Taxation on Investors and Traders

Investor or Trader?

According to Central Board of Direct Taxes(CBDT):

• Investor: anyone who invests with the intention of earning through dividends
• Trader: anyone who buys and sells with the intention of profiting from the price rise.

Note

Income classification

When trading or investing income can be classified under these heads:

1. Long term capital gain (LTCG)
2. Short term capital gain (STCG)
3. Speculative business income
4. Non-speculative business income

So based on the type of income you are classified as a trader or an investor. It is important to note here that income means both profit and loss.

Tax Calculated under different heads

Example 1

Assume you buy stocks or Mutual Funds today for Rs.50,000 and sell the same after 365 days at Rs.55,000 .
Here, the profit or gain of Rs.5,000/- is considered asLong term capital gain. 
The tax amount will depend on the type of transaction

Example of non-listed off market transaction: Purchase and sale of shares belonging to startup companies by Venture Capitalists

Example 2

Assume you buy stocks or Mutual Funds today for Rs.50,000 and sell the same within the completion of 365 days, say at Rs.55,000
Here, the profit or gain of Rs 5000 is considered as Short term capital gain.

Example 3

Assume for the financial year profit from trading intraday stocks was Rs. 100,000, and income from other business was Rs. 400,000.
Here as the trading is Intraday so it will be considered as speculative business income. In such a condition, there is no fixed rate like capital gains tax rate. It has to be added to the rest of other income and tax has to be paid as per the tax slab you fall in.

Example 4

Assume a trader cum hotelier earns Rs, 500,000 by trading Futures & Options. Besides this assume he also earns Rs.20,00,000/- from his hotel business.
Here as the trading is being done in Futures & Options so it will be a Non-speculative business income. Therefore his total income for the year is Rs 25,00,000/- (Rs.500,000 + Rs.20,00,000) and therefore his tax obligation is as follows:

Effectively the business man here is paying 30% of his F&O profits as taxes.

Taxation for investors

A person buying and selling shares after taking delivery to the DEMAT account can be considered as an investor as long as his intention is to earn profit through dividends. If the frequency of transactions (buy/sells) is high(few times every week), it is best to consider them as trades and not investments.

If investing/trading on the markets is the only source of income, and even if the trading frequency is moderate, it is best to classify income from all your equity trades as a business income instead of capital gains.

On the other hand, if you are salaried or have some other business as your primary source of business, it becomes easier to show your equity trades as capital gains even if the frequency of trades is slightly higher.

Taxation for investors: Long Term Capital Gains

Tax on Stocks/equity

Tax on Equity oriented Mutual fund

For non-equity oriented/Debt Mutual Fund

Taxation for investors: Indexation

Indexation is done to eliminate the effect of taxation on LTCG in case of non-equity oriented mutual funds, property, gold, and others.

Indexation is a simple method to determine the true value from sale of an asset after considering the effect of inflation. This can be done with help of Cost inflation index (CII) which can be found on the income tax website.

Example
LTCG : Rs 2,00,000
Tax without indexation(@20%): Rs 40,000

Using cost inflation index from the income tax website 

CII in the year of purchase (2005): 497

CII in the year of sale (2015): 1024

Indexed purchase value = Purchase value * (CII for year of sale/ CII for year of purchase)

= Rs 100000 * (1024/497) = Rs 206036

Long term capital gain = Sale value – Indexed purchase value

= Rs 300,000 – Rs 206,036 = Rs 93,963

Therefore tax on LTCG(@20%) = Rs 18,792

Taxation for investors: Short term capital gain

For stocks/equity

If the transactions (buy/sells) are executed via off-market transfer (where shares are transferred from one person to another via delivery instruction booklet and not on the exchange) where STT is not paid, STCG will be taxable as per your applicable tax slab rate. 

For equity mutual funds

For non-equity oriented/Debt MF

Taxation for investors: Days of Holding

If the stocks are purchased multiple times during the holding period then the holding period will be determined using FIFO(First In First Out) method.

Example

Assume 100 were bought on 10th April 2014 shares at Rs.800 per share, and on June 1st 2014 another 100 shares were bought at Rs.820 per share.

A year later, on May 1st 2015, 150 shares were sold at 920.

Following FIFO guidelines, 100 shares bought on 10th April 2014 and 50 shares from the 100 bought on June 1st 2014 should be considered as being sold.

Hence, for shares bought on 10th April 2014 gains = Rs 120 (920-800) x 100 = Rs 12,000/- (LTCG and hence 0 tax).

For shares bought on May 1st, Gain = Rs 100 (900-800) x 50 = Rs 5,000/- (STCG and hence 15% tax).

Taxation for investors: Securities Transaction Tax

STT (Securities Transaction Tax) is a tax payable to the government of India on trades executed on recognized stock exchanges. The tax is not applicable on off-market transactions which is when shares are transferred from one DEMAT to another through delivery instruction slips instead of routing the trades via exchange. But off market transactions attracts higher capital gains tax as explained previously. Current rate of STT for equity delivery based trades is 0.1% of the trade value.

When calculating taxes on capital gains, STT can’t be added to the cost of acquisition or sale of shares/stocks/equity. Whereas brokerage and all other charges (which includes exchange charges, SEBI charges, stamp duty, service tax) that you pay when buying/selling shares on the exchange can be added to the cost of share, hence indirectly taking benefit of these expenses that you incur.

Taxation for investors: Advance Tax

Every tax payer with business income or with realized (profit booked) short term capital gains is required to pay advance tax on 15thSept, 15th December, and 15th March. Advance tax is paid keeping in mind an approximate income and taxes that you would have to pay on your business and capital gain income by the end of the year. You as an individual are required to pay 30% of the expected annual tax that you are likely to pay for that financial year by 15th Sept, 60% by 15th Dec, and 100% by 15th March. Not paying would entail a penalty of annualized interest of around 12% for the period by which it was delayed.

Even if you eventually end up making a profit for the entire year which is lesser than for what you had paid advance tax, you can claim for a tax refund.

Taxation for investors: Short and long term capital losses

Short term capital losses if filed within time can be carried forward for 8 consecutive years, and set off against any gains made in those years.

Example

Loss for the previous year was Rs 2,00,000 then this can be carried forward and if gain for this year is Rs 1,00,00 then still no tax needs to be paid and it can be settled for previous loss. Remaining loss of Rs 1,00,000 can be settled against the gain for next 7 years.

Taxation for Traders

Income from trading can be described as business income which can be

• Speculative business income
• Non speculative business income

Income from shorter term equity delivery based trades (held for between 1 day to 1 year) are also best to be considered as non-speculative business income if frequency of such trades executed by you is high or if investing/trading in the markets is your main source of income.

Taxation on business income

There is no fixed rate for tax on business income. Income from all the sources are added and tax is levied according to the slab rate.

Example

Total Business income = Rs 12,00,000
Total capital gains = Rs 1,00,000
 

Tax on Business income:

Tax on SCTG(@15%) =  Rs.15,000

Carry forward business loss

Speculative losses can be carried forward for 4 years, and can be set-off only against any speculative gains you make in that period.

Non-speculative losses can be set-off against any other business income except salary income the same year. Non-speculative losses can be carried forwarded to the next 8 years.

Speculative (Intraday equity) loss can’t be offset with non-speculative (F&O) gains, but speculative gains can be offset with non-speculative losses.

Example

Total income = Rs 5,00,000 + Rs 1,00,000 = Rs 6,00,000

Therefore Rs 45,000 will be paid as tax and speculative income loss will be carried forwarded as it can be settled against speculative gains only.

Business expenses when trading

Following are some of the expenses that can be shown as a cost when trading

• All charges when trading (STT, Brokerage, Exchange charges, and all other taxes). I hope you remember that STT can’t be shown as a cost when declaring income as capital gains, but it can be in case of business income.
• Internet/phone bills if used for trading (portion proportionate to your usage on the bill)
• Depreciation of computer/other electronics (used for trading)
• Rental income (if the place used for trading, if a room used – portion of your rent)
• Salary paid to anyone helping you trade
• Advisory fees, cost of books, newspapers, subscriptions and more…