Derivative trading involving futures and options, future and options on stocks, commodities, currencies has become quite popular among investors these days. Futures and Options trading can be quite a complex financial instrument to trade in,and many investors are unaware regarding the process involved and how to report futures and options trading in their Individual Income Tax Returns.
What are Derivatives?
Derivatives are financial securities whose value relies on or is derived from its underlying asset or a group of assets. By itself, a derivative is a contract between parties whose price is determined by the changes in the price or value of the underlying asset. Some of the commonly known underlying assets are stocks, shares, bonds, currency, commodities, market index, interest rates etc.
Transaction and trading of derivatives can be done either over the counter or on exchanges. OTC or Over the Counter derivative comprises of the large proportion of derivative instruments in circulation. While derivatives traded over exchanges can be highly regulated and standardised, derivatives traded Over the Counter carry greater risk compared to standardised derivatives.
What are Futures and Options?
A future is an obligation and a right for buying and selling an underlying asset at a fixed price which is deliverable at the fixed time. Whereas options are a right to buy or sell an underlying asset without the obligation. The right to buy is referred to as a call option whereas the right to sell is referred to as a put option.
Steps to Report Futures and Options Trading in ITR
1. Reporting Profits and Losses from Future and Options Trading
Taxpayers are required to report the incomes and losses from trading in futures and options, especially if an individual is salaried. In the event of non-reporting on income and earning from future and options trading, the individual is liable to receive notices from the Income Tax Department towards non-compliance and can be fined and required to pay taxes on undeclared income along with interest and penalty
2. Reporting Future and Options Trading as Business
Investors can report income and losses from trading in futures and options as business income unless the individual has incurred only a few trades during the fiscal year. This rule is applicable only for individuals,and one does not need to form a separate legal entity towards conducting futures and options trading as the Income Tax allows individuals to have business income as well. By reporting futures and options trading as a business, individuals can avail claim expenses as well.
3. Expenses Allowed to be claimed
One of the advantages of declaring income earned from futures and options trading is that individuals are also allowed to claim expenses incurred to conduct or participate in futures and options trading. In case claiming business expenses is resulting in a business loss in the ITR reporting, it is acceptable. Taxpayers can claim only those expenses which have been exclusively and directly incurred for conducting the business, i.e. trading in futures and options. These expenses include brokerage and commission of the broker, subscription to journals and literature related to trading, telephone and internet expenses, consultancy charges if any, in case professional services or advise has being availed towards helping in futures and exchange trading. While claiming these expenses, it is essential to maintain all bills, invoices and receipts of these expenses. Also, as per the Income Tax Act, none of these expenses over Rs 10000 can be paid in cash,and all expenses have to be paid using cheques are transferred from banks such as IMPS, NEFT, RTGS etc. In an event when a certain expense has been incurred for both personal and business use, it can be proportionately claimed in the ITR.
4. Mixed Investment Portfolio
Often, many investors can have a mixed bag of investment portfolio which include shares and stocks, currency, futures and options etc. Further, these investments and transactions can be short-term, long-term or intra-day in nature. These investments need to be separated and segregated to file tax returns. Income and losses from different forms of investments need to be calculated and computed separately and not merged together. Investors need to choose wisely and stick to a principle of the financial report for the long term. Hence, an individual can have several forms of business incomes within the same fiscal year.
5. Maintaining Records
When an individual claims business incomes and business expenses in their ITR, it becomes essential for them to maintain records of these transactions leading to business incomes and expenses. These records include bank statements, trading statements, invoices and receipts of expenses, etc. These are sufficient for preparing a profit and loss account towards determining the business income to be reported in the income tax returns.
6. Tax benefits on losses due to Futures and Options Transactions
One of the biggest advantages of reporting futures and options trading in the Income Tax Returns is the benefit of claiming business losses. Business losses can be adjusted against the income earned from other heads which include income from interest and rental. Further, all unadjusted losses can be carried forward for eight financial years, which can be adjusted against any future business gains.