F&O taxation: What you need to know about turnover, losses, and ITR filing

Exercise caution while reporting speculative and non-speculative income in your income tax returns

In Futures and Options (F&O) trading, turnover is calculated based on the absolute profits and losses from each trade, which differs significantly from traditional business turnover, where it represents the total revenue from sales. Understanding this distinction is crucial for traders, as it impacts their tax audit obligations.

The treatment of losses adds another layer of complexity. Speculative losses can only be offset against speculative gains within the same financial year and can be carried forward for just four years. In contrast, non-speculative losses, such as those from F&O trading, offer far more flexibility. These can be set off against any income (except salary) within the same year, and can be carried forward for up to eight years. This provides traders with much more leeway for tax planning and optimisation, thus making F&O income a more attractive avenue for traders looking to manage their tax liabilities effectively.

Tax classification and expense deductions

F&O trading is not treated as a speculative transaction under the Income Tax Act when conducted on a recognised stock exchange. This is clearly defined under Section 43(5), which excludes such transactions from the scope of speculative income. Hence, F&O transactions are treated as non-speculative business income and taxed under the head "Profits and Gains from Business or Profession (PGBP)".

Income from F&O trading, whether it results in profit or loss, must be reported as business income in the income tax return. As this is considered business income, the trader is allowed to deduct business-related expenses incurred during trading. These expenses include brokerage charges, transaction costs, internet and telephone bills, depreciation on laptops or other assets used for trading, subscription fees for trading platforms or market research tools, advisory fees, consultancy payments, and any salaries paid to staff directly involved in trading.

Also read: Filing ITR? Four key points salaried taxpayers should keep in mind

Turnover calculation and audit thresholds

The turnover in F&O trading is not the total value of contracts traded but the sum of the absolute values of all profits and losses from each trade. For example, if you make a profit of Rs 20,000 in one trade and a loss of Rs 15,000 in another, the turnover is Rs 35,000 (Rs 20,000 + Rs 15,000).

For futures, turnover is the absolute profit or loss on each squared-off position. For options, turnover includes the absolute profit or loss on the sale and purchase of options, as well as the premiums received when options are written (sold). This method of calculating turnover is important because it determines the applicability of tax audit under Section 44AB and the eligibility to opt for presumptive taxation under Section 44AD.

If the turnover from F&O trading is up to Rs 3 crore, traders may choose to opt for the presumptive taxation scheme under Section 44AD. Under this scheme, if you declare net profits equal to or greater than 6 percent of turnover (for digital transactions), then you are not required to maintain books of accounts or get your accounts audited. However, if the profit declared is less than 6 percent, and the total income exceeds the basic exemption limit, a tax audit becomes mandatory under Section 44AB(e).

A tax audit is not required if the turnover exceeds Rs 3 crore but is up to Rs 10 crore, and more than 95 percent of transactions are digital. If the turnover exceeds Rs 10 crore, a tax audit is compulsory under Section 44AB(a), irrespective of the nature of transactions.

Loss set-off rules and ITR filing

All expenses claimed against F&O income must be directly related to the business activity. These can include rent for an office (if any), electricity used in a trading workspace, internet service, and telephone bills. Costs of trading platforms and software, consultancy and research fees, and salaries paid to helpers or analysts are also eligible for deductions. Traders must ensure that these expenses are legitimate, supported by bills or invoices, and that payments are made through identifiable modes such as bank transfers to ensure transparency.

After deducting allowable expenses, the net profit from F&O trading is added to the taxpayer's total income and taxed according to the applicable slab rate for individuals or the applicable rate for entities like firms or companies. There is no fixed tax rate for F&O trading, such as capital gains; the tax is levied based on the total taxable income.

Also read: Capital Pains: Accurately reporting capital gains across multiple brokers

In the case of losses from F&O trading, the nature of the income being non-speculative business income allows for certain benefits. Losses can be set off against any other income, except salary income, in the same financial year.  If the loss cannot be adjusted in the same year, it can be carried forward for up to 8 years, and in subsequent years, it can be set off against any non-speculative business income. However, the income tax return must be filed within the due date under Section 139(1) to carry forward such losses. Filing the return after the due date will disqualify the taxpayer from carrying forward the loss to future years. Meanwhile, for speculative income, losses can only be set off against speculative gains within the same year, and if not fully set off, can be carried forward for a maximum of 4 years.

The correct income tax return (ITR) form for F&O traders is generally ITR-3, which is meant for individuals and Hindu Undivided Families (HUFs) having income from business or profession. This form allows for the declaration of business income, deductions of expenses, depreciation, audit details, and balance sheet information. In cases where the trader opts for presumptive taxation under Section 44AD and meets all eligibility conditions, they may file ITR-4, but this is applicable only if the taxpayer does not have capital gains, foreign assets, or other complex income.