ITR Filing & Tax Audit for Income from F&O Trading

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Traders dealing in Futures & Options (F&O) usually enter into big transactions on a regular basis but the profit earned by them in such transactions is fairly small. As the volume and value of transactions is very high, the manner of filing of ITR and computing the Turnover for the purpose of Tax Audit is slightly different as compared to other businesses.

This article focuses on Tax to be levied in case of Income/Loss from Trading in Futures and Options F&O.

ITR to be filed in case of Income/Loss from Futures & Options

The income/loss arising from trading in F&O Transactions would be treated as a Business Income/Loss and therefore ITR 4 would be applicable in this case.

However, the good part is that Section 43(5) has specifically excluded transactions in F&O Market from being treated as Speculative Transactions. Even though these transactions are non-delivery based transactions, these transactions would still be treated as Non Speculative.

As such transactions in the F&O Market on the Stock Markets would be treated as Non Speculative Transactions, they would be taxed just like any other business income. The expenses incurred for the purpose of Business like Telephone Expense, Internet Expense etc would also be allowed to be claimed in the income tax return.

The tax on the balance taxable income arising on sale of F&O Transactions would be levied as per the applicable income tax slab rates.

Tax Audit in case of Income from trading in F&O

Since the Income from F&O Trading is considered as a normal business income, normal provisions of the Income Tax Act will apply in this case. The trader would be required to prepare normal books of accounts under Section 44A of the Income Tax Act.

Moreover, if the turnover is more than Rs. 1 Crore or if the Profit disclosed is less than 8%, the taxpayer would also be required to get the Tax Audit conducted under Section 44AB. This tax audit would be required to be conducted by a practising Chartered Accountant for each year for which the turnover exceeds Rs. 1 Crores.

Computation of Turnover in case of F&O Transactions for Tax Audit purposes

The value of transactions in F&O is usually very high but the profit margin is fairly low.  Although, the tax audit is required only in cases where the where the annual turnover is more than Rs. 1 Crores, but in case of Traders who deal in the F&O Market, they are easily able to generate such turnover in a month. Although the turnover is very high but the profit margin is fairly low.

Moreover, the transactions in F&O Market are completed without the delivery of shares or securities. The transactions are also squared up by payment of differences. The contract notes are issued for the full value of the asset purchased or sold but the entries in the books of accounts are made only for the difference. The transactions may be squared up at any time on or before the expiry date.

Therefore in case of Derivatives Transactions in the F&O Market, the manner of computation of turnover is different from the manner of computation of turnover in case of other businesses. In case of F&O Transactions, the turnover would be determined as follows:-

  1. The total of favourable and unfavourable trades would be taken as the turnover
  2. Premium received on the sale of options is also to be included in the turnover
  3. In respect of any reverse trade entered, the difference thereon, should also form a part of the turnover.

This can be explained with the help of an example. Assuming an F&O Trader enters into the following 2 transactions:-

  1. Purchases 1 Lot of Futures of Reliance worth Rs. 5 Lakhs and sells it for Rs. 5.50 Lakhs thereby receiving a profit of Rs. 50,000.
  2. Purchases 1 Lot of Futures of Tata Motors worth Rs. 2 Lakhs and sells it for 1.90 Lakhs thereby incurring a loss of Rs. 10,000.

In case of the above 2 transactions:-

  1. Total profit = Rs. 50,000 – Rs. 10,000 = Rs. 40,000
  2. Turnover for the purpose of Tax audit = Rs. 50,000 + Rs. 10,000 = Rs. 60,000

Nature of Income in case of Delivery Based Transactions

If the transactions in share market are entered into for the purpose of Investment – the gains arising on such transactions would be treated as Capital Gains. However, if the transactions are entered into as a Business transaction – the income arising on sale would be treated as Income from Business/Profession.

It would be determined on the facts of each case whether the delivery based transactions are to be treated as Capital Gains or are to be treated as Business Income.

If these transactions are treated as Business Transactions, then the tax would be levied as mentioned above. If the transactions are considered as Investments, then the tax would be levied in the manner as described in this article – Treatment of Capital Gains on sale of Delivery based Shares.

Treatment of Loss arising in F&O Transactions

As the transactions entered into in the F&O Market are treated as Non Speculative Transactions, the loss arising out of F&O Transactions would be allowed to be set off against all other incomes except Salary Income.

If the Loss is not set off against the incomes of the same financial year, then such loss can be carried forward and set off against future incomes. However, for the loss to be carried forward and set off, the loss should be disclosed in the Income Tax Return and the ITR should be filed before the due date of filing of income tax return.

If the Loss is not disclosed in the income tax return or the income tax return is not filed before the due date – the loss would not be allowed to be carried forward. Loss claimed in ITR filed after the due date of filing of Return as Belated Return is not allowed to be carried forward.

Karan is CA by Qualification with the rare distinction of being awarded All India Rank 22. He is also the founder of this website and loves to help people with their Tax Queries.