Ready for futures and options? This is how you will be taxed
PremiumTax audit to carry forward losses is mandatory only if the total turnover from F&O trades exceeds ₹10 crore
Delhi-based Lakshaya Bakshi has a special request for the finance minister ahead of the upcoming Union Budget–remove tax audit for traders who have losses to carry forward from investments made in futures and options (F&O). The 29-year-old marketing professional is unaware that tax audit to carry forward losses is mandatory only if the total turnover from F&O trades exceeds ₹10 crore.
“As a precautionary measure, my father’s chartered accountant suggested that I get my accounts audited for the purpose of income tax filing to avoid getting a notice from the income tax department," he said.
Bakshi’s is not a standalone case where many chartered accountants (CAs) audit F&O trades even when not applicable. “Rules around calculating turnover, profitability, etc., in the case of F&O trading are too complicated and therefore, most CAs end up auditing just to avoid complication," said Karan Batra, founder, chartereclub.com.
Last week, Nithin Kamath, chief executive officer of Zerodha, pointed out in a tweet that failing to declare trading income, including losses, in income tax returns (ITRs) can lead to automated notices and penalties. “Considering the user growth in the last 18 months, the number of notices are bound to go up exponentially next year (sic)," he tweeted.
If you’re one such trader new to the derivatives market or are planning to dive in, read on to know the tax implications of dabbling in F&Os.
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BUSINESS INCOME
For the purpose of taxation, gains from F&O is treated as business income and not capital gains. This means that the taxpayer needs to opt for ITR-3 or ITR-4 to file his tax returns.
As tax rules treat gains from F&O as business income, losses from F&O trading can be set-off against interest income, other business income, rent from property and even capital gains. Unadjusted losses can be carried forward for eight years, but in the case of futures, unadjusted losses are allowed to be set-off only against non-speculative income.
If a taxpayer has losses to carry forward, he cannot opt for ITR-4 as the utility doesn’t allow carrying forward any losses or bringing forward losses from last year.
Rahul Dwivedi, founder, D Rahul & Associates, points out that salaried individuals with income from F&O should be careful about choosing between the new and old tax regime. “A salaried individual can switch between the two regimes every financial year depending on his prevailing tax liability. However, taxpayers with business income can exercise the option of switching back to the old tax regime only once and once exercised, they will have to continue in the old regime for that and all subsequent years," he said.
TAX audit of F&O income
Tax rules require taxpayers to maintain books of account when the business income exceeds ₹2.5 lakh or gross receipts from business exceeds ₹25 lakh in any of the preceding three financial years. It is easy to cross this limit in the case of F&O as the method of computing turnover for F&O trades can easily run the turnover into seven-digit figures. For this reason, Dwivedi said taxpayers can just maintain their tax P&L (profit and loss) statement provided by the broker.
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“Maintaining accounting records separately is not required. A taxpayer can just get monthly or yearly turnover statements from his or her broker. They can double up as accounting statements as they are authenticated and maintained by a third-party," he said. “It’s a fairly transparent process because the broker discloses all the transaction data of F&Os done through them to the IT department and therefore, there is no scope of manipulation. Just maintain statements from your broker so that you can support the information in your IT return if the tax department sends an intimation."
The trickiest part around F&O tax rules is determining whether you need to get your accounts audited by a CA or not.
There are two main criteria under which tax audit needs to be done. One, if your total turnover exceeds ₹10 crore. “This limit is applicable only in the case wherein at least 95% of the total amount paid towards trades is made through digital payment modes. In cases where the cash receipts or cash payments exceed 5% of the total receipts/payments, the turnover threshold is ₹1 crore above which audit needs to be done," said Gautam Nayak, partner, CNK & Associates LLP.
Two, under the presumptive taxation scheme, if the taxpayer with turnover below ₹2 crore has incurred profits less than 6% of the total turnover, tax audit is mandatory.
“As per the clarification provided by the IT department, this condition is applicable to only those traders who have opted in and out of presumptive taxation scheme in any of the preceding 5 financial years. The reason behind this condition is that if a taxpayer is opting out of presumptive taxation scheme, the taxman wants to ensure by going through their books of account whether they are reporting accurate information or not," said Vishvajit Sonagara, founder, Quicko.com.
Under the first condition, though the threshold of ₹10 crore turnover may seem huge, it can be breached easily if a taxpayer has multiple trades in a year, especially in the case of an active trader.
This is because calculation of turnover from F&O takes into account both favourable and unfavourable differences (profit/loss), said Sailesh Kumar, partner, Nagia Advisors.
In the case of futures, turnover is the sum of both profit and loss made on the various trades throughout the year. In the case of options, the premium received on sale of options is also added to the absolute profit to arrive at the total turnover (see table)..
“Losses and profits in the case of derivative trading can be exponentially higher than the positions a trader takes. Because of this, turnover, at most times, is inflated. This gets all the more pronounced in the case of options as the calculation also accounts for the premium received on the sales proceeds, which inflates the total turnover even more," said Vishvajit Sonagara, founder, Quicko.com.
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