All About Derivative under Income Tax Act

This Article explains What Is Derivative, Income From Derivatives, Maintenance Of Books Of Accounts, Calculation Of Turnover Of Derivative, When Is An Audit Mandatory, Tax Treatment Of Derivative And Treatment Of Adjustment For Loss.

WHAT IS DERIVATIVE

A derivative means an instrument whose value is derived. It has no value of its own. Its price is based on the underlying asset. Derivatives of stocks and indices can be traded on Indian stock exchanges. The most popular form of derivatives are futures & options (F&O).

A futures contract means an agreement to buy or sell on a future date. This contract expires on a pre-set date. On expiry, futures are executed by delivery of the underlying asset or via payment.

Options and futures are alike but when you do an options contract, you can choose to not make the transaction.

INCOME FROM DERIVATIVES

Income from F&O deals is almost always treated as business income. This treatment is irrespective of the frequency or volume of your transactions. That may come as a surprise if you are salaried and have never run a business. Taxpayers who have business income must file ITR-3.

As per Indian Tax Laws, Incomes are reported under five heads of income i.e. Salary, House Property, Capital Gains, Business and Profession and Other Sources. F&O trade is reported under the head ‘Business’ in Income Tax Return (“ITR”).

Under Section 43(5) of Income Tax Act, a business is categorized as speculative or non-speculative.

• Speculative business income:Income from intraday equity trading is considered as speculative.
• Non-speculative business income:Income from trading F&O (both intraday and carryforward) on is considered as non-speculative business. F&O is also considered as non-speculative as these instruments are used for hedging and also for taking/giving delivery of underlying contract.

MAINTENANCE OF BOOKS OF ACCOUNTS

All the transaction carried out need to be recorded. This includes buy/sell transactions, expenses like electricity bills, demat charges, phone bills, advisory fee etc. In case a trader is involved in multiple forms of trading in shares like intraday trading, F&O, making investments in MFs, holding shares for more than twelve months from the date of purchase, the business income from each of these must be declared separately since the tax treatment differs based on the type of dealing. The common expenses can be bifurcated depending on the proportion of time spent on the various types of trades.

CALCULATION OF TURNOVER OF DERIVATIVE

For every trade, contract notes are issued which show the value of derivative bought or sold. While for the recording purpose only the difference between is used. Take this example:

1. RK bought one lot of RAK Foundation at 2.0 lakhs and sold it for 2.8 lakhs (Profit = Rs 80,000)
2. RK bought one lot of RAK Inc. at 3.5 lakhs and sold it for 3.00 lakhs (Loss= Rs 50,000)

The turnover shall be calculated as Rs 80,000 + Rs 50,000 = Rs. 1.30 lakhs. Also, any premium received when you’re writing an option must be added to the turnover value.

Read- ICAI FAQs on How to Compute Turnover In Case of Future & Options, Speculation for Tax Audit

WHEN IS AN AUDIT MANDATORY

An audit is required if you have a business income and if your business turnover is more than Rs 1 crores. 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:

In case of Profit from transactions of F&O Trading:

1. In the case of profit from derivative transactions, tax audit will be applicable if the turnover from such trading exceeds Rs. 1 crore.
2. Tax audit u/s 44AB row’s. 44AD will also be applicable, if the net profit from such transactions is less than 8% of the turnover from such transactions.

In case of Loss from F&O Trading:

1. 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 r.w.s. 44AD.

TAX TREATMENT OF DERIVATIVE

Business Income: If you are trading in the stock market frequently (mostly non-delivery trade), returns from it can be classified as follows:

• 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.
• 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.

TREATMENT OF ADJUSTMENT FOR LOSS

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.

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.

In case you need any information or clarification, please feel free to write us on carkadvisory@gmail.com or drop WhatsApp on 9910765030

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