Taxation of Shares, Futures And Options

In the previous financial year that is FY 2020, in India, fresh Demat accounts opening jumped to a record high, around 14.2 million fresh Demat accounts have been opened during the year.  This jump is more than three times the number of new accounts opened in FY 2019 (4.70 million accounts).  The accounts are not merely opened, in fact, they have also been used actively by the traders/investors this is evident from the growth in the business of a company appointed as a Security Depository that is Central Depository Securities Ltd.  [“CDSL”].  CDSL has recorded the highest growth in its business.  The revenue of CDSL in FY 2020 – 21 was up by 150% of its immediately preceding financial year.

Now, a salaried person, a businessman, a professional or a student, almost everyone has started investing in the share market. Therefore, it is of utmost importance to understand the intricacies of taxation of share market transactions.  In this article we are going to deal with three types of share trading.  Those are as follows:

a) Delivery based

b) Intraday (Non – delivery)

c) Futures and options

To understand the topic lucidly and to deal with the various issues the author has compiled the FAQs as follows:

A. DELIVERY BASED

1. Profit or loss from the delivery-based share transactions is offered to tax under which head?

Ans:   Profit or loss from the delivery-based share transactions can be offered to tax under two heads.  Those are Capital Gains or Profit and Gains from Business or Profession (PGBP).

2. How the heads for taxing the delivery-based share transactions shall be decided?

Ans:   The Central Board of Direct Taxes (“CBDT”) vide Circular No. 6 / 2016, dated 29^th February 2016, has issued instructions as follows:

a) Where the assessee itself, irrespective of the period of holding the listed shares and securities, opts to treat them as stock-in-trade, the income arising from transfer of such shares / securities would be treated as its business income,

b) In respect of listed shares and securities held for a period of more than 12 months immediately preceding the date of its transfer, if the assessee desires to treat the income arising from the transfer thereof as capital gains, the same shall not be put to dispute by the Assessing Officer. However, this stand once taken by the assessee in the particular assessment year, shall not be allowed to adopt a different / contrary stand in this regard in subsequent years.

c) In all other cases, the nature of the transaction shall be decided on the basis of the intention of the assessee (whether the assessee intends to carry on the business or it is merely an investment.)

3. If the assessee desires to treat the shares as capital assets, then how income from the transfer of shares will be offered to tax?

Ans: The income from the transfer of capital assets is offered to tax under the head capital gains. There are two types of capital gains.  Those are short-term capital gains and long-term capital gains.   If the capital asset (shares) is held for more than 12 months then the income from the transfer of such capital asset is treated as long-term capital gains.   In any other case, it will be treated as short-term capital gains.

4. Mr. X purchased shares of the listed company on 11.10.19 and sold them on 11.10.20, whether the profit earned on transfer of shares is short-term capital gain or long-term capital gain?

Ans: For listed shares to be long term capital asset, it has to be held for more than 12 months.  Now, the issue in the above question is whether for a computing holding period of asset date on which asset is acquired and date on which asset is sold is to be included or excluded?  The said issue is answered by the Delhi High Court in the case of Bharti Gupta Ramola v. CIT – [(2012) 251 CTR 139 (Delhi)], the court has held that while computing the holding period of an asset both date on which the asset is acquired and the date on which the said asset is sold or transferred are to be included.  Therefore, in the given question Mr. X has held the shares for more than 12 months therefore income earned will be long-term capital gain.

5. What is the tax rate in case of short-term capital gains and long-term capital gains?

Ans: Short term capital gains: – 15%

Long term capital gains: – 10% (Above ₹1 lakh)

(Up to ₹ 1 lakh the long-term capital gain is exempt from tax)

6. Whether expenses like STT paid, rent, salary, or any other expenses allowed against the capital gain?

Ans: No, as per section 48 of the Income – tax Act, expenditure incurred wholly and exclusively in connection with such transfer is allowed as deduction.  Therefore, only the brokerage paid shall be allowed as a deduction and no other expenses including STT will not be allowed as a deduction.

7. How the losses will be set off in case of capital loss from the transfer of shares?

Ans: Short-term capital loss can be set off against both long-term capital gain and short-term capital gain.  Whereas, long-term capital loss can be set off only against long-term capital gain.  Loss under the head capital gains will not be allowed to be set off against income from any other head.

8. Whether the chapter VI – A deduction will be allowed as against the income under the head capital gains?

Ans: No, Chapter VI – A deductions are not allowed against the capital gains.

9. If the assessee desires to treat the shares (delivery based) as stock in trade, then how turnover will be computed?

Ans: The total value of sales is to be considered as turnover.  For example, Mr. Y purchased 100 shares for Rs. 500 per share and sold it for Rs. 580 per share.  In this case the turnover is Rs. 58,000/- (Rs. 580 x 100 shares)

10. Whether expenses will be allowed as a deduction from the business income?

Ans: Yes, all the expenses incurred for carrying on the business shall be allowed as deduction including STT paid on the sale of shares.

11. Whether set off of losses will be allowed in case of business loss?

Ans: The business of delivery-based share trading is a non-speculative business and therefore profit or loss from any other business can be set off against the profit or loss from the share trading business. In fact, the business loss can be set off against any other head of income except the head of salary.

12. Whether income from delivery-based share trading can be offered under section 44AD (presumptive income)?

Ans: Yes. There is no bar in offering the share business income on presumptive basis.

B. INTRADAY (NON-DELIVERY BASED)

1. Whether the income from intraday trading is taxed under the head capital gains or business income?

Ans:  As per section 43(5) of the Income – tax Act, 1961, intraday trading comes under the purview of speculative transactions, and therefore it will be offered to tax under the head PGBP as a speculative income.

2. Whether expenses are allowed against the speculative business income?

Ans:  Yes, all the expenses related to the business are allowed as a deduction.

3. How to compute turnover for determining the applicability of tax audit under section 44AB of the Act in case of intraday trading in shares?

Ans: In intraday trading, the contracts are squared up by paying out the difference which may be positive or negative. As such, in such transaction, the difference amount is ‘turnover’. Accordingly, the aggregate of both positive and negative differences is to be considered as the turnover of intraday transactions.

Example:

* Ignore the negative sign for computing the turnover.

4. How the losses will be allowed to set off in case of speculation loss?

Ans: The speculation loss will be set off only against speculation income.  Unabsorbed loss can be carried forward maximum up to 4 assessment years.

C. FUTURES AND OPTIONS TRADING

1. Whether income from futures and options transactions is offered to tax as business income or capital gains?

Ans:   It is a business income.

2. Whether it is a speculative business income or non – speculative business income?

Ans: In futures and options, the contract is settled otherwise than by actual delivery.  The contract is squared up by paying / receiving the difference on settlement.  From the features of these transactions, it appears to be the speculative transaction but Section 43(5) of the Income – tax Act, 1961 which defines the ‘speculative transaction’ has carved out an exception and has specifically excluded futures and options trading from the speculative transaction.  Therefore, income from futures and options trading is non – speculative business income.

3. How to compute turnover for tax audit purpose in respect of futures and options transactions?

Ans: As per Para 5 of Guidance Note on Tax Audit issued by the ICAI, the turnover in case of futures and options is computed in following manner

a) The total of favorable and unfavorable differences shall be taken as turnover.

b) Premium received on sale of options is also included in turnover.

c) In respect of any reverse trades entered, the difference thereon, should also form part of the turnover.

Examples of computation of turnover of futures:

* Ignore the negative sign for computing the turnover.

Examples of computation of turnover of options: 

* Ignore the negative sign for computing the turnover.

4. Whether losses from F&O transactions can be set off against other business income or other heads of income?

Ans: Yes, loss can be set off against any other business income, and also the set-off is allowed against any other head of income except salary.  The unabsorbed loss can be carried forward maximum up to eight assessment years.

D. APPLICABILITY OF TAX AUDIT

As per section 44AB of the Act, the audit is applicable to an assessee whose turnover exceeds 1 crore during any previous year.  Vide Finance Act, 2021, the limit has been increased to 10 crores w.e.f. FY 2020 – 21, provided the following conditions are fulfilled:

• aggregate of all amounts received including the amount received for sales, turnover, gross receipts during the previous year, in cash, does not exceed 5% of total amounts received; and
• aggregate of all payments made including the amount incurred for expenditure, in cash, during the previous year does not exceed 5% of the total payments made.

1. Whether the above limit of tax audit is applicable to all type of transactions (delivery based, non – delivery based and F&O)?

Ans: Yes.  The above limit is applicable to intra – day trading, delivery-based trading and also futures and options trading.

2. Whether provisions of section 44AD is mandatory?

Ans: No. The Assessee is not mandatorily required to offer its business income under section 44AD of the Act.

3. During FY 2020 – 21, Mr. ‘A’ opened Demat account and started trading in futures and options. The turnover from such trading is 70 lakh and profit from such trading is 3.20 lakh.  ‘A’ has an interest income of ₹ 1 lakh.  Whether the tax audit is mandatory to Mr. ‘A’?

Ans:  Mr. ‘A’ has a turnover of ₹ 70 lakh and a profit of ₹ 3.20 lakh.  The profit is lesser than the prescribed limit as per section 44AD (6% / 8%) and also the turnover is less than the prescribed limit of section 44AB of the Act.  If Mr. ‘A’ maintains the books of account then tax audit is not applicable to Mr. ‘A’.

If Mr. ‘A’ does not maintain the books of account then he will have to opt for presumptive income u/s 44AD.  As the profit is less than the specified limit (6% /8%) in that case the tax audit becomes mandatory.

4. ‘B’ is a new investor, opened his demat account during FY 2020 – 21 and has a turnover of ₹ 3 crores from share trading (non-speculative) during the year and has earned a profit of ₹ 10 lakh from such trading. Mr. ‘B’ transfers all the funds in Demat account through net banking and all the business-related payments are incurred through the banking channel.  Whether tax audit is applicable to Mr. ‘B’ for FY 2020?

Ans:   The prescribed limit of tax audit u/s 44AB has been increased to 10 crores w.e.f. FY 2020 – 21.  Turnover of Mr. A from share trading is ₹ 3 crores and has not received any amount otherwise than by banking channel and has not made any payment otherwise than through banking channel.  Therefore, the new limit of 10 crores will be applicable to Mr. ‘B’ and he shall maintain the books of account.  In such a case no tax audit is mandatory.

5. ‘C’ has a salary income of ₹ 12 lakhs and turnover during the year from share trading (non-speculative) is ₹ 1.10 crores. The loss from share trading is ₹ 1 lakh. Whether tax audit is applicable?

Ans: If Mr. ‘C’ has not offered income from share trading u/s 44AD in immediately preceding AY and if maintains the books of account during the relevant AY.  In such a case, no tax audit is applicable to Mr. ‘C’.

6. ‘D’ is engaged in the business of cloth store. The turnover from cloth store during FY 2020 – 21 is ₹ 1.70 crores and Mr. ‘D’ every year offers profit from the business u/s 44AD of the Act. During relevant previous year, he opened a Demat account and traded in futures and options. The turnover from trading is ₹ 40 lakh.  Whether tax audit is applicable?

Ans: Mr. ‘D’ is engaged in multiple businesses that are cloth store and share market trading.  Now, the question in the above example arises is whether the turnover of all the business activities should be clubbed together to determine whether the prescribed limit as laid down in section 44AB of the Act has exceeded or not?  As per Para 5 of the Guidance Note on Tax Audit, where the assessee carries on more than one business activity, the turnover of all business activities should be clubbed together to determine the prescribed limit as laid down in section 44AB of the Act has been exceeded or not.  However, any of the businesses of the assessee is covered by section 44AD and the assessee opts to be assessed on presumptive basis for such a business, the turnover thereof shall be excluded.

In the present example, Mr. ‘D’ offers business income from cloth stores on a presumptive basis.  If Mr. ‘D’ maintains the books of account for share trading then no tax audit is required in the present case as from the aggregate turnover of ₹ 2.10 crores, ₹ 1.70 crores shall be offered to tax on a presumptive basis, and remaining turnover of share trading that is ₹ 40 lakh is within the prescribed limit of section 44AB.

E. OTHER Q&A

1. Dividend declared and distributed on or after 01.04.2020 by a company is taxable in whose hands?

Ans.  Dividend declared and distributed during or after FY 2020 is taxable in the hands of recipient shareholders.

2. Whether expenses will be allowed as a deduction against the dividend income?

Ans. No expenses shall be allowed to be deducted from dividend income except interest on loans taken to invest into shares of companies. The deduction of interest expenses shall be allowed subject to a maximum of 20% on dividend income.

3. How the shares and securities held as stock-in-trade of a business shall be valued as on the last date of the financial year?

Ans: As per ICDS VIII, listed securities held as stock-in-trade shall be valued at lower of cost or net realizable value.  Unlisted shares shall be valued at actual cost initially recognized.

4. Whether the provision for mark to market loss on valuation of the shares and securities as on the last day of the previous year shall be allowed as a deduction?

Ans: Yes.  It is allowed as a deduction.  The Mumbai Tribunal in the case of Edelweiss Capital Limited v. ITO [I.T.A. No. 5234 / Mum / 2007, Order dated: 10.11.2010] has allowed the provision for mark to market loss as a deduction.  Thereafter, there are series of decisions, allowing the mark to market loss as a deduction.        

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Disclaimer:  The content/information in this article is only for the general information of the reader and shall not be construed as legal advice.  The opinion expressed herein is the personal opinion of the author and it cannot be treated or deemed as the legal opinion.  The author does not intend in any manner to solicit work through these taxation-related articles. The articles are only to share information based on recent developments and regulatory changes. While the Author has exercised reasonable efforts to ensure the veracity of the information/content published, the Author shall be under no liability in any manner whatsoever for incorrect information, if any.