. Explaining Speculation and Non-Speculation Business:
Trading in shares can be of two types namely
A) Delivery based trading
B) Non delivery based (also called intraday trading)
3.1. DELIVERY BASED TRADING:
Under this type of trading, the share transaction is said to be complete only when there is actual delivery of shares/securities upon the settlement of transaction i.e. in other words, when shares are purchased/ sold on delivery basis, then those shares will be transferred to/from Demat account of the buyers/sellers. The buyer of the share will have to pay the full value of share and the share will become his asset with that either he can trade in his business or hold for investment.
3.2. NON DELIVERY BASED TRADING (or intraday trading):
Intraday trading by the name itself one can get a view that it refers to the trading system where the traders have to square-off their trade on the same day. Squaring off the trade means that the traders have to do the buy and sell or sell and buy transaction on the same day before the market close. In other words in this trading, shares are not actually transferred to the DEMAT account of the buyer instead they have to square off their position before the market close on same day by selling the same number of shares. The buyer of the shares will not pay the full value of shares instead he will pay only the difference margin arising on account of such buy/sell transaction.
3.3 Speculative Business Income:
3.3.1. Income from intra-day trading is considered as speculation income and taxed as such.
3.3.2. As per Section 43(5) of the Income Tax Act, 1961, intra-day trading shall be considered as speculation business transactions and the income therefrom would be either speculation gains or speculation losses. Income from speculation gains is taxed at the normal rates.
3.3.3. Intra-day trading is the trading of shares within the same day. Generally, delivery is not taken in case of intra-day trading, and thus, these are said to be speculative transactions. As per Section 43(5) of the Income Tax Act, 1961, the said transactions shall be considered as speculation business transactions and the income therefrom would be either speculation gains or speculation losses.
3.3.4. For a person earning income from any head of income, intra-day trading in shares is always treated as speculative business. Section 43(5) of the Income Tax Act, 1961, deals with speculative transaction. It states that a transaction of purchase or sale of a commodity including stocks and shares settled otherwise than by actual delivery or transfer of the commodity or scrip is a speculative transaction.
3.3.5. In intra-day trading in shares, there is no actual delivery as the shares enter and exit from the trading account on the same date and it does not enter the DEMAT account at all.
3.4 Non Speculative Business Income:
3.4.1. Income from trading F&O (both intraday and overnight) on all the exchanges is considered as non-speculative business income as it has been specifically defined this way. F&O is also considered as non-speculative as these instruments are used for hedging and also for taking/giving delivery of underlying contract. Even though currently almost all equity, currency, & commodity contracts in India are cash settled, but by definition they give rise to giving/taking delivery (there are a few commodity future contracts like gold and almost all agri-commodity contracts with delivery option to it).Income from shorter term equity delivery based trades (held for between 1 day to 1 year) are also best to be considered as non-speculative business income if frequency of such trades executed by you is high or if investing/trading in the markets is your main source of income.
3.4.2. Profit / Loss in derivatives (futures and options) is treated as non-speculation business even though delivery is not effected in such transactions.
3.4.3. From the reading of the above it is clear that trading in derivatives including commodity derivatives on a recognized stock exchange will not be considered as a speculative transaction and hence not treated as speculative business. Therefore since these are not considered as speculative business, therefore income from such transactions will be considered as normal business income and loss from such transactions will be considered as normal business loss.
4. How is turnover computed.?
DETERMINATION OF TURNOVER:
DETERMINATION OF TURNOVER IN RESPECT OF SPECULATIVE TRANSACTION
Now, your attention may be directed to the Para 5 of “Guidance Note on Tax Audit under Section 44AB of the Income Tax Act,1961″ issued by The Institute of Chartered Accountants of India (ICAI), which provides the guidelines regarding “Turnover or Gross Receipts in respect of transactions in shares..” as follows:
a) In a speculative transaction, the contract for sale or purchase which is entered into is not completed by giving or receiving delivery so as to result in the sale as per value of contract note.
b) The contract is settled otherwise and squared up by paying out the difference which may be positive or negative. As such, in such transaction the difference amount is ‘turnover’.
c) In the case of an assessee undertaking speculative transactions there can be both positive and negative differences arising by settlement of various such contracts during the year. Each transaction resulting into whether a positive or negative difference is an independent transaction.
d) Further, amount paid on account of negative difference paid is not related to the amount received on account of positive difference. In such transactions though the contract notes are issued for full value of the purchased or sold asset the entries in the books of account are made only for the differences.
e) Accordingly, the aggregate of both positive and negative differences is to be considered as the turnover of such transactions for determining the liability to audit vides section 44AB, whether the differences are positive or negative.
DETERMINATION OF TURNOVER IN RESPECT OF NON SPECULATIVE TRANSACTION
Determination of turnover in case of F&O is one of the important factors for every individual for the income tax purpose. Turnover must be firstly calculated, in the manner explained below:
1. The total of positive and negative or favorable and unfavorable differences shall be taken as turnover.
2. Premium received on sale of options is to be included in turnover.
3. In respect of any reverse trades entered, the difference thereon shall also form part of the turnover.
Here, it makes no difference, whether the difference is positive or negative. All the differences, whether positive or negative are aggregated and the turnover is calculated.
DETERMINATION OF TURNOVER IN RESPECT OF DELIVERY BASED TRANSACTION:
Where the transaction for the purchase or sale of any commodity including stocks and shares is delivery based whether intended or by default, the total value of the sales is to be considered as turnover.
Like a normal business, computation of income in case of F&O transactions or Intra-day trading would broadly be: Turnover – Purchases – other expenses
Further, income from F&O trading can also be computed using the presumptive scheme u/s 44AD, which essentially presumes the income to be 6% (in case of 100% electronic transactions)
5. When is audit required?
An audit is required if you have a business income and if your business turnover is more than Rs 2 crores (was Rs 1 crore until FY 16/17) for the given financial year. Audit is also required as per section 44AD in cases where turnover is less than Rs.2 Crores but profits are lesser than 8% of the turnover and total income is above minimum exemption limit.
Therefore, the applicability of tax audit will be as follows in case of F&O Trading:
5.1 In case of Profit from transactions of F&O trading
a) In the case of profit from derivative transactions, tax audit will be applicable if the turnover from such trading exceeds Rs. 1 crore.
b) Tax audit u/s 44AB r/w section 44AD will also be applicable, if the net profit from such transactions is less than 8% of the turnover from such transactions.
5.2 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 turnover, therefore Tax Audit will be applicable u/s 44AB read with section 44AD.
6. Tax Treatment:
Business income: If you are trading in the stock market frequently (mostly non-delivery trade), returns from it can be classified as follows:
6.1. Speculative Business income: Profit from intraday trading is categorized under speculative business income. Tax treatment is similar to your Business income tax. It is taxed as per the tax slab you fall in while losses can be offset only against speculative gains.
6.2. Non-speculative Business income: Income from trading futures & options on recognized exchanges (equity, commodity, & currency) is categorized under non-speculative business income. Tax on share trading in such cases is similar to your business income tax. The profits on F/O trading are taxed as per the tax slab you fall in whereas losses on such F/O trading can be set off against business profit.
7. Treatment of Adjustment for loss
7.1 Loss in respect of non speculative business income:
As per the Section 71 of the Income Tax Act, loss in respect of such business can be set off against any other heads of income including income from speculative business but excluding income under the head “salaries” of that year.
As per Section 72 of the Income Tax Act, if there is any such loss which is not set off against the above said incomes, such losses are eligible to be carried forward and set off against the other incomes excluding income from salary for a period of 8 subsequent assessment years in the manner as specified in the above order of set off.
7.2 Loss in respect of speculative business income:
As per the Section 73 of the Income Tax Act, loss in respect of speculative business cannot be set off against any other heads of income i.e. it can be set off only against other speculative incomes if any in that year.
If there is any such loss which is not set off, such losses are eligible to be carried forward and set off only against speculative incomes for a period of only 4 subsequent assessment years.
Maintenance of Books of Accounts in case of F&O Trading
Since income from F&O Trading is considered as normal business income, therefore normal rules for the maintenance of Books of accounts as stated in section 44AA of the Income Tax Act’1961 are applicable. These rules can be summarised as follows:
1) If there is loss in F&O trading or the Net profit is less than 8% (6%, if all trades are digital) of the turnover or the turnover exceeds Rs. 1 crore, then provisions of Tax Audit are applicable and in order to get tax audit done, maintenance of books of account are mandatory.
2) if there is a profit in F&O and the profit is 8% (6%, if all trades are digital) or more of total turnover , then only the income has to be declared as business income and accordingly ITR has to be filed. There will be no need to maintain books of accounts.
Provisions relating to filing of Income Tax Return for F&O trading income
Since income from F&O trading is to be treated as business income, therefore an individual filing return with F&O trading income has to file ITR in form ITR 4.
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.
If Tax Audit is not applicable: Due date will be 31st July of the Assessment Year.
Carry forward & and set off of Loss from F&O transactions
The set-off and carry forward of loss from F&O transactions is also one of the most important questions asked by people. The provisions relating to set-off and carry forward of F&O Loss are as follows:
If there is a loss in F&O and you are claiming the same in the Income Tax return then:
You should file it before due date to carry forward the loss and set off from income in future.
However, there are case laws which prohibit the carry forward and set-off of loss from F&O transactions stating share derivative transactions carry the character of speculative transactions for section 73 and any loss arising therefrom will be characterised as loss from speculative business and same cannot be set-off against normal business income
As per court section 43(5) defining speculative transaction is only for the purpose defining terms used in section 28 to 41.Section 43(5) has no application over section 73. (CIT v/s DLF Commercial Developers Ltd.)
Whereas actual turnover will be determined based on accounting entries passed in the books of account, in case of derivative transactions one will pass entry in books for differential amount only and the same will be regarded as turnover of the business for the purpose of Income tax.
Section 44AB(a) of Income tax Act, 1961 (“the Act”) provides that if the turnover or gross receipts exceeds Rs. 1 Crore then he is liable to get his books of accounts audited under Income tax. First Proviso to section 44AB provides that section 44AB will not be applicable in case the person declares profits and gains from business as per provision of section 44AD(1) and his total sales or turnover as the case may be doesn’t exceeds Rs. 2 Crore.
Section 44AD(1), starts with non-obstante clause with regards to section 28 to section 43C, provides that a sum equal to 8% of the total turnover or a sum higher than the 8% claimed to have been earned by the eligible assessee shall be deemed to be the profit and gains of such business and chargeable under the head “PGBP”. Explanation to section 44AD doesn’t specifically exclude transactions in derivatives – F&O as not eligible business.
Explanation 2 to section 28 provides that speculative transactions are of business nature then the same will be distinct transactions from any other business of the assessee.
Section 43(5) defines speculative transactions and specifically excludes derivative (F&O) transactions from the definition of speculative transactions.
Combined reading of section 28 and section 43(5) provides that derivatives (F&O) transactions will be treated as business and profit or loss will be taxable as business income only.
In case of Nand Lal Popli vs D.C.I.T. (ITA No.1161/Chd/2013 & ITA No.1162/Chd/2013) the Hon’ble ITAT, Chandigarh has held that asking the assessee to prove to the satisfaction of the Assessing Officer, the expenditure to the extent of 92% of gross receipts, would also defeat the purpose of presumptive taxation as provided under section 44AD of the Act or other such provision. Since the scheme of presumptive taxation has been formed in order to avoid the long drawn process of assessment in cases of small traders or in cases of those businesses where the incomes are almost of static quantum of all the businesses, the Assessing Officer could have made the addition under section 69C of the Act, once he had carved out the case out of the glitches of the provisions of section 44AD of the Act.
As per provision of section 44AD it is at the option of assessee to offer 8% or actual profit that he claims to have been earned from the said F&O transactions. If profit is offered at 8% then there will be addition to asset at actual profit that was earned by the assessee. It may possible that AO add differential amount as unexplained investment under section 69C of the Act
Computation of turnover for share/derivatives trading and applicability of Section 44AD. AO to either follow ICAI guidance note on tax audit or compute turnover based upon evidence on record – ITAT
According to the Guidance Note of ICAI on Tax Audit under Section 44AB of the Income-tax Act, 1961 “Sales”, “Turnover” and “Gross receipts” being commercial terms, should be construed in accordance with the method of accounting regularly employed by the assessee. As per the said Guidance Note, the method of accounting followed by the assessee is relevant for the determination of sales, turnover or gross receipts.
The said Guidance Note also prescribes the manner of determining turnover or gross receipts in respect of transactions in shares, securities and derivatives.
With regard to speculative transactions, (i.e. transaction in which a contract for the purchase or sale of any commodity, including stocks and shares, is periodically or ultimately settled otherwise than by the actual delivery or transfer of the commodity or scrips ) the Guidance note states that in such transactions though the contract notes are issued for full value of the purchased or sold asset the entries in the books of account are made only for the differences. Accordingly, the aggregate of both positive and negative differences is to be considered as the turnover of such transactions for determining the liability to audit vide section 44AB.
The instant judgment of the Tribunal deals with the following two issues:
(a) The computation of turnover in respect of trading of shares/derivatives
(b) Applicability of Section 44AD for deeming provisions of net profit and Audit liability under section 44AB of the Income Tax, 1961.
In the instant case, the assessee had challenged the order of the CIT(A) in upholding the order of the Assessing Officer (AO) in computing the turnover and making addition by applying profit rate of 8% of deemed income under section 44AD of the Income Tax Act, 1961 (the Act).
The assessee was a salaried employee and was also engaged in share trading. However, the income from the share trading had not been declared by assessee in his return.
The A.O. asked the assessee to furnish details of shares and derivative transactions made in equity shares. The assessee furnished details of trading equity share and derivative transactions made.
The assessee was further asked to explain why income from derivatives has not been shown in the return of income, to which, the assessee explained that since it was a case of loss, to which assessee did not intend to brought forward for set-off in the forthcoming years, therefore, loss was not declared in the return of income.
The AO noticed that the assessee had not got his accounts audited and neither he declared his business income at the rate of 8% of the gross receipts.
The assessee claimed that Section 44AD would not apply and that assessee earned loss.
The AO noted that in the case of share trading, the ICAI guidance note on tax audit under Section 44AB of the Income Tax Act is not adopted or recognised by the Income Tax Department, thus, it had no binding effect. However, the AO took the notice of the same and applied it to some extent.
The AO noted that the term “gross receipts” for the purpose of turnover has not been defined in the Act. The AO was of the view that normally, sales is an integral part of turnover. Sales in general mean purchase plus loss/profit. In the case of share trading, the assessee did the business just applying small amount against large scale purchases just applying margin money.
The AO noted that the assessee made total gross transactions (including both sale and purchase) of about Rs.11.67 crores, against which, assessee had invested fresh capital in purchase Rs. 10 lacs plus loss of Rs. 67,82,571/-. The A.O. then determined the turnover of assessee partly in the light of guidance note of ICAI and computed the total turnover of assessee at Rs.77,82,571/-.
The AO then referred to Section 44AD of the Act and held that these provisions were applicable to the assessee. Therefore, he computed a deeming profit by applying profit rate of 8%.
The CIT(A) dismissed the appeal of assessee holding that Section 44AD was applicable to the case as the assessee did not maintain the books of accounts and did not get the accounts audited.
The Tribunal opined that the margin money could never be the turnover of assessee and therefore, addition to that to the turnover was wholly unjustified.
The Tribunal further observed that the AO in the assessment order had referred to guidance note on tax audit under Section 44AB of the Act published by ICAI, but noted that it had not been recognised by the Department, therefore, same were not binding upon the Department. The AO, however, taken note of the same and applied to some extent for the purpose of computing the turnover of the assessee.
The Tribunal opined that the AO could not have gone in both ways. Either AO should do his own calculation based upon evidence and material on record to calculate the turnover of assessee for the purpose of making the addition or he should follow guidance note on tax audit published by the ICAI. No other
F&o is eligible business u /s 44 AD as far as I read. But if I am never opting for sec 44 AD presumptive section on the faith in f&o every transaction is processed digitally and I have to report the true picture and going with Net profit method always
Moreover , I learnt that if actual profit % is let’s say 15 % then 6% cannot be declared because in f&o as transactions are PAN no based and everything is under the scanner of I Tax deptt. in my opinion, generally assessees disclose only 8% or 6% as the case may be under 44AD under eligible business because they don’t maintain books and it’s difficult ascertain the exact net profit. but in your case, since the depository account holder itself maintains p& I, you can’t go with 8% or 6% but with the actual profit earned
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