Future and Options are stock derivatives that enable a future sale and purchase of commodities and securities in the stock exchange market. The date, quantity, and nature of the commodities and securities to be traded are predetermined and fixed by the parties in contract. While the buyer and the seller are obligated to trade the futures contracts on the fixed date without any option to bail out, the options contracts asserts the right of the traders to trade, and hence provides them the option to bail out at a later stage. Futures and Options trading help investors hedge the risks of losses caused by the trade of securities and commodities, primarily due to a sudden decline in their prices.
Futures and Options contracts can be easily traded and transferred in the Stock Exchange market, their values being subject to the dynamic values of the commodities and securities market in India. The income earned from the trade of such contracts are akin to any other business transactions and are thus, taxable under the same income tax rates as those imposed on any other business transaction carried out in India. Besides, the tax slabs applicable to futures and Options trading in India are also similar to the tax slabs applicable to any other business or individual taxpayer.
What is Futures and Options Trading?
Futures and Options are contracts that are signed between the seller and the buyer of such contracts for trading commodities and securities respectively, at a predetermined date in the future. In addition to the predetermined date of future trade, the prices and the quantity of commodities and securities to be traded are also decided beforehand. Such pre-fixed and predetermined contracts rescue its traders from the highly volatile stock market, where the fall in the prices of commodities and securities are extremely rapid and unpredictable.
Futures and options contracts are considered as stock derivatives, as their trade value is basically derived from the value of underlying assets like commodities, shares, stock market indices, Exchange Traded Funds, etc. Moreover, such contracts are traded in the stock exchange market, and are regulated by the Securities and Exchange Board of India (SEBI). Futures contracts act as a liability or an obligation for its seller and buyer, which means that the trade must be carried out at the date fixed in the contract, for a fixed price and quantity of the underlying asset. Neither the seller nor the buyer of the contract can bail out from it at a later stage, even if the trade incurs hefty losses upon them. Contrarily, an Options contract asserts the right to buy and sell, thereby providing its seller and buyer with the option to bail out from the contract at a later stage, if the sale of securities under the contract incurs losses upon them.
| S. No. | Futures Trading | Options Trading |
|---|---|---|
|
1 |
Contract between Buyer and Seller of the commodity
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Sale fixed at a future date, for a prefixed price and quantity of Securities
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|
2 |
Sale fixed at a future date, for a prefixed price and quantity of commodity
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Sale fixed at a future date, for a prefixed price and quantity of commodity
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|
3 |
Both buyer and seller are liable to carry out the trade on the date fixed for it.
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Both buyers and sellers have the option to bail out of the contract at a later stage, if either or both of them face any losses as a result of the trade under the contract.
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4 |
Asserts the liability of the traders to buy and sell under the contract
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Asserts the rights of the traders to buy and sell under the contract
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|
5 |
Directly affected by the underlying prices of the commodities
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Indirectly affected by the underlying prices of the commodities
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An Options contract can be categorized into Put and Call Options. The Put Option asserts the right of the seller to sell securities to the buyer, and provides him an option to bail out at a later stage in the contract, if he faces any losses as a result of the trade of securities, in effect of the contract. The buyer, however, cannot avail the option to bail out, even if he faces any losses resulting from the trade. The Call Option, on the other hand, provides a similar option to the buyer to bail out of the contract if he faces any losses as a result of trade carried out under the contract. Such an option, however, is unavailable for the seller under the Call Option contract.
Income Head, ITR Form, and Due Date for Futures and Options Trading
- Income Head-
Business and Professional transactions under the Income Tax Act 1961, can be classified into Speculative and non- speculative transactions. Section 43(5) of the Income Tax Act defines “Speculative transactions” as transactions in which a contract for the sale and purchase of any commodity, stocks, and shares, is periodically or ultimately settled otherwise, than by the actual delivery of commodities, stocks, or shares. Futures and Options trading involve a similar kind of trade in commodities and securities, seemingly appearing to be categorised as “speculative business transactions”.
However, Section 43(5)(d) and 43(5)(e) of the Income Tax Act exempts certain transactions from being classified as speculative transactions, including those dealing in the trade of derivatives, as defined under Section 2 (ac) of Securities Contracts (Regulation) Act and those dealing with commodity derivatives traded on recognized platforms like the stock exchange market. As a result, trading in futures and options contracts cannot be classified as Speculative business transactions, in pursuance of the exemptions mentioned above. As non-speculative business transactions, the income and losses reported shall be mentioned under the head “profits and gains from business and profession”. - ITR Form: Since income earned from futures and options trading is classified as non- speculative business transactions, the forms that will be required to file its returns include ITR-3 and ITR-4 for regular return filing and presumptive return filing of individuals.
- Due Dates: The due dates for filing ITR from financial year 2020-21 onwards is 31st July for traders who are not audited for tax and 31st October for traders who are audited for tax.
Future and Options Tax Audit
The applicability of tax audit depends on the trading turnover earned from the trade of future and options contracts. Follow the table below to get a thorough information on the tax audit applicability arising from future and options sale in India.
| Trading Turnover | Upto Rs. 2 crores | Rs. 2 crores to Rs. 10 crores | Rs. 10 crores and above |
|---|---|---|---|
|
Tax Audit Applicability
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Tax audit is applicable only when the profit or loss incurred is equal to or less than 6% of the turnover. For profit or loss incurred beyond 6% of turnover, tax audit is not applicable.
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Tax audit is applicable when the profit or loss incurred is less than 6% of the turnover, beyond which the applicability depends on the opting of presumptive taxation scheme. If the scheme has been opted for under section 44AD of the Income Tax Act, then tax audit is applicable, otherwise it is not applicable.
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Tax audit applicable irrespective of the amount of turnover, profit or loss.
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Future and Options Turnover Calculation
The turnover calculated for Futures and Options trading determines the tax audit applicability for such transactions. The turnover calculated for the purpose is called Absolute turnover, which is the aggregate sum total of the sale value, all the profit or loss values, and premium submitted (in case of Options trade only) in case of the concerned trade.
Illustration 1:
For instance, Mr XYZ earned a total profit of Rs. 50,000 from Options trading worth Rs. 5 lakhs with Asian Paints and incurred a loss of Rs. 40,000 from Options trading with HCL worth Rs. 4 Lakhs. While buying the Options, he paid a premium of Rs 300 to Asian Paints and Rs.500 to HCL. Then,
Absolute Turnover for Options Trading = Absolute Sale value + Absolute Profit/loss + Premium
which is,
Rs. 50,000 + Rs.300 + Rs. 5,00,000 = Rs, 5,50,800 for the first transaction,
And
Rs. 40,000 + Rs. 500 + Rs. 4,00,000= Rs. 4,40,500 for the second transaction
Based on the absolute value, we can infer that the tax audit shall not be applicable for these sets of transactions, as the absolute profit in the first case and the absolute loss in the second case is 9% of the turnover, which is Less than Rs. 2 crores in both cases.
Illustration 2:
For instance, Mr. ABC earned a total profit of Rs.500 on the sale of Futures contracts worth Rs. 5,000 to a company. Then,
Absolute Turnover for Futures Trading = Absolute sale value + Absolute Profit
Which is,
Rs.500 + Rs.5,000 = Rs.5,500
Based on the absolute value, we can infer that the tax audit shall not be applicable for the above transaction, as the absolute profit is 10% of the turnover, which is Less than Rs. 2 crores.
Income Tax on Future and Options Trading
Based on the absolute value, we can infer that the tax audit shall not be applicable for the above transaction, as the absolute profit is 10% of the turnover, which is Less than Rs. 2 crores.
| Taxable Income | Slab rate |
|---|---|
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Upto Rs. 2,50,000
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Nil.
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Rs. 2,50,001 to Rs. 5,00,000
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5%
|
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Rs. 5,00,001 to Rs. 10,00,000
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20%
|
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More than Rs. 10,00,000
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30%
|
Futures and Options New Tax Regime
A new tax regime was introduced in the year 2020 by the Indian Government, providing for lower tax rates and added tax slabs for HUF and individual taxpayers in India. It is optional for such taxpayers to opt for the new regime under section 115 BAC of the Income Tax Act. Traders of Futures and Options contracts can also opt for the new tax regime and benefit from the lower tax rates and a more segregated tax slab structure. The table below mentions the tax rates applicable for Futures and Options traders under the new tax regime.
| Tax Slabs under the new tax regime | Tax rates under the new tax regimes |
|---|---|
|
Upto Rs. 2,50,000
|
Nil.
|
|
Rs. 2,50,001 to Rs. 5,00,000
|
5%
|
|
Rs. 5,00,001 to Rs. 7,50,000
|
10%
|
|
Rs. 7,50,001 to Rs.10,00,000
|
15%
|
|
Rs. 10,00,001 to Rs.12,50,000
|
20%
|
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Rs. 12,50,001 to Rs.15,00,000
|
25% |
|
More than Rs.15,00,000
|
30% |
However, taxpayers opting for the new tax regime must meet fulfill the following conditions:
- The trader cannot claim deductions under Chapter VI A of the Income Tax Act
- Trader cannot set off any brought forward business losses
- Trader cannot carry forward the current losses to future years
- Trader must file Form 101E on the Income tax portal
- Traders opting for the new tax regime for the first time, have the option to revert back to the old tax regime. However, such an option is not available if he opts for the new regime for the second time as well.
Carry Forward loss for Futures and Options Trading
Traders of Futures and Options contracts can carry forward their losses arising from the trading of such contracts, to subsequent years, and can be set-off against any business income or profit earned in the carry forward years, whether speculative or non-speculative. However, the losses cannot be carried forward beyond a period of 8 years, according to the Income Tax Act. The provision for carry forward of losses helps in reducing the tax burden on traders, at a time when they are encountering heavy losses in the market
Trading in Futures and Options contracts are a preferred choice for most investors, owing to multiple significant benefits it offers. Besides hedging the risks of losses arising from a sudden and unprecedented decline in prices of commodities and securities, trading in futures and options also keeps the traders and speculators informed and updated about the pattern of fluctuations in pricing of the traded commodities and securities, so that they can eventually earn maximum profits from the sale of Futures and Options contracts. While trading in Options provides the option to bail out at a later stage to both buyers and sellers, if they face any loss as a result of the trade, such an option is not available for the traders of Futures contracts, which indicates that the risks and liabilities of the sellers and buyers of futures contracts are equally balanced.