Futures and Options stock trading methods available at fingertips of cell phones and laptops have created a new set of traders who are desirous of making quick money by short term trading and not holding to Equity for years. Not to mention, heavy advertisements of “Binary options” (which is mainly practiced in the US and European market), has created another array of traders in Indian Derivative Market bringing in a wave of New Income Tax Assessees.
Similar to Sensex, which is the Benchmark Market Index of Bombay Stock Exchange (BSE), Nifty 50 is the benchmark index by the National Stock Exchange(NSE) having 50 preselected shares of the Stock market. A movement in these indexes defines the overall idea of price movements of the entire market. Nifty 50 is the most traded index future used by Traders and portfolio investors to hedge their holdings.
We all have clients who are engaged in the Derivative Market and Intraday Trading. We are asked to file their returns and several questions arise in the minds of those who are doing the filings for the first time as there is no specific guidance on it in Income Tax Provisions.
Common Queries and confusions that arise in minds first-time Filers are:-
- Is trading in futures and options a business income or is it a Speculation income under Capital Gain Head?
- Can we opt and file return u/s 44AD for trading in Futures and Options and is it allowed to file loss return for Futures and Options trading u/s 44AD without getting audited?
- What shall be the method of calculation of turnover?
- Set off and Carry forward of Losses of Futures and Options trading (as most of the cases its Loss).
- Accounting, Audit points, and Which ITR should we file?
Few important Terms for better understanding of the subject before we proceed:-
- Contract Notes:- Contract notes (similar to Invoices in common language)contain details of Transactions undertaken by the trader which defines his/her obligations. It contains additional details such as Brokerage charged by broker, GST, SEBI Fees, STT, Exchange charges, and other charges.
- Market Lot:- Equity shares can be purchased In minimum Qty of 1 Equity of shares but Derivative stocks are combined with a market lot. A lot is a predefined number of shares of a company. Eg – Lot of Company X is 500 then trading in one lot means trading in 500 shares of those companies.
- Option Selling:- It is not to be confused with PUT buying. When you buy a PUT, you estimate the share price to go down. When you sell an option, you get the premium against the risk of selling a contract be it Call or Put. It is also not to be confused with Futures selling. Selling Futures and Selling options are different from each other.
- Options Premium:- It is the small token amount a trader has to pay to the option seller against which the seller locks the trade or either upside or downside movement. This is the amount of money that virtually goes in the seller’s account from buyer’s accounts.
- Futures Margin:- It is the premium paid by the buyer to undertake a trade. No virtual money goes to the Futures seller but it is a security amount kept by the broker. It varies for each stock as per market conditions and expected volatility. Suppose the share of the price of a company is Rs. 1000 per Equity share and lot size is of 300 shares than to buy 300 shares a trader will need 1000 x 300 = 3,00,000/- but a future contract can be bought for 70-80 thousand for that company. This 70-80 thousand is like a security deposit with the broker also known as margin. It is further classified as Span and Initial Margin.
- Square Off Trade:- When a contract is entered upon (either for upside or downside, for futures or Options) it opens a position and when you exit the contract (buy selling if you previously bought or by buying if you previously sold) then you close the contract. This is called squaring off the Contract.
- Reverse Trade:- When the trader reverses his trade i.e. if he was long, he will turn short and if he was short he will turn long. This is different from normal trade as there are no separate trades executed, only the direction of trade is changed. Otherwise, normally 3 trades are executed First to enter a contract with long/short positions. Second for Squaring off that position. Third for entering the reverse position. But in a Reverse trade, only one order is executed and its long/short direction is reversed with the broker.
Is Income from Futures and Options a business income or speculative income.
Speculation is when you enter and exit a trade without getting actual delivery of the Stock or any commodity. Futures and Options looks similar but it has been separately classified as Non-Speculative Business Transactions. All the Taxation under Futures and Options shall be classified under PGBP head and not to be confused under Capital Gain Heads. Only Intraday trades or shares are to considered part of Capital Gain Speculative transactions. Intraday Trade of Derivatives instruments is also part of business income and not Speculative incomes.
Can we Opt for 44AD presumptive taxation for Future and Options Transactions.
Yes, there are no restrictions u/s 44AD to opt in case of Futures and options transactions and it is an eligible business. The calculation of turnover is discussed later.
- It is advisable to declare the actual profits from Futures and Options trading in case opting for 44AD and not fixing the profit @6% as in case digital transactions. Though return can be filed with 6% profit but declaring actual profit would be correct and advisable.
- In the case of profit for the year is less then 6% of turnover, Accounts are required to be maintained and audited.
- In case of Loss and total Income of assessee is below 2.5 lacs and thus not chargeable to Tax. In such a case if both conditions are satisfied then there is no restriction in opting for Section 44AD and not required to get accounts audited but it is advisable to get the accounts audited before the filing of loss returns to avoid future litigations.
There is no Separate Audit limit for Futures and Options Traders and normal audit limits shall apply.
From FY 2020-2021, the Audit limit of 5 Crs shall be applicable as the entire mode of transactions is by digital means.
What shall be Considered as a turnover.
- As per Guidance Note on Tax Audit by ICAI:- Page 25 Para 5.14 States that the turnover can be determined as follows :-
- The total of favorable (profits on Square off contract) and unfavorable (loss on Square off Contract) differences shall be taken as turnover.
- Premium received on sale of options is also to be included in turnover.
- In respect of any reverse trades entered, the difference thereon should also form part of the turnover.
- As Per Income Tax Act :- No separate definition of Turnover is provided as per Income Tax Provisions for Futures and Options.
Let us understand with an Example :-
Rohit has entered into following Transactions in Futures and Options Market :-
- Bought one lot of 300 shares of Company X Futures @1000 Price and later sold @ 1050.
- Bought one lot of 500 shares of Company Z Call Options @ Rs. 30 Premium and later sold @ Rs. 40 Premium.
- Sold one lot of 1000 Shares of Company A Call options @ Rs. 20 Premium and Later bought @ Rs. 30 Premium
- Bought one lot of 800 Shares of Company B Futures @ 500 Price but reversed Trade @ 530.
|Script||Lot||Buy @ Rs.||Sale @ Rs.||Turnover|
|Company X Futures||300 Shares||1000||1050||300 x 50 = 15000|
|Company Z Call Options||500 Shares||30||40||500×10=5000|
|Company Z Call options Sale *||500 Shares||NA||40||500×40=20000|
|Company A Options Sold||1000 Shares||NA||20||1000×20=20000|
|Company A Options Bought and Sq Off||1000 Shares||30||20||1000x(-20)=(20000)**|
|Reverse Trade Company B||800 Shares||500||530 (reversed here)||800×30=24000|
*Option sales is also added in turnover ** Loss in trade is also added in turnover
Thus Total Turnover for the above transactions should be 1,04,000/-.
Important Note:- Turnover is calculated only to evaluate if the assessee is required to be audited or not. It has no other significance in terms of calculation of Turnover for 3CD Accounting ratios or to mention else where as business turnover.
Set off and Carry forward of Losses of Futures and Options trading (as most of the cases its Loss).
Since it is business transactions calculated under the head PGBP then the same rules and provisions shall be applicable for Set off and Carry forward of losses even for Futures and Options transactions. Only for Intraday transactions in Equity Shares, the Losses shall be treated as Speculative losses.
Accounting should be performed individual trade wise as per contract Notes in accounts. A summary of transactions can be created where the buy and sell rate is defined and net profit or loss is calculated when Squared Off. Most of the cases the broker maintains the trade book which has a summary of transactions. Auditor can verify the trade book with copy of contract notes and vouchers present with client.
All the charges are deductible i.e. Brokerage charged by broker, GST, SEBI Fees, STT, Exchange charges, other charges as per contract note, salaries paid to employees, depreciation on assets and interest Expenses are also allowable deductions. This list is not exclusive and any other expenses done by trader are also an allowable expense.
- Check whether all the transactions are duly recorded with books. This can be matched with the transaction statements. Brokers provide under mentioned documents
- Annual Transaction statements – Trading ledger
- Contract notes on the day of trading
- Profit and Loss statements
- Capital Gain Statements
- Transaction statement script-wise mentioning Buy and Sell rate.
- Open Positions at the end of Year
- STT and other taxes statements
- Balance with Broker in and open positions to be separately maintained. A common error is the amount transferred to the broker and the net withdrew is shown as closing broker balance by the client.
- TDS u/s 194C on brokerage if it crosses the threshold limit.
- TDS u/s 194A shall be applicable if interest is charged by the broker. Broker charges interest on an overdue amount if a trader fails to deposit money in their trading accounts for transactions executed by him.
- TDS u/s 194J is deductible if any professional charges are charged by the broker for special services such as Portfolio Management Services (PMS). In the case of PMS, a separate audit is performed at the broker level also and that audit report should also be called and verified.
- All other TDS provisions are applicable as usual.
- Contract notes shall be checked with emails provided by NSE and BSE on a sampling basis as per the decision of auditor and nature of transactions. NSE/BSE also provides emails for transactions executed by traders. Any variance between these emails and contract notes provided should be discussed with the client.
- Open positions at the end of the year shall be separately disclosed.
- ITR -3 should be filed in case of Audit cases and ITR 4 if opting for presumptive taxation. Other ITR to be filed which shall depend upon a case to case basis.