Understanding the tax rules for trading income

For traders, apart from predicting the stock market, reporting their income from intra-day trading or futures & options (F&O) in their tax returns can be another mind-boggling activity. But the rules for reporting trading income are quite straightforward and they seldom change.

A low-down

Profits/gains from intra-day trading or F&O must be treated as ‘Business Income’ and reported under ‘profits and gains from business or profession (PGBP)’.

Income from trading is further sub-divided into speculative and non-speculative. While the profits/losses from intra-day trading is deemed speculative, profits/losses from F&O is treated as non-speculative.

Both speculative and non-speculative profits under PGBP will be part of the total taxable income.

Tax payable is to be calculated on the aggregate taxable income based on the applicable income-tax slab rate.

Reporting business income allows you to deduct associated expenses. Thus, costs such as broker’s commission, demat charges and internet costs incurred on trading can be claimed as expenses, before reporting the trading income.

Tax treatment for speculative and non-speculative income differs if one of them is a loss.

If the non-speculative income derived from F&O is a loss, the amount equivalent to the loss incurred can be set off against any head of income, except salary. The unutilised loss, if any, can be carried forward for the next eight years and can be set off only against non-speculative income.

Suppose your salary income is ₹6 lakh per annum and you have an annual rental income of ₹2 lakh. You also entered into an F&O contract during the year and incurred a loss of ₹3 lakh. In this case, the total income would be ₹6 lakh (₹6 lakh + ₹2 lakh – ₹2 lakh loss on F&O). The balance F&O loss of ₹1 lakh can be carried forward to the future.

On the other hand, an intra-day trading loss (speculative), can be set off only against speculative income. The unutilised balance, if any, can be carried forward for the next four years to be set off against speculative incomes.

Note that while non-speculative loss incurred in a year can be set off against speculative gain, speculative loss cannot be set off against non-speculative gain.

Compulsory audit

As income from stock trading is defined as ‘Business Income’, tax provisions relating to audit of individuals carrying on a business or a profession also become relevant.

As per the Income Tax Act, tax audit is mandatory if the ‘turnover’ from the business exceeds ₹1 crore.

Several assessees are doubtful if they have to obtain a tax audit report to set off or carry-forward the losses incurred on trading. Archit Gupta, founder and CEO of ClearTax, says a tax audit is not a pre-condition to set off or carry-forward the losses from trading, provided the individual’s turnover is not more than ₹1 crore.

But what is a turnover? In case of intra-day trading, the transaction would be settled by paying out the difference. For such transactions, the difference, whether positive or negative, is the turnover.

In case of F&O, the trading turnover is the absolute sum of favourable and unfavourable differences of the contracts, plus the premium received on sale of options.

Suppose you bought a futures contract for ₹5,00,000 and sold it for ₹5,50,000. The profit (positive difference) — in this case, ₹50,000 — will be part of the turnover.

Say, you also entered into an option contract. You bought one lot (1,000 units) of stock ‘X’ at ₹200 and sold it at ₹180.

In this case, the turnover would be the negative difference of the contract (1,000 x (₹180 – ₹200) plus the premium received on sale of the option contract (1,000 x ₹180).

Thus, the total turnover from your trading activity will be ₹50,000 + ₹20,000 + ₹1,80,000 = ₹2,50,000.

If you are an assessee who opted to pay the income tax under the presumptive tax scheme (income deemed to be 6 or 8 per cent of the turnover), the applicable tax audit provisions are different.

Assessees under the presumptive taxation scheme are obliged to tax audit when the profits reported from the business (trading, in this case) is less than the specified amount (6/8 per cent of the turnover) but the total income from all the other sources such as salary, rental and business, is more than the maximum income tax exemption limit, that is ₹2.5 lakh.

For example, if an assessee under the presumptive taxation scheme reports a net loss on trading but his/her total income (including salary) is more than ₹2.5 lakh, tax audit becomes mandatory.