Overview on Stock Market Trading & its impact on taxation

Article explains Basic concept of Stock Market Trading and  its impact on taxation, Taxation for Investing in Stock market – Equity Trading as Business and as Investment, Taxation for Investing in Stock market – F&O Trading as Non Speculation Business, How to compute turnover limit in F&O, Expenses which can be claimed against F&O turnover, carry forward of Loss in F&O, IT which can be filed by person in F&O Trading and due dates for ITR filling by Person in F&O Trade.

Future and Options (F&O) Trading is a popular activity amongst people during this pandemic period. Recent web series on Mr. Harshad Mehta added fuel in new comer with saying “Risk he to ishq he” In what can be good news for India’s stock market, 6.3 million demat account were opened between April-September as Covid drove millennials to enter and invest in stock markets due to availability of multiple online trading platforms. That’s why Income Tax provisions on F&O trading need to be analysed carefully.

1. Investing in Stock market – Equity Trading

A. Business

• • Speculative (Intra-day Trading)
  • Non-Speculative (Frequent Delivery based Trading)

B. Investment

• • Short Term
  • Long term

2. Investing in Stock market – F&O Trading

 C. Business

• • Normal business consider as Non – Speculative.

Basic concept for better understanding

Derivatives are the instruments whose value is derived from an underlying asset. Its value is based on an underlying asset. The most popular derivatives are futures and options.

Futures is a contract to buy or sale an underlying asset on a specified date at a pre-determined price. On expiry of contract, futures are executed by delivering the underlying asset or through payment.

Options is a contract same as future, except in option, one party of the contract has an option (right).

Intra-day trading deals with buying and selling of stocks on the same day, during the trading hours such that all positions are closed before the market closes for the trading day.

“Profits & Gains from Business or Profession” (section 43(5) of the Income Tax Act) “Profit” from Intraday Trading will be considered as Speculation Gain  “Loss” from Intraday Trading will be considered as Speculation Loss

Speculative income– (Intraday “Equity” Trading) Profits made from intraday trading of equity shares are classified as speculative income. This is so because those investing in a stock for less than a day are presumably not investing in the company but only keen on speculating its price volatility to turn a profit

Non-speculative income- (Intraday “F&O” trades) Profits made from intraday or overnight trading of Futures and Options are considered to be non-speculative income. This is so because certain F&O contracts still have a delivery clause whereby the underlying shares/commodities exchange hands between traders on the expiry of contracts.

Taxation for Investing in Stock market – Equity Trading as Business

• Speculative business income/loss (intra-day equity trading)

1. Tax rate- normal rate of tax as per slabs

2. Loss in speculation business can be set off only against profit in speculation business

3. Can be carried forward for 4 assessment year (subject to return filled within time limit as per section 139(1))

4. Tax audit applicability – (i) where turnover exceed Rs. 1 Crores (ii) In case of books of accounts not maintained, turnover not exceed Rs. 2 crores and estimated income is below 6% of turnover and net total income is above basic exemption limit of Rs. 2.5 Lakh

• Non-speculative business income/loss 

1. Tax rate- normal rate of tax as per slabs

2. Loss from a non-speculation business can be set off against income from speculation or non-speculation business (except salary income)

3. Can be carried forward for 8 assessment year (no time limit for unabsorbed depreciation, exp. on scientific research, loss from specified business u/s 35AD) (subject to return filled within time limit as per section 139(1))

4. Tax audit applicability – (i) Where turnover exceed Rs. 1 Crores (ii) In case of books of accounts not maintained, turnover not exceed Rs. 2 crores and estimated income is below 6% of turnover and net total income is above basic exemption limit of Rs. 2.5 Lakh

Taxation for Investing in Stock market – Equity Trading as Investment

Long term capital gain /loss- equity investment holding for more than 1 years

1. Tax rate -10% (gain upto Rs. 1 lakh not chargeable to tax)

2. Long term capital loss can be set off only against long term capital gain

3. Can be carried forward for 8 assessment year (subject to return filled within time limit as per section 139(1))

Short term capital gain /loss- holding period is more than 1 day and less than 1 year

1. Tax rate -15%

2. Short term capital loss can be set off against any capital gain (long term / short term)

3. Can be carried forward for 8 assessment year (subject to return filled within time limit as per section 139(1))

Taxation for Investing in Stock market – F&O Trading as Non Speculation Business

Section 43 subsection 5 has excluded transaction of future and options as speculative transaction. However exemption is available only for equity. Thus if F&O for commodities are done the same will be termed as Speculative in Nature. Other then commodity trading profit or loss arising out of transaction is treated as Business Loss or profit in nature.

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. If the turnover from such trading exceeds Rs. 1 crore but less than 2 crore then the audit can be avoided if we can show the profit at minimum 8% (6%, if all trades are digital).

3. Tax audit u/s 44AB r/w section 44AD will also be applicable, if the net profit from such transactions is less than 8% (6%, if all trades are digital) of the turnover from such transactions.

4. Further, please note that any turnover more than 2 crore then audit u/s 44AB will irrespective applicable

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% (6%, if all trades are digital) of the turnover, therefore Tax Audit will be applicable u/s 44AB r.w.s. 44AD.

How to compute turnover limit in F&O?

Ans: In normal business turnover is based on sales and thus reaching the limit takes time. But in F&O it reached easily as each lot is valued high, Limit is reached easily. Therefore computation method need be different. Thus for computing turnover limit Following things should be added:

a. Profits from the trade

b. Loss from the trade

c. Premium received from sale of Options

d. In case of Reverse Trade, difference should also be added

To make it clearer let’s take an example: Mr. Z buys 5000 units of Futures of ABC Ltd. at Rs. 200 and sells it at  Rs. 180. He also buys 4000 units of futures of XYZ Ltd at Rs 220 and sells it at Rs 300.

Loss made Mr. Z= 5000*(200-180) = 100,000(Negative is ignored in turnover)

Profit made by MR. Z= 4000*(300-220) = 320,000

Therefore, total turnover shall be 4,20,000 although income of Mr. Z is 2,20,000.

For computation of turnover of futures, the total of positive and negative or favorable and unfavorable differences shall be taken as turnover.

Any Expenses can be taken for set-off against F&O turnover?

Ans: Expenses that can be claimed by F&O trader are the following associated expenses:

1. Broker’s Commission

2. Subscription to trading journals

3. Internet and telephone charges

4. Depreciation on assets for e.g. computers used for trading

5. Consultancy expenses if any;

Can losses be carried forwarded in case of loss in F&O?

Ans: Yes Losses can be carried forward subject to following conditions:

1. Return should be filed on or before due date:

2. Loss should be disclosed in the return

3. Set off is not allowed against Salary Income

4. Loss should not be of Commodity trading

5. Speculative Loss can be carried forward for 4 years. It can be set-off against Speculative Business Income only

6. Non-Speculative Loss can be carried forward for 8 years. It can be set-off against both Speculative Business Income and Non-Speculative Business Income. So, losses on F&O trading can be set off against income of interest income from bank, rental income or capital gains but only in the same year.

Which ITR form to be filled?

Since F&O trading is classified under business income we can use ITR 3 AND ITR4.

ITR3 can be filed for F&O trading income and also if any capital gains are to be reported.

ITR 4 is similar to ITR3 but with a presumptive scheme if you are using Section 44AD. It cannot be used to disclose any capital gains or if losses have to be carried forward under any head of income.

What is due dates for ITR filling?

1. 31st July – If Tax Audit is not applicable

2. 30th September  – If Tax Audit is applicable

Conclusion: Based on the above discussion it can be said that F&O profit/loss consider as Normal business profit/loss and Equity Profit/loss differ as  per case to case on basis maintaining books of accounts & separation of Trading equity and investment equity. However computation needs to be done carefully in order to avoid the litigation. Further profit margin also need to be identified as if its below 8% (6%, if all trades are digital) same would be liable to tax Audit under section 44AB.

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About the Author: The Views Expressed in the article is personal opinion of author. The author is Practicing CA having core expertise in Stock market transaction and one can reach him on mail queries on caparagdavda@gmail.com  The article can be said as reference material. However courts can take different opinion based on nature and circumstances of each case.