Khushi Khandelwal –
In this article, I have tried to resolve many doubts and confusion regarding taxability provisions on whether or not futures and options are subject to liability under section 44AD as per the latest amendments and if we search online about this topic then it will show that futures and options are liable under section 44AD as it is considered as normal business or profession but we have written this article by taking second view that futures and options are not liable for 44AD.
Naturally, those who are dealing in financial and commodity markets will be concerned about price fluctuations, since changes in prices can mean losses – or profits. To protect themselves, they resort to derivatives like Futures and Options.
Futures are financial agreements or derivative contracts between two parties to purchase or sell an item in a certain quantity at a fixed price and date. It renders the parties to the agreement legally obligated to settle the transaction, regardless of whether they make a huge profit or suffer a substantial loss.
Options trading refers to a contract between the buyer and the seller, the option holder is making a prediction about the price at which an underlying securities or index will eventually trade. The holder may buy or sell at the strike price on the expiration date, but isn’t obligated to do so.
Primarily, there are two forms of options—
Call Option and Put Option
The call option holder gets into the contract with the writer to purchase or sell a security if the price goes up to the strike price—on the expiration date. Thus, a call buyer has a bullish view of the underlying stock or index, while a call seller thinks the prices will either stay the same or drop.
In a put option, the buyer bets on a lower future price on the expiration date. Here, the put buyer is bearish and feels that the underlying stock or index price will fall on the expiration date. In contrast, the put seller assumes that the price will remain unchanged or rise in the future.
Derivative trading (F & O trading) has become a normal now a days. Most of the people do Futures& Options trading without having knowledge about its taxability, or required to maintain books of accounts or not.
Let’s dig deep into this.
Under what head Futures and Options are taxable?
Trading in Futures and Options is a business transaction. Yes, you read it correctly. The derivatives transactions constitute business on the basis that:
> Futures and Options neither have voting rights nor right to control
> Futures and Options would have a short life of about 3 months. It can’t be held as investment
> Trading in Futures and Options is an adventure in nature of trade
To support the same, there are following judicial precedent-
> CIT v. Blue Berry Trading Co. (P.) Ltd. [2022] 143 taxmann.com 140 (Mumbai – Trib.)
> DCIT, Cir-6, Kolkata, Kolkata v. Loknath Saraf Securities Ltd., Kolkata ITA 695/KOL/2008
> Deepak Sogani v. DCIT-24 [2016] 68 taxmann.com 332 (Mumbai – Trib.)
From the foregoing discussions it is apparent that trading in Futures and Options is not considered as Long-Term Capital Gain as the term of future and options is 3 months.
Business Income versus Short Term Capital Gain
Trading in Futures and Options is business income and not short term capital gain. Following are the effects that results when futures and options income is considered as business income rather than short term capital gain-
> As per section 44AA, in case of business assessee is required to maintain books of accounts. However in case of short term capital gain there is no requirement of maintenance of books of accounts. Therefore, keeping books of accounts becomes challenging for small assessee.
> As per section 44AB, a tax audit is necessary if business turnover or gross receipts exceed the permissible limits. This increases the burden on the small assessee. As per section 271B of the Income Tax Act, if you fail to get your accounts audited, the Assessing Officer may levy a penalty equal to Rs. 1,50,000 or 0.50% of gross turnover, whichever is lower.
> Income tax returns for business income must be filed using ITR Form 3, which calls for additional details like preparation of a balance sheet and a profit and loss statement among other details.
Speculative or Non Speculative ?
The business income is normally divided into speculative and non-speculative income. Section 43(5) defines a speculative transaction to mean eligible transaction in which a contract for purchase or sale of any commodity, including stocks and shares is periodically or ultimately settled otherwise than by actual delivery or transfer of the commodity or scrip.
Explanation to section 43(5) provides that an eligible transaction in respect of trading in derivatives carried out on a recognized stock exchange shall not be treated as speculative transaction subject to compliance of prescribed conditions.
Hence, if trading in Futures and Options are carried out on a recognized stock exchange and provisions of section 43(5) are complied with, then income from Futures and Options shall not be considered as speculative business.
How to Calculate Futures and Options Turnover ?
It is important to determine turnover in order to determine the applicability of tax audit as per Section 44AB of the Income Tax Act, 1961 or declaring income u/s 44AD.
In order to determine the total turnover derived from the trading of Futures and Options, it is necessary to take into consideration the following factors:
1. While calculating the turnover, the total of positive and negative differences are to be considered.
The following example of Mr. X will help us to understand better :
|
Script Name |
X Future | Y Future | A Option | B Option |
| Purchase Value | 4,00,000 | 6,00,000 | 5,00,000 | 700,000 |
| Sale Amount | 3,80,000 | 6,35,000 | 5,30,000 | 680,000 |
| Gain/ Losses | (20,000) | 35,000 | 30,000 | (20,000) |
| Turnover | 20,000 | 35,000 | 30,000 | 20,000 |
Total Profit Rs.250000
Total Turnover Rs.105000
2. The premium received by the trader while selling the options has to be included.
For example – Mr. Y buys 200 units of options @ Rs 300 and sold for Rs 290.
Then, total loss is Rs.2,000 and total turnover is Rs.60,000 [Loss 2000 +Premium of option 58,000(200×290)]
3. In case of reverse trades entered by the trader, the difference thereafter will also be a part of the turnover.
In above example, Mr. Y made reversal of the sold options at Rs.280. Then, the loss on reversal of sold options of Rs.2,000 would be included in calculation of turnover.
The net amount receivable or payable is mentioned at the end of the contract note:
Futures and Options- The Road Ahead in 44AD/Turnover/Business
Section 44AD provides that a sum equal to 8% /6% of the total turnover or gross receipts or a sum higher than the 8% /6% claimed to have been earned by the assessee shall be deemed to be the profit and gains of such business.
Section 44AD was inserted in the Income Tax Act with a view to provide method of estimating income from the business of civil construction or supply of labour for civil construction work. The scheme, when introduced, was optional and an assessee could offer that his income at presumptive rate.
The benefits of presumptive taxation scheme were further extended to all businesses w.e.f. 1-4-2011 except in case of income from profession, commission, brokerage and agency.
Section 44AD doesn’t specifically exclude transactions in derivatives – Futures and Options as not eligible business.
In Futures and Options transactions, profit or loss of each transaction is considered as turnover. In the above example of Mr.X turnover is calculated as under :
| Profit (30,000+35,000) = | 65,000 |
| Loss (20,000+20,000) = | 40,000 |
| Total Turnover = | 1,05,000 |
So if presumptive rate of 6% is applied on the turnover it will be 6% of Rs.1,05,000i.e Rs.6,300 whereas its actual income is Rs.25,000.
Thus, choosing the presumptive basis results in absurdity. Hon’ble Supreme Court, in the case of CIT vs Sri J.H. Gotla, Yadagiri on 29 August, 1985AIR 1698, 1985 SCRSupl. (2) 711has observed that any interpretation which leads to absurdity or unintended consequences that interpretation has to be ignored. The interpretation which justify the purpose of legislation (purposive interpretation) has to be applied.
CONCLUSION
The presumptive taxation scheme was introduced to simplify the law for small business/ profession. However, the legal position to certain aspects of these sections is still subject to multiple views and interpretation. But as per my opinion a assessee can’t choose presumptive taxation scheme for Futures and Options.
Income of Futures & Options is considered as business income. Therefore, assessee is also liable for maintenance of accounts as per section 44AA and for audit under section 44AB if the prescribed limits in respective sections are exceeded.
More emphasis on irrelevant explanation. Concluded the taxability of F&O in 1 line by referring a case law which is nowhere related. Using the interpretation of very generic case while there might be 1000s generic of case laws which can be applied in totally opposite manner. for example: Yes,it may not be morally correct to declare 8% when you actually earned a 20% or 30% profit. But, when was tax a morality issue. It is a legal issue. Even Supreme Court has commented that “Cases are to be decided by courts on legal principles and not on one’s own moral views. Law is different from morality”.
Dr T. A. Quereshi vs Commissioner of Income Tax (2006 287 ITR 547 December 18, 2006
Dear Madam, This is very helpful as it is precisely defined. However regarding STCG, I think we can disclosed it under STCG. There is no restriction in section 45 (the charging section of CG). Though the time period of future and options is 3 months, but it is still an assets ( a right on derivatives). Future and Options are derivatives and derivatives are assets. Therefore, I have strong view that it may also be shown under STCG. If there is any any legal provision against showing in STCG, I will really thankful to you, to provide the same. Thank You again.
Dear writer,
The total profit given in the example should be Rs. 25,000 instead of Rs. 2,50,000.
And in my view section 44AD doesn’t restrict the profit % to 6 or 8.
As per the provision if you want to disclose profit as per 44AD than you should declare actual or 6%/8% ( as the case may be) which ever is higher.
Further, Sec 44AD doesn’t specifically exclude F&O trading. in my view one can opt it considering all the applicable condition according to the case..