Tax Audit Requirement on Profit or Loss from Futures and Options (F&O) Trading
Futures and Options (F&O) trading has gained significant popularity among traders and investors in India. However, many are unaware of the tax implications and audit requirements associated with F&O transactions. Since F&O trading income is classified as business income under the Income Tax Act, it is subject to tax audit provisions if specific conditions are met. This article provides a detailed guide on the tax audit requirements for profits and losses from F&O trading, with a particular focus on cases where losses occur or profits are below 6% of turnover.
Tax Filing and Audit Rules for Salaried Individuals Trading in Stocks or F&O
Many salaried individuals who dabble in stock markets or trade in Futures & Options (F&O) often wonder how these activities affect their income tax return and whether they need to get a tax audit done. This guide breaks it down clearly, based on the latest rules under the Income Tax Act, 1961.
Understanding Stock and F&O Trading from a Tax Perspective
When it comes to taxation, trading in shares or F&O is generally divided into two types:
- Speculative Transactions: These are trades where buying and selling happen on the same day (like intraday equity trading). Since there’s no actual delivery of shares, it’s treated as speculative business income.
- Non-Speculative Transactions: This includes F&O trading and delivery-based share trading. Even though they’re part of the stock market, they’re treated differently for tax purposes and are considered non-speculative business income.
Classification of F&O Trading Income
Under the Income Tax Act, 1961, any income earned from F&O trading is treated as business income. This classification applies irrespective of whether an individual is a full-time trader or has F&O trading as a secondary source of income.
F&O trading income can be categorized into:
- Profits: Taxable under the head “Profits and Gains from Business or Profession” (PGBP)
- Losses: Allowed to be set off and carried forward as per business loss provisions
Since this income is considered business income, it requires compliance with provisions related to bookkeeping, tax audit, and advance tax payments.
Calculation of Turnover for F&O Trading
Determining whether a tax audit is required depends on the calculation of trading turnover. The turnover for F&O trading is calculated as follows:
- Absolute sum of profits and losses: The turnover is the sum of absolute values of profits and losses from F&O transactions.
- Premium received on sale of options: As per the latest ICAI guidelines, the premium received is included in turnover.
- Reverse trade differences: The difference in squared-off trades also contributes to turnover.
Example of Turnover Calculation in case of F & O
| Trade Type | Profit (₹) | Loss (₹) | Absolute Value |
|---|---|---|---|
| Trade 1 | 50,000 | – | 50,000 |
| Trade 2 | – | 30,000 | 30,000 |
| Trade 3 | 20,000 | – | 20,000 |
| Total Turnover | – | – | ₹1,00,000 |
In this case, the total turnover is ₹1,00,000.
Tax Audit Applicability for F&O Trading
A tax audit under Section 44AB of the Income Tax Act is applicable based on turnover, profit/loss, and mode of transactions.
1. Tax Audit Requirement in Case of Loss or Low Profit (Profit Below 6%)
A tax audit becomes mandatory if:
- The turnover is up to ₹2 Crore and profit is less than 6% of turnover or there is a loss.
- The total income exceeds the basic exemption limit (₹2.5 lakh for individuals below 60 years, ₹3 lakh for senior citizens, ₹5 lakh for super senior citizens).
Example:
- Turnover: ₹1.5 Crore
- Profit: ₹50,000 (less than 6% of turnover)
- Total Income (Including Salary & Other Sources): ₹5 Lakh
- Tax Audit Required? → Yes (since profit is below 6% and total income exceeds the exemption limit)
If total income does not exceed the exemption limit, a tax audit is not required, even if there is a loss or low profit.
2. Turnover Between ₹2 Crore and ₹10 Crore
- If 95% or more transactions are digital: No tax audit required
- If digital transactions are less than 95%: Tax audit is mandatory
3. Turnover Exceeding ₹10 Crore
- Tax audit is compulsory, regardless of profit/loss or mode of transactions
Tax Advantages of Reporting Losses in F&O Trading
If you’ve incurred losses while trading in Futures and Options (F&O), there’s some good news—these losses can help you save on taxes. F&O losses are classified as business losses under the Income Tax Act and can be set off against income from other sources, such as interest or rental income.
If you’re unable to fully adjust the losses in the same financial year, you can carry them forward for up to eight assessment years, allowing you to offset them against future business income, including profits from F&O trading. This helps reduce your taxable income in subsequent years.
Why It’s Crucial to Declare F&O Losses in Your ITR
Many individual investors, especially salaried professionals who dabble in F&O trading, often neglect to declare these transactions in their Income Tax Returns (ITR). This is either due to lack of awareness or the misconception that only profits need to be disclosed. However, under Indian tax laws, disclosing all sources of income—including F&O trades—is mandatory.
Moreover, brokers are required to submit a Statement of Financial Transactions (SFT) to the Income Tax Department each year. This means your trading activity is already on the department’s radar, even if you don’t report it. Failure to report F&O transactions can result in:
- Scrutiny notices from the IT Department
- Penalties for non-compliance
- Compulsory tax audit in certain cases
- Additional consequences for not maintaining books of accounts
Properly declaring F&O losses not only ensures compliance but also helps you legally reduce your tax liability in current or future years. If you’re trading in F&O, it’s highly advisable to consult a tax expert to ensure accurate reporting and claim all legitimate tax benefits.
Consequences of Not Complying with Tax Audit Requirements
Failure to conduct a mandatory tax audit attracts penalties under Section 271B of the Income Tax Act.
- Penalty: 0.5% of turnover or ₹1,50,000, whichever is lower
- Risk of scrutiny: Higher chances of receiving an income tax notice
- Loss carry forward restrictions: Losses cannot be carried forward if the audit requirement is not met
Frequently Asked Questions (FAQs)
1. Is F&O trading income considered capital gains?
No, F&O trading income is treated as business income, not capital gains.
2. Which ITR form should be used for F&O trading income?
Use ITR-3 (for individuals with business income).
3. Can F&O losses be set off against other income?
Yes, F&O losses can be set off against any income except salary and can be carried forward for 8 years.
4. Are salaried individuals required to undergo a tax audit for F&O losses?
Yes, if total turnover and income exceed the limits prescribed under Section 44AB.
5. Is the premium received on options included in turnover?
Yes, as per ICAI guidelines, the premium received on options is included in turnover.
6. What is considered a digital transaction for tax audit purposes?
Digital transactions include payments through UPI, net banking, debit/credit cards, and online transfers.
7. How to ensure compliance with tax audit requirements?
Maintain detailed records of transactions and consult a Chartered Accountant for accurate filing.
Understanding tax audit requirements for F&O trading is essential to avoid penalties and legal complications. Traders incurring losses or declaring profits below 6% must carefully evaluate their turnover and total income to determine if a tax audit is mandatory. Always analyze turnover, profit percentage, and mode of transactions to ensure compliance with the Income Tax Act.