Gain/Loss On Futures And Options – Income Tax Treatment
Derivative trading, or the trading of futures and options, has increased dramatically in the last few years. Usually referred to as F&O. People who had previously been involved in it on a part-time basis are now pursuing it full-time. Along with their jobs, people are earning extra money through trading. Through F&O investment, investors can forecast the price of stocks or commodities and earn substantial returns. However, there is a significant risk involved.
Investors are talking a lot about trading futures and options, or F&O, on stocks, currencies, and commodities, but they need to know how this is taxed. Allow us to better understand how to handle your taxes.
What is F&O, or futures and options?
Financial derivatives instruments traded on stock exchanges are called futures and options, or F&O. These are contracts that let investors guess or hedge their bets on how the prices of underlying assets—like stocks, commodities, currencies, or indexes—will change in the future. This is a quick summary of options and futures:
A standardised contract for the purchase or sale of an underlying asset at a fixed price and future date is known as a futures contract.
Regardless of the market price at the time the contract expires, it requires the seller to sell the asset at the agreed-upon price and the buyer to buy it.
Futures are highly standardised with respect to contract size, expiration date, and settlement method. They are traded on organised exchanges.
The buyer of an options contract is granted the right, but not the responsibility, to purchase (call option) or sell (put option) an underlying asset at a strike price on or before a specific date (expiry date) at a given price.
For the option, the buyer gives the seller a higher price.
If the buyer chooses to exercise the option, the seller is required to comply with the terms of the agreement.
Options come in a variety of forms, including index options, stock options, and commodity options, and are also traded on organised exchanges.
Future and Option Trading.
Options & Futures Trading is the act of exchanging derivatives for an underlying asset at a fixed price. A currency, equity shares, or a commodity could be this underlying asset.
With futures, a trader purchases or sells a contract at a fixed price and on a fixed future date.
Options provide the buyer the right, not the obligation, to purchase or sell, so he can terminate the agreement if he suffers any losses.
Treatment of Futures and Options in the ITR along with the adjustment of Losses?
Trades of futures and options are reported under Profit and Gains from Business or Profession. Net of all the trades whether positives or negatives are considered as Business Income. Whereby for reporting purposes Turnover is considered as Absolute amount of ( Selling Amount – Purchase Amount). While Profits are reported under Profit and Gains from Business and Profession and taxed as per the slab rate of the assessee.
Trading in futures and options is regarded as non-speculative activity under Section 43(5). This implies that the taxation of any income derived from F&O trading is comparable to that of business transactions.
Transactions can be offset against all other sources of income (salary excluded) in the event of a F&O loss. This is a main advantage. These sources of income could come from a business or occupation, real estate, or other sources. For instance, if you are paying Rs 100,000 in rent each month, you will receive Rs 12,00,000 a year. If you have any loss on F&O for the year, which let’s say is Rs. 200,000, you can deduct this loss from your rental income. Your taxable income will drop to Rs. ((1200000- (30%*1200000)- 200000)= 640,000 as a result.
In this instance, the loss may be carried forward over the following eight years if it could not be set off in the current year. But for the next eight years, nothing will change; but you can only deduct it from your business income.
When reporting F&O income, which ITR form should I file?
To file an ITR, there are various forms available. Given that F&O income and losses are regarded as typical business income and losses, selecting the appropriate option is crucial depending on the nature of your revenue. Therefore, the appropriate form to report this income is ITR-4. To guarantee accurate reporting of your income and prevent any discrepancies, it is imperative that you choose the appropriate ITR form.
What variables are considered and how is F&O turnover calculated?
Calculating trading turnover is crucial to determining whether or not the tax audit is relevant.
Total Profit (the absolute total of the gains and losses on all of the transactions that were made during the year) is the turnover for futures and options trading.
Here, the sum of the positive and negative differences equals the profit or loss.
Let’s use an example to better understand this:-
On 07/09/2023, Mr. X purchases 400 Nifty Futures contracts at a price of Rs. 50. On October 20, 2023, he sells these contracts for Rs. 30. Additionally, on October 5, 2022, Mr. X purchases 200 Sensex Futures contracts for Rs. 100. On December 9, 2023, he sells these contracts for Rs. 150.
Loss from Trade 1 = (30-50) * 400 = Rs. -8,000
Profit from Trade 2 = (150-100) * 200 = Rs. 10,000
Turnover = 8000+10,000=Rs.18,000
Profit/ Loss from Business and Profession = Rs. 2000
The Advantages of Reporting Your F&O Loss
There are various advantages Futures and Options (F&O) loss when submitting your income tax return. These advantages include:
Tax Deduction: One of the main advantages of proving the loss is that it can be deducted from any other money you have received. You can deduct a loss on a F&O trade from all sources of income other than your salary. This could come from a job work, a business, a house property, or any other source of income. It lowers your total amount of owed taxes. This may assist in reducing your tax obligation.
Carry Forward: You may carry forward unabsorbed losses to subsequent fiscal years if your F&O losses in a given year surpass your total income. Your tax obligation in later years can be decreased by deducting these losses from your F&O gains. Carry Forward of losses would only be available if the return is filed timely as per Section 139(1)
Documentation for Future Use: When you accurately report your F&O losses, you get a record of your financial transactions that you can use for future financial planning or loan applications.
Adjustment against F&O Gains: Declaring the losses enables you to offset them against the gains, lowering the total tax obligation on F&O transactions, if you have both F&O gains and losses in a financial year.
Preparation of Books of Accounts and Audit Requirements
It is significant to note that once your account is classified as a business, appropriate books of accounts must be kept if the income exceeds Rs 2,50,000 or the turnover exceeds Rs 25,00,000 in any of the preceding three years, or in the first year in the case of a new business. Individuals conducting business, such as F&O trading, are subject to the same rules. Under Section 44AA of the Income Tax Act, the trader would have to prepare regular books of accounts. However, a tax audit under Section 44AB will be carried out if the turnover surpasses Rs. 10 crore or the profit declared is less than 8%. This implies that you must have a Chartered Account audit your accounts, and you must file your tax return and the audit report by the deadline set by the act.
Under Section 271A, there is a penalty for failing to keep accounting records. The fine is Rs 25,000. Furthermore, failing to have books audited in accordance with Section 44AB may result in a fine under Section 271B equal to the lesser of Rs 1.5 lakhs or 0.5% of gross receipts or turnover.
In what situations and with whom is a F&O trading tax audit permissible?
Case 1: Up to $2 Cr in trading turnover.
Tax Audit is not applicable if the profit is greater than or equal to 6% of Trading Turnover and presumptive taxation has been chosen.
If the taxpayer’s income exceeds the exemption limit and they have lost money or made money that is less than 6% of trading turnover, a tax audit is necessary.
Case 2: Trading Turnover Exceeds $2Cr and May Reach $10Cr
A tax audit is necessary if the taxpayer has lost money or made a profit that is less than 6% of trading turnover.
The Tax Audit is relevant if the profit exceeds or equals 6% of Trading Turnover and presumptive tax has not been chosen.
The Tax Audit is not relevant if the profit is greater than or equal to 6% of Trading Turnover and presumptive tax has been chosen.
Case 3: The trading turnover exceeds $10 billion.
Tax Audit is relevant in every situation, regardless of trading volume.
