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Personal Finance

How does taxation work for F&O Traders?

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This post is part of our series on taxation for investors in India by Sandeep Koonaparaju. Sandeep is a practicing Chartered Accountant based out of Bangalore.


Three frequently asked questions by F&O traders

  1. How is the turnover of F&O business computed?
  2. When should I get  the books audited? 
  3. Is audit compulsory if I declare income at less than the presumptive rate, or losses?

In this post we make an attempt to answer these questions in plain English while avoiding technical jargon to the extent possible. 

So, let’s start with the first question, how is turnover computed?

A majority of the F&O traders already know the answer and if you are one of those you can skip this part. 

The method of computing turnover is different for futures and options. Let’s understand these separately.

Futures: Turnover for trading in futures is arrived at by adding the absolute value of profit or loss made from each trade. Absolute value is the value of profit or loss ignoring the signage (where negative indicates loss). The table given below explains it.

How does taxation work for F&O Traders?

Options: Moving on to options. We need to add the premium received on sale of options to the absolute value of profit/loss. Let’s look at the table below, to understand this.

How does taxation work for F&O Traders?

As you can see in the first trade, the premium received (9,00,000) is added to the absolute value of loss (1,00,000) to arrive at turnover. 

When is an audit needed?

For ease of understanding, let’s segregate the conditions for audit into turnover based and non turnover based conditions.

Turnover based conditions

The general rule is that an audit is needed for businesses whose turnover exceeds 1 crore. 

Exceptions to this rule are:

  1. If cash receipts and payments do not exceed 5% of total receipts and payments respectively, then the limit is enhanced to 10 crores
  2. For taxpayers declaring income under presumptive taxation under 44AD (8%/6%) the limit is 2 crores (discussed in detail later in the article)

 

Non-Turnover based conditions

  1. A Person engaged in “specified professions” declaring profits less than 50% of turnover.
  2. A person engaged in business who has opted for presumptive taxation (8%/6%) in any of the last 5 years but does not opt for the same in the current year.
  3. Certain other “specified businesses”  not declaring minimum profit under presumptive taxation (F&O trading does not fit into this category)

 

Presumptive Taxation and Audit

While there are multiple sections in Income Tax Act that refer to presumptive taxation, the current discussion is restricted to presumptive taxation under section 44AD (applicable to a majority of businesses including F&O trading).

44AD provides an option for small businesses to declare income at a predefined percentage (8%/6% for non cash/cash turnover respectively) of turnover, provided the turnover does not exceed 2 crores. As an F&O trader if your turnover does not exceed 2 crores you can choose to declare income at the presumptive rate. A word of caution here, if you have opted for presumptive taxation in a particular year, and want to declare losses or income at less than the presumptive rate in any of the next five years then:

  1. You cannot opt for presumptive taxation for five years succeeding the year in which you declared such losses or lesser income and
  2. Audit will be mandatory for that year if your total income exceeds the basic exemption limit.

A question that’s commonly asked is, is audit applicable if you declare losses or profit at less than the presumptive rate even if turnover is within the prescribed limit of 1 Crore or 10 Crores?

Upto the year 2016, there was a clause in section 44AD that required a taxpayer to maintain books and get them audited if he declares income less than the presumptive rate or declares losses. In Finance Act 2016 this clause was replaced by a new clause. Under the new clause audit is required only if a taxpayer has declared income at presumptive rate in any of the previous five years but wants to declare losses or income at less than the presumptive rate in the current year, provided his total income in the current year exceeds the basic exemption limit. 

Is it getting too complex? Let me illustrate it through a few examples:

Example 1

Mr X started trading in F&O for the first time during FY 2020-21. Turnover during the year is 75 lacs and he made a loss of 2 lacs. 

Audit is not required in such cases as turnover is within the specified limits.

Example 2

Mr X started trading in F&O for the first time during FY 2020-21. Turnover during the year is 4 crores and he made a loss of 20 lacs. 

Audit is not required if the 5% condition related to cash transactions specified above is fulfilled. 

Example 3

Mr X started trading in F&O for the first time during FY 2020-21. Turnover during the year is 12 crores and he made a profit of 10 lacs. 

Audit is required as turnover exceeds the permissible limit of 10 crores.

Example 4

Mr X started trading in F&O for the first time during FY 2019-20 and declared profit at the presumptive rate of 8%/6% as applicable (for F&O traders it is generally 6%). During the year 2020-21 turnover from F&O trading was 10 lacs and he incurred a loss of 2 lacs and Mr X does not have any other income during the year.

Mr. X wants to declare and claim the loss of 2 lacs. It will have the following implications:

  1. Audit is not applicable as his total income for the year does not exceed the basic exemption limit.
  2. He cannot declare profit at presumptive rates for 5 more years, i.e upto 2025-26.

Example 5

Same facts as discussed in Example 4 except that Mr X has income of 10 lacs during the year. 

The implications are:

  1. Audit is applicable as his total income for the year exceeds the basic exemption limit.
  2. He cannot declare profit at presumptive rates for 5 more years, i.e upto 2025-26

And that’s it. As an F&O Trader, keep these points in mind, and you’ll be fine come tax-filing season.

Other Popular Taxation Articles

A brief guide to ESOP taxation in India

How taxation works for AIF and PMS Investors

The Basics of Capital Gains Taxes

How to set-off and carry forward losses


If you’re a Capitalmind Premium member you can continue the conversation and ask more specific questions on the #taxation channel in Slack. You can reach Sandeep on email sandeep.vvc98 [at] gmail.com

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