Taxation of Future & Options- F&O Trading

A large number of investors are nowadays trading in futures & options commonly known as ‘F&O’ of stocks, currencies, and commodities. The turnover involved in the F&O segment is generally very high as compared to trading in the cash segment. Therefore, the F&O trading needs proper accounting by the investors along with timely audit and return filing compliances. But unfortunately, most of the investors dealing in the F&O segment are not aware of these compliances. Due to this, they fail to declare F&O income or losses while filing their income tax returns.

It is important to know that the Income Tax Department keeps a close watch over the F&O trades made in the stock exchanges. Hence, it is pertinent that every investor should know about their legal obligations attached to F&O trading. An attempt has been made to explain income tax compliances related to F&O trading in this article. If you are an F&O trader, this article will be certainly helpful for you.

Is Profit or loss on F&O Transactions taxable?

The answer to this question is ‘Yes. Profits arising from F&O transactions carried out in stocks, commodities, or currency are taxable under the Income Tax Act. It is to be declared while e-filing income tax returns.

Under which head profit or loss on F&O trading is taxable in Income Tax?

• Any income arising from F&O trading is to be treated as ‘Business Income’ according to Income Tax Act. Further, losses from F&O trading shall also be disclosed as losses under the head “Business & Profession.”
• Under Income Tax Act, any business income is shown either as ‘Speculative’ or ‘Non-Speculative’ income. In the case of F&O trading, profits or losses are to be treated as ‘non-speculative. Hence, the income of F&O trading will be taxed similar to any other business income.
• F&O income shall be taxed at the applicable income-tax slab rates.

Can expenses be claimed against income arising on F&O trading?

• In the previous question, we have discussed that F&O trading is treated similarly to any other business. Therefore, you will be eligible to claim a deduction in respect of expenses incurred for earning F&O income.

• Following are the expenses for which deduction can be claimed from F&O income:

(a) Brokerage paid to share broker
(b) Subscription to journals relating to shares viz. Dalal Street
(c) Subscription cost of software for market research & analysis
(d) Telephone & Broadband Expenses
(e) Investment consultancy charges paid
(f) Salary of Research Team hired
(g)Printing & Stationery Expenses

• According to Income Tax Rules, you are required to keep proper vouchers, bills in support of your claim for expenses and maintain proper books of accounts for F&O business.

• Please also ensure that expenses are not paid in cash in excess of Rs. 10,000 as these will not be allowed under Income Tax.

Whether books of accounts are required for F&O trading?

The conditions for compulsory maintenance of books of accounts are given in section 44AA of the Income Tax Act, 1961. If any one of the following two conditions is satisfied, you are required to maintain proper books of accounts:

If you fall under any of these two criteria, you should prepare your books of accounts in proper form so that these could be produced if asked by the Assessing Officer. Failure to maintain proper books of accounts may lead to a penalty of up to Rs. 25,000 under section 271A of the Income Tax Act.

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Which ITR form should be used to file returns for F&O Income?

• F&O trading is treated as a non-speculative business under Income Tax law. ITR-1 & 2 are not suitable in this case as these forms are generally meant for those taxpayers who are having ‘salary’ or ‘other sources’ income.
• ITR-3 has been prescribed for disclosing business income as per Income Tax Rules. Therefore, if you are an individual taxpayer, you must use Form ITR-3 for income tax return filing in case of F&O business
• In case profit/ loss is declared under presumptive taxation scheme, Form ITR-4 should be used.

Is audit compulsory in the case of F&O trading?

• It is already discussed in the above section of the article that F&O trading is treated as a normal business income. Therefore, normal income tax provisions are applicable to F&O trading.
• Tax Audit is applicable in the case of a business if the gross receipts, sales or turnover exceeds Rs. 1 crore according to section 44AB of the Income Tax Act.
• If the turnover from F&O trading is more than Rs. 1 crore in your case, tax audit is applicable and you should get accounts audited by a Chartered Accountant and file Tax Audit Report in Form No. 3CB-3CD to the Income Tax Department.
• Further, if the turnover is more than Rs. 1 crore but less than Rs. 2 crores, you may avoid the audit by declaring a minimum of 8% profits (6% in case of digital transactions) u/s 44AD of the Income Tax Act. But it is not a viable option looking into the meager profits on F&O transactions.

• If you fail to get your accounts audited as per the provisions of section 44AB, the Assessing Officer may levy a penalty equal to Rs. 1,50,000 or 0.50% of gross turnover, whichever is lower under section 271B of the Income Tax Act.

Due date of filing return in case of F&O Trading:

• Income Tax Return is required to be filed generally on or before 31^st July in the case of non-audit taxpayers.

• If your accounts are audited, the due date of filing the tax audit report will be 30^th September and the due date of filing the return will be 31^st October.

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How to compute turnover in the case of F&O trading?

This is one of the most important questions before every F&O trader that “How to compute turnover in case of F&O trading?” It should be noted that the manner of computing turnover in the case of F&O trading is a bit different as compared to any other business activity. The turnover of an F&O business is calculated on the basis of the absolute value of profit or loss.

Illustration to understand the Turnover computation

Suppose Mr. Mehta entered into the following F&O transactions during the year as below:

Take one more example to simplify the computation of F&O turnover:

Suppose, Mr. Mehta buys 25 (one lot) Nifty at 18,000 and sells it at 17,900, he incurs a loss of 25 * 100= Rs. 2500. This negative difference will be counted as turnover. Further, he buys 100 (four lot) of Nifty 18,000 calls at Rs. 20 and sells it at Rs. 30. In this case, firstly the favorable difference or profit of Rs. 1000 (100 * 10) will be the turnover. Also, the premium received on sale shall also be considered as turnover, which is Rs. 3,000 (30*100). So, the turnover from Option trades will be Rs. 1000 + 3000 = Rs. 4000. Thus, the total turnover from F&O trading will be Rs. 6,500 (2,500 + 4,000).

Taking one more illustration:

Mr. Mehta buys one lot (100 shares each) of TCS future @ Rs. 2000 and sells at Rs. 2,100. He also buys 2 lots (100 shares each) of options of Infosys at Rs. 300 and sells at Rs. 290.

Solution:

Is carry forward or set-off of F&O losses allowed?

• Yes, Income Tax Act allows set-off & carry forward of F&O losses. F&O losses are treated as non-speculative business losses. Therefore, you can set off F&O losses against any other income.
• Order of Set-Off:

(a) Intra-Head Adjustment: Firstly, F&O losses can be set off against income from any other business or profession (non-speculative as well as speculative)
(b) Inter-head Adjustment: Then, remaining F&O losses can be set off against income under any other head except salary income

• Carry forward to next year: If F&O losses could not be set off in the same financial year, you can carry forward such losses to the next 8 financial years. But in subsequent financial years, set-off is permissible against non-speculative business income only.

What are the conditions for carry forward F&O losses?

F&O losses remaining unadjusted can be carried forward to the next financial year subject to the following conditions:

• Income Tax Return should be filed by the taxpayer on or before the due date i.e. 31^st July/ 31^st October
• Such loss should be declared in the return
• Set-off in the subsequent financial year is allowed only against non-speculative business income.
• Carry forward is allowed for being set off in the next 8 financial years only.

Conclusion: Computing turnover and preparing books of accounts in the case of F&O trading is not a simple task. The F&O trader should first arrange a global transaction report from the broker so that computation can be made easily. He should ensure that the turnover is calculated correctly as all other compliances including audit and return filing will depend upon it. Most importantly, you should file income tax return on or before the due date of filing return.

Disclaimer: The above article is based upon the opinion of the author and is meant for informative purposes only. Readers are requested to act diligently and under consultation with a professional while acting on the basis of the above information.