All types of trading income are to be reported in income tax returns (ITR), even when the taxpayer has made only losses. The fact that F&O and intra-day trades are not reported in the annual income statement (AIS) adds to the misconception that these are reported only when the trader has made profit. However, since such trades involve several high-value transactions, they have to be shown in the ITR.
In this article, Mint gives you a rundown of how the different types of trading incomes are reported in tax returns.
Futures and options
Trading in stocks derivatives counts as business income for income tax filing. It is to be reported in ITR-3, or ITR-4 when you opt for a presumptive income scheme.
Apart from filing the more complex ITR-3 or ITR-4, you may also need to maintain books of accounts or get tax audit done under different conditions.
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The books of accounts—or, in simple words, the profit and loss (P&L) statement—is to be made when the F&O turnover exceeds ₹25 lakh or income exceeds ₹2.5 lakh. Both these criteria are to be checked for the last three financial years. So, if your F&O turnover was below ₹25 lakh in FY24 but exceeded this threshold in FY23, you still need to submit accounting records in the current assessment year. The taxpayer doesn’t need a chartered accountant (CA) for creating books of accounts and can just use the P&L statement given by the broker.
Turnover is the net sum of both profit and losses made on various trades throughout the year. This method of computation has been adopted after the Institute of Chartered Accountants of India (Icai) released a guidance note in 2022 that excluded the sale amount of options from the turnover calculation. This has come as a relief to most derivatives traders as including the sale amount of options easily inflated the turnover to the threshold above which tax audit is required.
Though the income tax department has not released a circular reinforcing the same, Prakash Hegde, a CA and principal consultant of direct taxation at Acer Tax & Corporate Services LLP, Hegde advises that taxpayers only consider the profit and losses, and not the sale amount.
“Income tax laws don’t define turnover. It is the Icai’s guidelines on tax audit that do, so these should be followed to decide whether audit is required or not. But since this doesn’t come from a law and rather a guidance note, it is not binding on the tax authority and there have been some cases where the tax authorities have disputed the new method,” he said.
A tax audit has to be done by a CA, and is mandatory under two conditions: when the turnover exceeds ₹5 crore or when the taxpayer opts out of presumptive income scheme.
“The ₹5 crore threshold is applicable when at least 95% payments are done through banking channels. Else, the threshold is ₹2 crore for individuals and ₹1 crore for companies and LLPs (limited liability partnerships),” said Hegde.
When a taxpayer opts for presumptive income scheme, they have to continue it for a block of five years. Opting out in between makes it mandatory to get a tax audit done. “After opting out, taxpayer will also have to get their books audited for the next five financial years if the total income exceeds the basic exemption limit each year,” said Sambhav Daga, a practising CA.
Not auditing the accounting records when mandatory attracts a penalty of 0.5% of the turnover, with maximum penalty capped at ₹1.5 lakh.
It should be noted that taxpayers can claim certain expenses incurred towards carrying out F&O trades, which can be reduced from the turnover. These include trading expenses like securities transaction tax (STT), demat charges, brokerage and indirect expenses including subscription of courses, websites or publications taken to learn F&O, fees of trading software and depreciation of laptop and mobile phone used for trading.
Losses from F&O are allowed to be set off against rent, other business income, interest and capital gains, but not salary. Leftover losses can also be carried forward to up to eight years. However, from second year onwards, income options for setting off the losses shrink, as per Karan Batra, founder of Charteredclub.com. “Carried-forward losses from F&O can only be set off against business income. All other avenues of capital gains, income from other sources and rent are not allowed,” he said.
Intra-day trading
When stocks are bought and sold within the same day before the market closes, such transactions are called intra-day trades. For taxation purposes, intra-day income too is treated as business income, but these are categorized as speculative income, as opposed to F&O that are treated as non-speculative transactions.
The downside is that losses from speculative business can only be set off against other speculative incomes, like gambling and horse races. Also, losses from intra-day trades can be carried forward to four years, whereas F&O losses are allowed to be carried forward to eight years.
Batra said the department has categorically defined F&O as non-speculative income, whereas intra-day is speculative business. “It could be because derivatives trading is used for hedging,” he said.
Turnover calculation, thresholds for accounting and audit, and expenses to claim for intra-day trades are the same as F&O.
Stocks trading
For taxation purposes, delivery trading—stocks held for one or more days—can be categorized as either business or capital assets depending on the frequency of trades. While there is no concrete definition of the two in the tax laws, Batra said a simple method is to classify as per the frequency of trades.
“When the taxpayer frequently trades shares and it’s their primary income, it should be reported as business income. However, a few trades in a year can be declared capital assets,” he said. “I have a pensioner client who has over 10X profits on shares sold this year. Though the profits are huge, he has done less than ten trades in the last one year, so we are declaring the income as capital gains.”
Depending on whether the trading is classified as capital assets or business, the reporting varies drastically.
First, for capital gains, the taxpayer can file ITR-2, whereas business income can only be filed in the more complex ITR-3. Second, for business income, the taxpayer has to maintain accounting records and get a tax audit done under the same conditions that apply to F&O.
Third, for setting off losses, while a business loss can be set off against rent, capital gains, income from other sources and other business income, capital loss can only be set off against capital gains.
Taxpayers should choose between declaring trading income as business and capital gains strictly on the basis of frequency of trades and not to benefit from lower tax rates applicable to the latter. Batra noted that trades declared as capital assets are more likely to be disputed by the tax authorities. “I strongly advise against declaring trading income as capital assets when it is an individual’s primary income or if they trade daily despite working a day job. If the tax department disputes, it will definitely go into litigation,” he said.