With an increase in awareness about Capital Market coupled with saving habits, people from young generation and especially among young salaried persons (Having risk appetite) Future and Options (F&O) is getting quite popular among investors. Even if Investors are comfortable dealing in derivatives but its tax treatment is still is mystery to many.
In this article we have discussed about the classification of income arising from dealing in F&O, its inclusions while calculating the turnover limit and disclosure in ITR.
Nature of Derivative Income –
The gains or losses arising from trading in F&O are always taxable under the head ‘Profits and Gains from Business or Profession’. The Income-tax Act classifies the business income into ‘speculative’ and ‘non-speculative’. Though Income arising from speculative transactions are taxable under the head PGBP, yet they are treated differently and rigorously from non-speculative business income.
A transaction is deemed as speculative if it is periodically or ultimately settled otherwise than through actual delivery or transfer. In case of derivatives, the transaction are ultimately settled without deliver of underlying asset. However, Section 43(5) has specifically excluded the derivative transaction from the meaning of speculative transaction as these instruments are used for hedging of underlying assets. Thus, income or loss from dealing in F&O shall be deemed as normal business income (non-speculative business) even though delivery is not effected in such transactions.
The income from F&O trading can be offered to tax under the normal scheme of taxation or the presumptive scheme of taxation under Section 44AD. Under the presumptive scheme, the investor can choose to declare the profits at the rate of 6% of turnover as the payment is always received through banking channels. The presumptive income computed as per the prescribed rate is the final income and no further expenses will be allowed or disallowed. Also, the person opting for this scheme is not required to maintain the books of accounts prescribed under section 44AA and can pay 100% of the advance tax in a single instalment up to 15th March.
Reporting in ITR –
Since the trading in derivative(F&O) is considered as business income, it can be reported in Form ITR-3 or ITR-4, if assessee is an Individual or HUF. The form ITR-4 can be used only by the taxpayers opting for the presumptive scheme of taxation.
Applicability of Tax Audit –
The person trading in the F&O is required to get his books audited by a chartered accountant in the following two situations:
- If the turnover in the business exceeds one crore rupees in any previous year then the taxpayer is required to get his accounts audited. However, the person is not required to get his accounts audited if he opts the for presumptive taxation scheme under section 44AD. The person can opt for the presumptive taxation scheme under section 44AD, only if his turnover does not exceed 2 Crore Rupees.
- If the taxpayer has opted for the presumptive taxation scheme under section 44AD in any of the last 5 previous years but do not opt for in a current year and his total income exceeds the maximum amount which is not chargeable to tax, he is required to get his accounts audited
Computation of Turnover –
The Income-tax Act doesn’t contain any provision or guidance for computation of turnover in F&O trading. However, the Guidance Note on Tax Audit issued by the ICAI prescribes the method of determining turnover which shall be as under:
- The total of favorable and unfavorable differences is 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.
All the differences, whether favorable or unfavorable, are aggregated to calculate the turnover. The computation of turnover is a very important factor as the applicability of tax audit is determined on the basis of turnover. Also, if the taxpayer is opting for the presumptive taxation scheme under section 44AD, he can declare the profit at the rate of 6% such turnover.
Set-off and Carry Forward of Losses –
The losses from the trading of F&O is treated as a normal business loss. It can be set-off against the income from the other heads. However, the business loss cannot be set-off against the income from salary.
The unabsorbed loss can be carried forward up to 8 Assessment years. It can be set-off only against the business income in the subsequent years. It is important to note that the assessee is entitled to carry forward the business loss provided the return of income is filed on or before the due date. If such return is not filed within the prescribed due date, the right of carry forward and set-off is lost.