This blog explores the tax audit requirements for Futures and Options trading in India, outlining key provisions and considerations under the Income Tax Act. It clarifies the classification of F&O transactions as non-speculative transactions and explains turnover calculation methods essential for determining audit applicability. By providing insights into mandatory audit scenarios and avenues to avoid obligations, the blog equips you with the essential knowledge to navigate legal and tax complexities effectively, ensuring compliance and minimizing financial risks in F&O trading.
The National Stock Exchange is one of the busiest in the world when it comes to trading in Futures and Options contracts. Financial year 2021-22 itself recorded futures and options trading worth USD 226,031 billion on the NSE. Such huge volumes of trade indicate that investments in futures and options contracts are extremely profitable in India. Even if the profit margins are negligible, investors still prefer trading in Futures and Options contracts as the risks of losses arising due to dynamic fluctuations in market prices are minimal.
Futures & Options traded in India are considered non-speculative financial instruments under the Income Tax Act of 1961. These instruments are traded to hedge future risks of losses arising from a sudden decline in prices of underlying assets, and thus, investors trading in such instruments are required to get their accounts audited for payment of taxes. This blog discusses in detail the tax audit requirements for Futures and Options trading in India, based on profits earned and losses faced as a result of such trade.
Classification of F&O Trading as Non-Speculative Transactions
Since F&O trades are settled without facilitating any delivery of shares or underlying assets, they might appear to be speculative financial instruments. However, their classification is exactly the contrary. In this context, let us first understand what speculative financial instruments actually are.
According to Section 43(5) of the Income Tax Act, speculative transactions are transactions where the sale of stocks and commodities is settled without their actual delivery to the buyer. However, there is a list of exceptions mentioned in this section, which includes commodity trade to hedge future risks of losses. This includes Futures and Options trading as well.It is based on this exception that Futures and Options trading is classified as “Non-speculative transactions”, even though their trades do not involve any physical delivery of stocks or commodities.
For all practical purposes like tax assessment, accounting, tax audits, and filing of income tax returns, trade in Futures and Options shall be considered “ Non-speculative” transactions only. As no actual delivery of shares or underlying assets takes place here, the traders have to book their profits or losses by either receiving or paying the concerned amount at the time of settlement
Meaning of Turnover in Tax Audit Requirements for F&O Trading
Ta Audit Requirements for F&O trading is determined based on the turnover involved. Therefore, it becomes extremely necessary for assessees to thoroughly examine their turnovers as defined under the Income Tax Act. The definition of turnover for F&O trading is calculated as mentioned below. Note that after calculating these limits, their values must be compared with the ceiling or threshold limits prescribed under income tax laws to determine the tax audit requirements per se.
- In the case of transactions that have been squared off, the aggregate of the favorable and unfavorable differences (i.e. profits + losses), is used to determine the resulting turnover of the transaction. Note that losses are not to be subtracted from the profits, rather their numerical values are to be summed up to calculate the absolute turnover.
- The premium submitted in case of Options transactions is also added to the sum total of profits and losses, in order to calculate the absolute turnover. Remember that this provision is only applicable to options trading and not to Futures trading.
- The above-mentioned values are to be added to the basic sale price of the futures and options contracts.
Tax Audit Requirements for Futures and Options Trading
The statutory provisions regarding tax audit requirements for futures and options trading have been mentioned in sections 44 AB(a) and section 44 AB(e) of the Income Tax Act. According to these sections, two different grounds prescribe mandatory tax audits requirements. Let’s understand both of them distinctly.
Provision for Tax Audit under Section 44 AB(a) of the Income Tax Act, 1961
Section 44AB (a) prescribes the turnover limits regarding tax audit requirements for F&O trading in India. Tax audit shall be mandatory for all F&O transactions exceeding the turnover limit of Rs.10 crores, irrespective of the profits or losses faced in such transactions. Since futures and options transactions are completely digital, the tax rate prescribed under section 44AD will be 6%, instead of 8% in all other cases.
Condition for Tax Audit under section 44 AB(e) of the Income Tax Act, 1961
A person carrying out F&O trading must get his accounts audited if section 44 AD(4) applies to him and his taxable income is more than what has been prescribed as the basic exemption limit. In this context, Section 44AD (4) states that, if an F&O trader has opted out of the Presumptive Taxation Scheme in the previous year, after being enrolled under it for any of the preceding 5 years , and if his accounts showed losses or profits below 6% of the turnover earned in the previous year, tax audit requirements become mandatory, even though the turnover for the previous year is recorded below Rs.2 crores.
Note: An assessee has the option to disclose his taxable income as 6% or more, of the turnover and remain free from any Tax Audit obligations, as long as his turnover does not exceed Rs. 2 crore in the previous year, and he is currently enrolled under the Presumptive Taxation Scheme.
| Tax Audit Applicability | Tax Audit Applied | Section Applied | Reason for Applicability |
|---|---|---|---|
|
Presumptive Scheme Opted and Turnover less than Rs.2 cr. |
No |
N.A. |
No tax audit requirement exists when the Presumptive Scheme is opted for. |
|
Presumptive Scheme Not
Opted and Turnover Less than Rs.2 cr |
No |
N.A. |
The normal threshold limit prescribed under section 44AB(a) will apply |
|
Presumptive Scheme Previously Opted and Subsequently Withdrawn; Turnover Less than Rs.2 crores |
Yes |
44 AB(e) |
Section 44AB(e) says Tax Audit is to be done mandatorily if section 44AD(4) is applied |
|
Turnover between Rs.2 Crores and Rs. 10 Crores |
No |
N.A. |
The normal threshold limit prescribed under section 44AB(a) will apply |
|
Turnover more than Rs.10 Crores |
Yes |
44 AB(e) |
As the turnover has crossed the normal threshold limit under section 44AB(a), Tax Audit becomes mandatory |
Trading in futures and options carries inherent risks due to market fluctuations. These financial instruments enable investors to hedge against risks by agreeing to trade at predetermined prices on specified future dates. If market prices exceed the agreed-upon prices, investors can mitigate potential losses. However, if market prices fall below the contract prices, investors may face losses instead of potential profits. Additionally, legal and tax liabilities, such as mandatory tax audit requirements for F&O trading, can add to the cost burden for investors. Therefore, it’s crucial for investors to thoroughly understand these implications before deciding to trade in futures and options.
FAQs
Q1: What are the tax audit requirements for futures and options trading in India?
Tax audit requirements for futures and options trading are mandated under sections 44AB(a) and 44AB(e) of the Income Tax Act. Section 44AB(a) necessitates tax audit if F&O transactions exceed the turnover limit of Rs. 10 crores, regardless of profits or losses. Section 44AB(e) requires audit if an individual opts out of the Presumptive Taxation Scheme and incurs losses or profits below 6% of turnover, even if turnover is below Rs. 2 crores.
Q2:How is turnover calculated regarding tax audit requirements for F&O trading?
Turnover calculation regarding tax audit requirements for F&O trading includes the aggregate of favorable and unfavorable differences (profits + losses) for squared-off transactions. Additionally, premiums in options transactions are added to this sum. The basic sale price of futures and options contracts is also considered in turnover calculation.
Q3:Under what circumstances is tax audit applicable for F&O trading?
Tax audit is applicable if F&O trading turnover exceeds Rs. 10 crores, as per Section 44AB(a). Additionally, if an individual withdraws from the Presumptive Taxation Scheme and incurs losses or profits below 6% of turnover, audit becomes mandatory under Section 44AB(e), even if turnover is below Rs. 2 crores.
Q4: Can an individual avoid tax audit requirements in F&O trading?
Yes, individuals can avoid tax audit obligations by disclosing taxable income as 6% or more of turnover, provided turnover does not exceed Rs. 2 crores, and they remain enrolled under the Presumptive Taxation Scheme. This exempts them from audit requirements outlined in Section 44AB(e).
Q5: Why is understanding tax audit requirements crucial for investors in futures and options trading?
Understanding tax audit requirements is crucial for investors as it helps them navigate legal and tax obligations associated with F&O trading. Failure to comply with audit requirements can result in penalties and additional financial burdens. Thorough comprehension empowers investors to make informed decisions and manage their tax liabilities effectively.
Here in above tax audit applicability table it is clear for turnover less than 2 cr with Presumptive Scheme opted and not Opted.
1)What if my turnover is more than 2 cr and less than 10 cr with Presumptive Scheme opted and not Opted? Or above 2 cr this Presumptive Scheme is not available?
2)Future and option transactions are digital in nature.Due to this tax audit will require up to 10 cr,right?
Previously Option turnover was calculated
Options Turnover = Absolute profit + premium on sale of options
But now
Options Turnover = Absolute profit
Is it right?