Tax experts say that salaried individuals who trade in F&Os on the side often misreport it in their ITRs
Data from brokerage firms reveal heightened interest from small investors in derivatives market in the last 18 months as the markets soared to historical highs. However, few know that dabbling in futures and options (F&Os) entails relatively complex tax-filing rules.
Profits made from F&O trading are treated as business income for the purpose of taxation. This means that taxpayers who have made money or incurred losses in the derivatives market will have to file their income tax returns (ITRs) through ITR Form-3 or Form-4.
Tax experts say that salaried individuals who trade in F&Os on the side often misreport it in their ITRs. This slip-up happens because salaried individuals typically opt for the simple ITR Form-1 to file their tax returns and also that ITR-3 is used by legally incorporated companies or individuals engaged in any business or profession.
ITR-3 is the most complicated of all the forms and typically requires help from a tax expert for error-free filing. However, there’s some relief for taxpayers. Income from F&O qualifies for presumptive scheme of taxation and hence, taxpayers can opt for the comparatively easier ITR Form-4 in place of ITR Form-3.
But, the caveat with using ITR-4 is that you cannot carry forward any losses or bring forward losses from last year.
Moreover, business income also entails additional tax rules with respect to maintaining accounting records. If a taxpayer’s income exceeds ₹2.5 lakh or gross receipts from business exceed ₹25 lakh in the first year when the business income is earned, she will have to maintain accounting records. This can be done by using trading statements, bank statements and expense receipts to work out your profit and loss account.
That’s not all. Those whose total trading turnover from F&Os exceeds ₹1 crore, it will need to be audited by a chartered accountant. Failure to submit an audit report along with tax returns attracts penalties. These rules not only increase compliance burden but also cost of ITR filing for small taxpayers. Turnover in the case of futures is the total of profit and loss made on trades during the financial year. For options, apart from the absolute profit (addition of profit and loss), the premium received on their sale is also added to derive total turnover. This method of computation can easily push an individual’s turnover from F&Os over ₹1 crore through a few trades.
To understand this with an example, say, an individual has bought one lot of A company’s futures for ₹5 lakh and sold them for ₹4.5 lakh, incurring a loss of ₹50,000. She bought another lot of company B’s options for ₹8 lakh and sold it for ₹8.3 lakh, making a profit of ₹30,000. As per the tax rules, total turnover of her F&O trading will be ₹9.1 lakh as the premium of ₹8.3 lakh received on sale of options will also be added. In reality, she has made a net loss of ₹20,000.
Reporting F&O trading is all the more important when you have incurred losses. Losses from trades can be adjusted against rental income, interest income and capital gains. However, it can’t be set off against salary. Unadjusted loss can be carried forward for eight years, but in the case of futures, unadjusted losses can only be set off against non-speculative income.
