financial services

What Income Tax is due on Derivatives Trading


With several new-fangled forms of investment coming up it may be difficult for income tax authorities to classify heads of income for purposes of national revenue. Derivatives trading in the National Stock Exchange reports daily turnovers of over Rupees 1 crore which is far more than what is achieved by cash markets on the same exchange. Trading in derivatives is increasing in popularity ever since they were introduced back in 2000.

What are Derivatives?

A derivative is essentially a contract for fulfilling a financial transaction subject to changes in the value of an underlying asset. The asset could be a stock, commodity, currency, foreign exchange rate, market index or the policy rate of interest. A derivative becomes a security because it is a gamble on the future value of the said asset.

Experienced derivative traders study how the value of an asset changes using extensive algorithms and computer programs. As an example, the value of a stock has some co-relation with the gross turnover of a company, its profit and loss statement, balance sheet and so on. All round sector specific climate, policy news and people’s spending tendencies combine to give value to that stock and analysts have developed software applications that present graphically the tendencies that values of the asset may assume.

Derivatives require excellent understanding of the underlying asset, its value and expiry of contracts, the party selling or buying and so on. People who include these in their investment portfolio are expected to possess the capacity for risk involved in such a market.

Is derivatives trading to be treated as a capital gain or as income from other sources in my ITR form?

According to Section 143(5) of the Income Tax Act, 1961, trading in derivatives is a non-speculative activity. That means it will not be treated like equity, land etc. where the concept of capital gains and indexation in respect of taxes arises.

Derivatives traders usually indulge in large transactions frequently but the value of each transaction is small. This income (or loss) is, instead, treated as income from business. This holds true even if the tax payer earns salary income from a regular job. That means, also, that you would have to file the form ITR-3 for showing income from business in the assessment year 2018–19 when e-filing tax returns.

Pros and Cons of F&O Trading in Terms of Taxation

But treating some income as a business income also has certain advantages. You can claim business expenses for brokerage fees, journal subscriptions to relevant magazines and so on.

You can also claim losses as losses from business and set off losses against earnings in the next assessment period. However, you may be required to maintain accounts or at least receipts, trading statements and bank account statements from which a P&L statement may be prepared. This will hold if your annual income is more than Rupees 2.5 lakh or if the gross annual turnover from all forms of business that you undertake is more than Rupees 25 lakh.

Know about how your Income Tax Return is Processed Get Details


You may need to have your accounts audited if you cross the exemption limit for businesses. The lower limit for businesses in terms of audit compliance for tax purposes is Rupees 2 crore of annual gross earnings.

If you do not meet this audit requirement you may have to fine of Rupees 25,000 for not maintaining proper bookkeeping. This goes up to 0.5% of gross turnover or Rupees 1.5 lakh for not performing an audit on time.

Get in touch with a CA or better yet, an online tax expert to monitor earnings and compliance. AllindiaITR is one of the leading platforms for CA assisted services in the market. It is the property of Corwhite Solutions Private Limited, a well-known IT solutions consultant.

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