Stock Market Traders: Understanding Tax Audit Rules for Intraday and F&O Trading

Synopsis

Stock market traders, especially those involved in intraday and F&O trading without a registered business, need to understand tax audit rules. Income from these activities is typically classified as speculative business income. Turnover calculation, based on the aggregate of positive and negative differences, determines audit applicability, generally requiring an audit if it exceeds Rs 10 crore for banking channel transactions.

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Now that the income tax return filing time is here you can start the process by first preparing your tax return information and data. To submit your income tax return (ITR), you will need to use the e-filing ITR portal or the income tax utility. If you are trading in securities and futures and options (F&O) in the stock market, it's important to pay attention to the tax audit requirements.

This article explains when stock market traders should conduct a tax audit and then file their ITR.

Stock market trading income classification

Taxmann research says that typically intraday trading in the stock market, along with future and option trading, is considered income from speculative business unless you are a registered business that solely engages in stock market trading. If you are a registered business focused only on stock market trading, you will report this income as business income.

This article is about those individuals who do not own any registered business, but are simply trading in the stock market, such as students and salaried Employees.

According to Taxmann Research, any gains or losses from intra-day trading, classified as speculative transactions, are always subject to taxation under the income category: 'Profits and Gains from Business or Profession'.

'Speculative transaction' means a transaction in which a contract for purchase or sale of any commodity including stock and shares is periodically or ultimately settled otherwise than through actual delivery or transfer of the commodity or scrips.

The Income-tax Act classifies the business income into 'speculative' and 'non-speculative' categories. There are no separate provisions for computation and taxability of income from speculative business except for the provisions relating to set-off and carry forward of losses.

Taxmann Research says the income from speculative business is computed in the same way as normal business and taxed at rates applicable to the individual taxpayer.

However, any loss arising from speculative business is not allowed to be set off from any other income including income from non-speculative business. In other words, loss from speculative transactions can be set-off only against income from speculative transactions.

Applicability of tax audit for stock market traders

According to Taxmann Research, for checking the applicability of tax audit in such cases, the turnover from intra-day trading first has to be computed.

The computation of turnover is a very important factor as the applicability of tax audit is determined on the basis of turnover. In cases where total sales, turnover or gross receipt from the business during the previous year exceed Rs 1 crore, a tax audit is required.

However, the raised threshold limit of Rs 10 crore shall be applicable if cash receipts and cash payments during the year do not exceed 5% of the total receipt or payment, as the case may be.

In other words, if more than 95% of business transactions are done through banking channels, then tax audit is required only when the turnover exceeds Rs 10 crore.

Taxmann Research points out that as intra-day trading in shares is done through banking channels, the tax audit in such cases shall generally be required only when the turnover exceeds Rs 10 crore.

Computation of turnover

According to Taxmann Research, the Income-tax Act does not contain any provision or guidance for computation of turnover in the case of intra-day trading. However, the Guidance Note on Tax Audit issued by the ICAI prescribes the method of determining turnover in case of speculative transactions.

A speculative transaction refers to a transaction in which a contract for purchase or sale of any commodity or securities, is periodically or ultimately settled otherwise than by actual delivery or transfer of commodity or scrips.

Thus, in speculative transactions, there can be both positive and negative differences arising from the settlement of contracts. Each transaction resulting in a positive or negative difference is an independent transaction. In such transactions, though contract notes are issued for the full value of the purchased or sold asset, the entries in the books of account only contain the differences.

Accordingly, the aggregate of both positive and negative differences is to be considered as the turnover.

For example, Mr. X does the following intra-day trading of shares during the year:

Securities

Purchase Value

Sale value

Amount of gain or (loss)

A

1,00,000

1,15,000

15,000

B

95,000

71,000

(24,000)

C

250,000

2,35,800

(14,200)

D

3,04,000

3,20,000

16,000

Computation of turnover from intra-day trading of shares (speculative transactions).

In speculative transactions, the aggregate of both positive and negative differences (income and loss) is considered as the turnover. Thus, the turnover of Mr X shall be computed as follows:

Securities

Amount of gain or (loss)

Securities

Amount of gain or (loss)

A

15,000

B

(24,000)

C

(14,200)

D

16,000

Total

69,200

Set-off and Carry Forward of Losses

According to Taxmann Research, the losses from intra-day trading cannot be set off against income taxable under any other head, i.e., salaries, house property, capital gains and other sources.

The losses from speculative business (i.e., loss from intra-day trading) can be set-off only against speculative profits (i.e., profit from intra-day trading). These losses cannot be set off against normal business profits, though both of them fall under the same heads of income: 'profits and gains of business or profession'. However, losses from a normal business can be adjusted against the profits of a speculative business.

The unabsorbed loss can be carried forward for up to four Assessment Years. It can be set off only against the speculative business income in the subsequent years. It is important to note that you can carry forward the business loss, provided the ITR is filed on or before the due date.

If such ITR is not filed within the prescribed due date, the right to carry forward and set-off is lost.

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