If you are a futures and options trader, especially in equities or indices then what is it that you need to know? Your first question would be, if it would be classified as speculative income.
After all, trading in futures and options does not lead to delivery into the demat account and hence by default it should be speculative income. In fact, it is not. Profits and losses from trading in futures and options are not classified as speculative income despite not resulting in delivery.
This is for the following reasons:
- The F&O transactions do not result in delivery because both futures and options are essentially designed as hedging products to protect your risk on cash positions.
- While these are non-delivery transactions by definition, futures and options are classified as securities under the Securities Contracts Regulation Act (SCRA).
- When you trade in futures and options, the intention is assumed to be delivery. This is unlike an intraday transaction where the intention is not delivery. That is why intraday trades are classified as speculative transactions while F&O is not.
- If F&O profits and losses are small then they can be treated as capital gains. If the volume is larger and trading more frequent then you will be required to show that as your business income.
All gains & losses in F&O have to be reported; it is mandatory
There are two ways of reporting F&O gains and losses. You can either report them as capital gains and losses or as business income. You can only report them as capital gains if the amount is very small and the trading is not frequent. Otherwise, they have to be reported as business income only.
The advantage of reporting as business income is that you can claim relevant expenses as tax shields like the STT, telephone charges, administrative expenses, internet charges etc.
If you file as capital gains you cannot claim benefit of STT or other relevant expenses. Hence reporting as business income or loss is more meaningful for you.
This rule of showing as business income also applies to individuals. You don’t have to be incorporated as a company or some legal entity to earn business income. One thing you need to remember is that you need to file your income tax returns using Form ITR-4 to report F&O gains and losses.
There are two advantages in filing as business income. Firstly, s stated above, you can claim relevant expenses as tax shields like STT, internet costs, office expenses, telephone costs etc. Secondly, if you show it as business income, you can set off your losses from F&O against any other business income and you can also carry forward these losses for a period of 8 assessment years.
Before filing your ITR how to classify your transactions?
This is an important step before you file your income tax returns. Normally, you have long term delivery, short term trading, intraday and F&O. How do you classify before filing each of these? Here are a few pointers…
- Classification your activity broadly into trading & investment, intranet trading and F&O trading as each of them has separate implications.
- For intraday, the gains and losses are speculative and can only be set off against speculative gains. Also carry forward is restricted to 4 years and not 8 years.
- Whether to show equity and F&O as capital gains or business income will depend on the size of transactions and the volumes. While the IT Act does not specific the level, it is a matter of judgement. If you are trading more than Rs.1 crore volumes per year it is better to show as business income.
- The Income Tax Department focuses on consistency of practice. If you adopt the capital gains approach or the business income approach to F&O, maintain consistency and don’t keep changing your methodology frequently.
How to maintain your accounting records for showing F&O income as business income?
The need to maintain accounting records arises if your net receipts are more than Rs 2.5 lakhs or gross receipts exceed Rs 25 lakhs in any of the 3 preceding years.
If you are an individual doing F&O trading and showing as business income, this rule will apply to you too. Your book keeping will be simpler.
You will have to systematically maintain your trading statements, expense receipts and bank account statements (with appropriate reconciliation). The profit and loss account can be prepared based on this available information.
Provisions pertaining to audit and filing of ITR for business income
A common question is who needs to get their books of accounts audited by a statutory auditor? Audit applies to a business if turnover exceeds Rs 1 crore, which is defined as the revenue of the business.
In such cases, you must get your accounts audited by a certified chartered accountant and submit the audit report along with your tax return.
Such audit reports must also be filed with the MCA in case you are registered as a private limited company or a public limited company. Failure to maintain books of accounts, not getting an audit done means penalties shall be applicable under income tax act. Visit this website for more information.