Income tax on Profit and Loss on Futures and Options (F&O) trading differs largely when compared with Income Tax on Gain or Loss on Sales of Shares
Here's is a quick overview of the future and options:
Futures and Options (F&O) are financial derivatives that derive their value from an underlying asset like shares or indexes of stock exchanges
Futures Contracts: Two parties agree to buy or sell an asset at a future date and price. The buyer is obligated to purchase, and the seller is obligated to sell the asset.
Options Contracts: Options provide the holder with the right, but not the obligation, to buy or sell an underlying asset at a predetermined price, known as the strike price, on or before a specified date.
Types of options: Call Options (for buying) and Put Options (for selling).
Income Tax on Trading in Future & Options
Trading in F&O including the trading of commodity derivatives on recognized stock exchanges is deemed as Business Income.
As per Section 43(5) of the Income Tax Act, 1961, profit/loss by trading in any shares, script or commodities will be considered speculative business income if the transaction is not settled by taking delivery (E.g. intra-day trading). However, there is an exception to the section which states that trading in derivatives and F&O trading will be considered as non-speculative business income (i.e. normal business income) even though transactions are settled without taking delivery.
Correct classification of Head of Income is necessary to determine the applicable tax rate, set of losses and carry forward of losses. As F&O trading is a normal business income following will apply to it:
1. Tax Audit Requirement in case it excess limit as specified u/s 44AB
2. Loss of F&O can be set off against House Property Income / Other Business Income / Capital Gains / Other Sources.
3. Loss can be carried forward to sett off against future business income for eight years.
4. Tax Rate will be as per the normal income tax slabs as applicable to individual or corporates or another entity.
Tax Audit & Calculation of Turnover on Trading in Futures & Options
As F&O trading is a business income, it will be subject to tax audit if the turnover exceeds the limits specified u/s 44AB.
However, before determining the applicability of tax audit, we need to understand the calculation of Turnover of F&O Trading is different as compared to other business income.
Turnover of F&O Trading is:
Total of the Favourable (Profit) and Unfavourable (Loss) of each squared of transactions during the year. For example, if the Profit from F&O transactions during the year is Rs 10 Lakhs and the Loss from F&O transactions is Rs 6 Lakhs then Total Turnover for Tax Audit is Rs 16 Lakhs.
In the case of options trading, if the delivery of the contract is settled then the premium received on sale is also to be included in total turnover.
Limit of Tax Audit For Applicability
1. If the Sum Total of Turnover of the F&O as calculated above and the turnover of any other business is more than 1 Crore, then a tax audit is applicable. However, there are a few exceptions to this:
If the turnover does not exceed Rs 2 Crore and the person opts for presumptive taxation u/s 44AD by declaring a profit of at least 6% on digital sales and 8% on cash sales then a tax audit is not applicable. Thus, in the case of F&O trading if the trader turnover is less than 2 Crore and the profit is more than 6% of the calculated turnover then a tax audit will not be required.
In case all F&O trading transactions along with other business income if any do not exceed Rs 10 Crore and total cash sales cash purchases do not exceed more than 5% of total sales or payment. Thus, if there is only F&O trading business then the turnover limit will be increased to Rs.10 Crores as F&O trading on stock exchanges will be definitely in digital form. In case there are other business activities it is to be ensured that cash sales or purchases are less than 5%. Then the limit of turnover for tax audit will be more than Rs 10 Crore.
2. In case when the trader has declared profit as per the presumptive taxation scheme in any of the last 5 previous years but does not opt for the same in the current year, he shall be liable to get his accounts audited if his total income exceeds the maximum amount not chargeable to tax i.e usually Rs 2.5 Lakhs, Further, he shall also not be eligible for the scheme for the next five years.