Module 7   Markets and TaxationChapter 3

Classifying Your Market Activity

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3.1 – Are you a trader or investor or both?

Identifying yourself as a trader or an investor is the first step to file your income tax returns.

This may seem like an easy task, but here is what this circular from CBDT (Central board of direct taxes) says:
“If you buy shares with the intent of earning income through dividends you are an investor, and if you buy and sell shares with the intent to profit, you are a trader”:).

Yes, that is how vague it is, and this is a circular dated 2007, released after 18 years of the original circular. Numerous judicial pronouncements and government were still unable to clear this highly debatable issue. Thanks to the vagueness of this circular, it has given too much power in the hands of the assessing Income tax officer (AO) especially considering the fact that most of the stock purchases are done intending to profit from the price appreciation.

Updated 2nd March 2016

Finally the income tax department has brought in clarity in classifying yourself as a trader or an investor (equity delivery trades) through this CBDT circular.

It now says that an individual can decide on his own to either show his stock investments as capital gains or as a business income (trading) irrespective of the period of holding the listed shares and securities. Whatever is the stance once taken, the taxpayer will have to continue with the same in the subsequent years.

So before filing income tax returns, you will have to first classify yourself as an investor, trader, or both.  We will in this chapter help you figure this out in line with what most AO’s would be expecting. By income, I mean both profits and losses.

When trading or investing you need to classify your income under one of these heads, broadly speaking they are –

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

Let us understand what each of these means.

Long term capital gain (LTCG)

Assume you buy stocks or Mutual Funds today for Rs.50,000/- and sell the same after 365 days at Rs.55,000/-, then the profit or gain of Rs.5,000/- is considered as Long term capital gain. Generally speaking, gain or profit earned by investing in stocks or equity mutual funds, and selling after 1 year from date of purchase can be categorized under LTCG. Currently, in India any gains realized and categorized as LTCG (equity & equity MF) is completely exempt from taxes for the first Rs 1lk and at 10% if LTCG for the year exceeds Rs 1lk (from FY 2018/19). Do note – the purchase and sale of shares have to be conducted via a recognized exchange.

Until FY 2017/18 – if you had bought Infosys shares worth Rs.1,00,000/- 10 years ago, and sold the same today for Rs 1 crore, you don’t have to pay any taxes on your gain or profit of Rs 99,00,000. So, taxes on long term capital gain of Rs 99,00,000 = 0 (Zero) or would have been exempt.

Going forward, LTCG exceeding Rs 1lk will be taxed at 10%. To ensure that this tax is applied only from the date of announcement of this tax (Union Budget, Feb 1st, 2018), a grandfather clause was introduced – for all stocks held before Feb 1st, the acquisition cost for the purpose of computing capital gains will be the higher of the actual purchase price or the maximum traded price on Jan. 31.

If the investment and the consequent sale were done via an off-market transaction,

  • Unlisted stocks – Tax on LTCG is 20% (for example purchase and sale of shares belonging to startup companies by Venture Capitalists)
  • Listed stocks – No tax on first Rs 1lk, Tax on LTCG at 10% exceeding Rs 1lk

Short term capital gain (STCG)

Assume you buy listed stocks or equity-oriented mutual funds today for Rs.50,000/- and sell the same within the period of 12 months, say at Rs.55,000/-, then the profit or gain of Rs.5,000/- is taxed as a Short term capital gain(STCG).

Generally speaking, gain or profit earned by investing in stocks or equity mutual funds holding for more than 1 day (also called delivery based) and selling them within 12 months from date of purchase can be categorized under STCG.

Currently, tax on STCG in India is flat 15% on the gain or profit from sale of shares or equity-oriented mutual funds.

Therefore, if you buy Infosys shares worth Rs 100,000/- today and sell the same 10 days later for Rs.120,000/-, then you are liable to pay 15% on Rs 20,000 (STCG) or Rs 3000/- as taxes.

So, tax on short term capital gain = flat 15% of the gain/profit (listed stocks).

Speculative Business income

As per section 43(5) of the Income Tax Act, 1961, profits earned by trading equity or stocks for intraday or non-delivery is categorized under speculative business income. Currency trading is also considered as speculative since there is no STT (unless you are using currency derivatives to hedge).

There is no fixed rate like capital gains tax rate when you have a business income. If you have a business income, it has to be added to the rest of your other income and tax has to be paid as per the tax slab you fall in.

For example, assume for the financial year my profit from trading intraday stocks was Rs. 100,000/-, and my salary for the year was Rs.400,000/-. So my total income for the year is Rs 5,00,000, and I have to pay taxes on this as per my tax slab, Rs 25000 in this case as shown below.

SL No. Slab Taxable Amount Tax Rate Tax Amount
1 0 to Rs.250,000 2,50,000 0% Nil
2 250,000 to 5,00,000 2,50,000 5% 12500
Total Tax applicable Rs. 12,500

So the point here is that one needs to club the speculative business income with other income sources and identify the taxable amount. Once this is done, the tax has to be paid based on the tax slab one belongs to.

Non – speculative Business income

Income from trading futures & options on recognized exchanges (equity, commodity) is categorized under non-speculative business income as per section 43(5) of the Income Tax Act, 1961.

As discussed earlier, business income has no fixed tax rate, you are required to add the non-speculative business income to all your other income, and pay taxes according to the slab applicable to you.

For example, assume a trader cum hotelier earns Rs, 500,000 by trading F&O. Besides this assume he also earns Rs.20,00,000/- from his hotel business. 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

SL No. Slab Taxable Amount Tax Rate Tax Amount
1 0 to Rs.250,000 2,50,000 0% Nil
2 250,000 to 500,000 2,50,000 5% 12500
3 500,000 to 1,000,000 5,00,000 20% 1,00,000
4 10,00,000 to 25,00,000 15,00,000 30% 4,50,000
Total Tax applicable Rs.562,500

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

You would be wondering why trading equity intraday is considered ‘speculative’ but trading F&O is considered ‘non-speculative’?

When trading intraday there is no intention of taking delivery, and hence it is considered a speculative business. F&O is defined as non-speculative by the government, maybe as they can be used for hedging and also for taking/giving delivery of the underlying contract (even though currently equity and currency derivatives in India are all cash-settled, but by definition, they give rise to giving/taking delivery. Certain commodity F&O contracts like gold have delivery options to it).

3.2 – Pros and cons of declaring trading as a business income

Let us look at the bright side first; here is a list of advantages of declaring trading as a business income

  1. Low tax – If the total income (trading + any other) is less than Rs.250,000/-, then there is no tax implication, and now even if less than Rs.500,000/- effectively one has to pay zero tax as you can avail a rebate if total income less than Rs 5lks.
  2. Claim expense – One can claim the benefit of all expenses incurred for the business of trading (while for capital gains only charges on your contract note other than STT can be claimed). For example, brokerage charges, STT, other statutory taxes while trading, internet, phone, newspapers, depreciation of computers and electronics, research reports, books, advisory, etc.
  3. Offset the loss with gains – If one incurs any non-speculative F&O trading loss, this can be set-off against any income other than salary. For example, if I incur Rs 5,00,000 loss in trading F&O and my other income (like rent & interest, excluding salary) is Rs 10,00,000, I will have to pay tax only on Rs 5,00,000.
  4. Carry forward the F&O loss – If there is net loss any year (non-speculative F&O + any income other than salary), and if income tax returns are filed before the due date, the loss can be carried forward for the next 8 years. During the next 8 years, this loss can be set-off against any other business gain (non-speculative business income). For example, if you had net loss of Rs 5,00,000 this year trading F&O which was declared on time, you can carry forward this loss next year and assuming you made a profit of Rs 20,00,000 next year, you can set off the previous year’s Rs 5,00,000 loss and pay taxes only on Rs 15,00,000.
  5. Carry forward your intraday equity loss – Any speculative or intraday equity trading loss can be set-off only against any other speculative gain (note: you cannot set-off intraday equity trading loss which is considered speculative with F&O trading which is considered non-speculative). Speculative losses can be carried forward for 4 years if the returns are filed on time. So assume an equity intraday trader makes a loss of Rs.100,000/- this year, he cannot offset this against any other business income. However, he can carry it forward to the next year (up to 4 years). Assume the next year he makes a profit of Rs.50,000/- by trading equity intraday, then, in that case, he can use the previous year’s Rs.100,000/- loss to offset the complete gains of this year (Rs.50,000). The balance loss of Rs.50,000/- can still be carried forward to the next 3 years. So do note, the partial offset of losses is possible.

The following table summarizes the above points –

Head of income under which Loss is incurred Whether loss can be set- off within the same year Whether Losses can be carried forward and set-off in subsequent years Time limit for carry forward and set-off of losses
Under the same head Under any other Head Under the same head Under any other Head
Losses of F&O as a Trader Yes Yes Yes No 8 years
Speculation Business Yes No Yes No 4 years
Capital Gain (Short-Term) Yes No Yes No 8 years

Now, here is a set of drawbacks for declaring your business income –

  1. Potentially high taxes – If you fall under the 30% tax slab, you will effectively pay 30% of all your trading profits as taxes
  1. ITR Forms – Declaring business income would mean having to use an ITR3 (ITR 4 until 2016) or ITR 4 (ITR 4S until 2016), which would mean needing help of a CA to file your IT returns. This can be an added effort and cost especially for those salaried people who might have been using the very easy ITR 1 or ITR 2 (we will discuss more on this topic in the chapter on ITR forms)
  1. Audit – Having to maintain the book of accounts which will need to be audited if your turnover goes above Rs 5 crore  (was Rs 2 crore until FY 19/20) for a year or if your profit is less than 6% of your turnover (we will discuss more on this topic in the chapter on Turnover)

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3.3 – What are you? Trader, Investor, or Both?

Coming back to our original discussion, according to 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.

As an investor, you can claim all your delivery based equity gains/profit to be capital gains. But as a trader, it becomes your business income which has its own pros and cons as discussed above.

The rule is very clear with respect to F&O trading, and intraday equity trading. F&O trading has to be considered as a non-speculative business, and intraday equity as speculative business. So if you trade these instruments, you have to use ITR 3 for filing IT returns. So even if you are salaried, you have to compulsorily use ITR3 and declare this income (profit or loss) from trading as a business.

Unlike what most people think, losses also are recommended to be declared. Hiding trading activity on the exchange from the IT department could mean trouble, especially in case of any IT scrutiny (IT scrutiny is when the assessing income tax officer (AO) demands you to meet him and give an explanation on your IT returns). The chances of getting a call for scrutiny are higher when the IT department systems/algorithms pick up trading activity on your PAN, but the same not declared on your ITR.

For equity delivery based investments, if you are holding stocks for more than a year, you would have received some kind of dividend and even if you didn’t, you can show them all as investments and claim an exemption under the long term capital gain. If you are buying and selling stocks frequently (yes it is an open statement, but there is no rule which quantifies ‘frequent’) for shorter terms, it is best to declare that as non-speculative business income instead of STCG.

Another thing to keep in mind is that if investing/trading on the markets is your only source of income, and even if your trading activity 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 is slightly higher.

Thankfully one thing that the circular clarified was that you can be a trader and investor both at the same time. So you can have stocks meant as an investment for the long term, and stocks meant for shorter-term trades. Just because you indulge in a lot of shorter-term trades, wouldn’t necessarily convert all your long term holdings or investments into trades and therefore bring those long term gains under business income. But it is important to clearly demarcate your trading and investment portfolio while filing returns.

Similarly, if you are trading F&O or intraday equity trading, you compulsorily have to classify yourself as a trader, but you can still show your long term investments under the capital gains head to get the benefit of LTCG being exempt from taxes.

So, you can be an investor, trader, or both, but make sure to keep the above points in mind, and do consult a chartered accountant before filing returns.

Even though this might seem confusing, rules are made for 1% of the population that is trying to break them. As long as your intent is right, you know the basic concerns of the IT department and keep those in mind while filing IT returns, it is quite simple. But stay consistent with the way you classify yourself, don’t keep switching between being an investor or trader to declare your equity short term trades.

If you follow these simple rules, let me assure you – there is no need to fear the taxman.

Before we wrap this chapter, here are some interesting links that you should read through.

CBDT circular on the distinction between trades and investments.

Business Standard – Is your return from stocks capital gains or business income?

Economic Times – Are you a stock trader or an investor?

Taxguru – Income from share trading – Business or capital gain?

Moneycontrol- Investor or trader: The argument continues

Economic Times – Budget 2014 clarifies that commodity trading on recognized exchanges is non-speculative

Economic times – New data mining tool may access PAN-based information of taxpayers, help check evasion


Key takeaways from this chapter

  1. Trading F&O (Equity, currency, commodity) is considered non-speculative business
  2. Trading intraday equity is considered speculative business
  3. Equity holdings for more than 1 year are considered Long term capital gain (LTCG)
  4. Equity holdings between 1 day to 1 year with a low frequency of trades is considered Short term capital gain (STCG), else in case of a high frequency of trades it should be considered as non-speculative business income

 

Disclaimer – Do consult a chartered accountant (CA) before filing your returns. The content above is in the context of taxation for retail individual investors/traders only.

516 comments

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  1. vishal patil says:

    Since my income was not taxable last year, I didn’t file returns. I’ll be filing returns first time this year. My question is Can I offsets gains in this year against the loss from last year, since I had not declared it last year?

    • Nithin Kamath says:

      Vishal, to carry forward loss it has to be filed within the due dates. So no, you cannot offset.

      • vishal patil says:

        Is it possible to file belated returns now.

        • Nithin Kamath says:

          Yes you can file belated returns which is advisable, but you can’t carry forward that loss.

          • Sri says:

            Hi Nithin,
            I have a similar question but bit different, I have filed the returns ontime with salary income details but have not disclosed trading losses for last 3-4 years, can I revise / rectify the returns now for those last 3-4 years and carry forward the losses to offset?

          • Nithin Kamath says:

            Sri, you can revise last two years, and since you have filed on time, so yeah you can declare the loss in the revised return and carry forward.

  2. Hi,first let me appreciate for detailed explanations provided in this article.i request you to put a snap shot of filled ITR forms for an investor,trader and both.i personally invest in delivery based equity and few i hold for more than a year and most i do positional trades plus investing in markets is my only source of income.Thanks in Advance.

  3. Kashmir singh says:

    my total income (salary+trading) profits less than 250000/ .it means I have no need to file tax return.

    • Nithin Kamath says:

      No need to file, but it is best you do. Will help you in the future to have income tax returns when applying for loans or any kind of credit.

      • Tapabrata says:

        sir, I have the same question and got answer on your reply. I have a very little knowledge about taxation…thats why I want to know if I dont need to file ITR, then what do you want to say by “best you do”??

        • Nithin Kamath says:

          The issue is, income tax department gets access from exchanges on all trades done. They have softwares that pickup people who have traded but not declared it on the ITR. They don’t get to know if any tax was evaded or not. So there is a chance of getting notice, asking why you haven’t declared.

  4. Vivek says:

    Thanks Nithin, Wonderful article.
    Would you help me in understanding if I can put Short term Equity-Delivery gains under the Capital gains head and Intraday+FnO under Business income while filing ITR4. Many Thanks.

    • Nithin Kamath says:

      Yep, that is the right way Vivek. Intraday equity trading has to be under speculative business income and F&O as a normal business income, but yes both under business income.

      • Hitesh says:

        This means Vivek has to declare himself as both trader as well as investor? or Just declaring trader will do ?

        • Nithin Kamath says:

          As soon as you do this – use ITR3 to show F&O trading as business and equity investing as capital gains, you are declaring as if you are both trader and investor.

  5. James says:

    Hi Nithin,

    A Great initiative and an excellent tutorial. Thanks a ton for this. I love Pi by the way and I am much profitable trading options for this financial year with Pi.

    I have a question on carry forward loss.

    I am a NRI and I had filed my returns before to carry forward my F&O trading loss. The Income sources I have that are taxable are:
    1. Rental income from a flat and a shop (approx. Rs. 175,000 PA)
    2. Dividend from shares (Approx Rs. 12,500 PA)
    3. Short term F&O Trading Loss of Approx Rs. -211,000
    4. Interest on Fixed Deposits sitting in my NRE Account (Exempt from tax)

    My question is, what will be the carry forward loss in the above case? Will it be the net of 1, 2 and 3 above whice is Rs. 23,500 OR will it be the full amount of Rs. 211,000?

    Thanks so much for your time.

    • Nithin Kamath says:

      James,

      Dividend from shares is anyways exempt from taxes.

      But yes, you can netoff your rental and interest income with trading loss. So your carry forward loss would be -2.11 + 1.75 + interest on deposits

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