Long-term investing is very different from short-term trading. New entrants into the options market may assume that the gains from their trades may be taxed as short-term capital gains. However, this is a common misconception. Options trading taxation is fairly different from capital gains tax, as you'll learn in this article. Furthermore, you will also find out if tax audit is applicable to options traders and discover the rules related to filing income tax returns after paying your options trading tax.
Classification of Options Trading Income
With the Income Tax Return (ITR) filing due date fast approaching, it is important to understand how options trading tax works. Options trading income is classified as non-speculative business income under the Income Tax Act, 1961.
This is different from speculative income, which includes any earnings from transactions that do not involve taking delivery of stocks or financial securities. For example, gains from intraday trading in the equity segment are classified as speculative income because traders do not take delivery of the shares they purchase. However, options trading is tagged as a non-speculative segment because of the assumption that participants use options to hedge their positions instead of carrying out speculative trading.
Additionally, since the earnings from options trading are considered to be business income, there is no fixed rate of options trading tax. Instead, the net earnings are added to your total income and taxed as per the income tax slab rate applicable.
Calculating Options Trading Turnover
Generally, the term turnover refers to the income earned from the sale of goods or services. When you apply that to the concept of options trading, you may expect that the turnover here will be the gains earned. However, that is not the case. Options trading turnover is calculated using the following formula.
F&O Trading Turnover = Absolute Profit
Here, the absolute profit includes both profits and losses. The positive or negative nature of the trading outcomes is not considered. Let us discuss an example to clarify this further. Say you carried out the following trades in the options market in FY24:
- Trade 1: A loss of Rs. 50,000
- Trade 2: A profit of Rs. 1,10,000
- Trade 3: A profit of Rs. 20,000
- Trade 4: A loss of Rs. 90,000
- Trade 5: A profit of Rs. 50,000
A common misconception may cause many traders to think that only the profits from these trades - amounting to Rs. 1,80,000 - will be subject to options trading tax. However, the absolute values of all the above outcomes will be added and considered as the turnover for options trading.
This will give you a total turnover value of Rs. 3,20,000.
Claiming Expenses as a Tax Deduction
One of the advantages of reporting business income is that assesses can claim any business expenses incurred as a deduction from the turnover, thereby reducing the overall tax liability. Since you will also report the absolute profit from your options trades as business income, you will be eligible for this benefit.
The common expenses that you can claim as business-related outlays at the time of filing your tax return include the following:
- Brokerage fees
- Electricity and internet charges
- Interest paid on loan availed for trading purposes
- Fees paid to financial advisors
- Professional fees paid to tax consultants
Choosing Presumptive Taxation Under Section 44AD
Assessees who declare business income during any given financial year are eligible to choose the presumptive tax scheme u/s 44AD. The key provisions of this scheme include the following:
- As per section 44AD(1), any assessee with a total turnover not exceeding Rs. 2 crore can choose this tax scheme and declare their taxable business income at 6% of the total turnover (since trading falls under the category of digital receipts).
- As per section 44AD(4), if you choose the presumptive tax scheme u/s 44AD(1), you need to continue opting for this method for five consecutive years. If you declare income lower than the presumptive income level, you will be subject to a tax audit.
Applicability of Tax Audit of Options Trading Income
Another aspect of reporting business income is the requirement of tax audit in certain cases. How do you find out if your options trading income will be subject to a tax audit under section 44AB? The following pointers can offer some clarity on this issue:
- Options Trading Turnover Exceeding Rs. 10 crore
Tax audit is mandatory for such traders as per section 44AB(a) irrespective of the actual profits or losses.
- Options Trading Turnover Between Rs. 2 crore and Rs. 10 crore
Since over 95% of the transactions are carried out digitally, a tax audit is not required for options traders with a turnover between Rs. 2 crore and Rs. 10 crore.
- Options Trading Turnover up to Rs. 2 crore
If you opt for presumptive taxation, a tax audit is not required. However, as per section 44AD(4), if you declare income less than 6% of your turnover or if you opt out of presumptive taxation within 5 years, a tax audit will be applicable.
Set Off and Carry Forward of Options Trading Losses
While you cannot deduct your options trading losses from the turnover, they can be adjusted against other heads of income like rental income, capital gains and income from other sources. That said, options trading losses cannot be set off against salary income.
If you have excess options trading losses even after setting them off against your income in the current financial year, you can carry them forward for up to 8 years. In these years, the losses can only be set off against eligible non-speculative income.
Income Tax Return Filing for Options Traders
To enjoy the benefits of setting off and carrying forward losses, you must file the right ITR within the due date applicable. Since you will be reporting business income, you need to file ITR-3 (or ITR-4 if you opt for presumptive taxation).
The due date for tax return filing is July 31 of the relevant assessment year if a tax audit is not required (or October 31 if a tax audit is required).
The Importance of Options Trading Strategies in Managing Your Options Trading Tax Liability
Your choice of options strategies can indirectly help you manage your options trading tax burden. This is because options trading turnover accounts for the absolute value of the outcomes of your trades. So, whether you incur losses or earn profits, both values will be included in the turnover. By choosing winning strategies, you can improve the probability of earning profits, thereby also increasing the chances of higher post-tax gains.
To become a more successful options trader, you can use the options strategy builder available in the Samco trading app. This inbuilt tool helps you find the top options trading strategies for different market scenarios - like bullish, bearish, neutral or volatile markets. Furthermore, you can also analyse each strategy before implementing it, thereby leading to potentially better trading outcomes.
Conclusion
This sums up the fundamentals of options trading tax and the regulations around calculating the turnover, carrying trading losses forward and filing income tax returns. If you engage in large volumes of options trading, you need to maintain a comprehensive record of your trades, so it is easy to compute your tax each year.
You can simply view or download the statement from the online platform offered by your preferred stock broker. Advanced platforms like the Samco trading app can help you with this. Additionally, you can also consider maintaining your own records to cross-check your trades and have a fair idea of the taxes you will need to pay, so you can start your tax planning exercise in advance.
In addition to bringing your options trading records to your fingertips, the Samco trading app offers a wide range of other benefits. You can rely on Options B.R.O, the options strategy builder from Samco Securities, to build, research and optimise your options trading strategies and maximise your profits. This is extremely important in the context of paying options trading tax, which is levied on the absolute turnover - which includes your profits and losses. So, the higher and more frequent your profits are, the less the net effect of the taxes will be.
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