Income Tax on Futures & Options and Turnover Calculation
Futures & Options or F&O, has started to attract interest from a lot of investors in the market lately. But one major mistake that all of them commit is that they do not report the same in their Income Tax Return (ITR), especially when they make losses. This is ignorance and having little or no knowledge about the same and the fact, that it is important and mandate to disclose all your sources of income. This would lead to receipt of notices from the Income Tax Department on the basis of non-compliance and also attract such other actions from the department.
F&O are major stock derivatives trading in the stock market and can be understood as the contract signed between two parties for trading the asset which is a stock for a predetermined price on a pre-determined date in the future. The major point here is to hedge the market risk which is a major part of stock trading and locking the price beforehand. The contracts derive their value or price on the basis of the underlying asset which can be shares, commodities, stock market indices, or such other assets. Since it is not easy to predict the price movements that might happen in the future, there can be a result of profit or loss if the prediction goes right or wrong.
Futures put an obligation on the parties entering into a contract to buy and sell shares of a specific company (from whom futures are derived) for a date and price which is pre-decided. And if the party to the contract sells the future before the expiry of such pre-decided date or on such pre-decided date then there will be a loss or profit made which can be termed as business loss or business profit.
Say, you bought 1000 shares of October Futures of SBI, for a price of INR 100 per share and are holding them. But before the expiry date, you sell the same at INR 110 and make a profit of INR 10 per share, which would total to INR 10,000 (1000*INR 10 per share). And this INR 10,000 is termed as business profit.
Under options, the parties who have entered into the contract are holding an option to buy or sell shares rather than holding an obligation to do the same. Here the option buyer should pay some premium amount for booking the options of a particular asset, say stock at a certain price specified. And on a future date, if the price of the underlying asset goes up, then the buyer will make a profit.
Say, you booked options of 1000 SBI shares for INR 100 and paying a premium amount of INR 2500. And then the price of these shares went up to INR 160, which would give you a profit of INR 60,000 (1000*INR 60 per share). But if the price goes down to say INR 90, then you will be making a loss of INR 10,000 (1000*INR 10 per share). As this is an option you can opt-out from such trading and would only lose the premium amount i.e., INR 2,500.
Income Tax on Futures & Options
In The F&O transaction, there is no actual delivery of the underlying assets or commodities like shares or ETFs. Since 2006, these transactions in derivatives are specifically exempted from the definition of speculative transitions. Due to this same reason, they shall be treated as ordinary business transactions and the income earned from the same shall be treated as business income for the taxation purpose.
Audit Applicability for F&O
The Income Tax Act specifies that any person who is carrying on business or profession should maintain proper books of accounts and the same should be audited if the turnover of such entity crosses a certain threshold limit. The specified threshold limit for professional taxpayers would be INR 50 lakhs and business entities would be INR 1 Crore.
But it should be noted that in the case of business entities whose 95% of receipts and payments are through digital mode, then the said threshold limit of INR 1 Crore mandating the requirement to get assesse’s books of accounts audited, will be extended to INR 10 Crore.
And if the turnover of the business entity is between INR 1 Crore and (less than) INR 2 Crore, then the profits can be declared under a presumptive tax scheme, which puts the taxpayer out of the requirement to get books audited. And here the declaration of profits should be 8% and 6% in case of digital transactions.
All the above-discussed points shall be applicable to the income earned through F&O transactions as it is considered as business income. And accordingly, the following should be noted:
- In case of a loss arising out of F&O Transaction, the benefit from the Presumptive Taxation scheme cannot be availed. And this will require the assessee to get the books of accounts audited if the turnover crosses INR 1 Crore.
- If the assessee earns profits from the F&O Transactions, then he can claim the benefit of the presumptive taxation scheme until the turnover crosses the threshold limit of INR 2 Crores. And if the profits declared are below 8% or 6% as the case applicable, the books shall get audited for the assessee under the Income Tax Act.
Computation of Turnover in F&O Transactions
With respect to F&O transactions, turnover for the purpose of tax audit shall be computed as below:
- The aggregate of the positive and negative differences which arise from F&O transactions should be computed as turnover,
- Premium which was received on the sale of options should be computed as turnover,
- In case of any reverse trades entered into, the difference thereon shall be computed as turnover earned.
Say, you bought 25 units or 1 lot of Nifty futures at 7000 and sell at 6500, INR 12,500 (25 x INR 500) the negative difference or loss on the trade is turnover.
In options, if you buy 100 or 4 lots of Nifty 7000 calls at Rs.30 and sell at Rs.40. Firstly, the favorable difference or profit of INR 1,000 (10 x 100) is the turnover. But premium received on sale also has to be considered turnover, which is INR 40 x 100 = INR 4,000. So total turnover on this option trade = 1000 +4000 = INR 5,000.
Loss from F&O Transactions
As F&O transactions are treated as non-speculative transactions, the loss arising out of such F&O transactions should be allowed to be set off against all other incomes earned by the assessee, except salary income. And if such loss has not been set off and claimed during the year during which it has arisen, then such loss can be carried forward and set off against any future incomes. But for being eligible for such future set off, such loss should be disclosed in ITR. It should be filed before due date as per section 139(1) for filing of ITR.
And if the same is not disclosed or ITR is not filed before the stipulated due date, then such loss cannot be claimed or carried forward.
Expenses Claimed Against Income from F&O
All kinds of expenses which are generally claimed against normal business income can be claimed. Examples of this would include telephone, internet, administrative expenses, interest, and such other expenses. The depreciation on the assets which are used for generating income from F&O can also be claimed as an expense.
As the income earned from F&O transactions are taxed under the head, ‘Income from Business or Profession’, ITR 4 should be filed, if they are declaring profits under the presumptive taxation schemes. Else, ITR 3 should be filed and the same shall be filed before 31st of July of the Assessment Year (AY).