Taxation on Derivative

For Foreign Portfolio Investors (FPIs), gains from derivatives trading are indeed taxed as capital gains, specifically under Section 115AD of the Income-tax Act. Here's a quick clarification:

Tax Treatment of Derivative Gains for FPIs:

• Capital Gains Classification: Derivative gains are generally treated as short-term capital gains (STCG) for FPIs, regardless of the holding period, because derivatives are usually settled in cash and not held for long periods.

• Tax Rate: Under Section 115AD, STCG from derivatives trading is taxed at a flat rate of 30% for FPIs (irrespective of whether the FPI is a resident or non-resident entity).

• Withholding Tax: There may also be withholding tax on the income earned by FPIs, but it can be reduced or eliminated depending on the Double Taxation Avoidance Agreement (DTAA) between India and the FPI's home country.

In derivatives trading, turnover is calculated differently from regular equity trading due to the nature of derivatives contracts. Here's how turnover is generally calculated:

1. For Futures Contracts:

• Turnover for futures contracts is the total value of the contracts traded, which includes both buy and sell transactions.
• The formula is:
• Turnover = Number of Contracts × Price per Contract × Lot Size
  • Number of Contracts: The total number of contracts traded.
  • Price per Contract: The price at which each contract is traded.
  • Lot Size: The quantity of the underlying asset per contract (which varies for different contracts).

2. For Options Contracts:

• Turnover for options is calculated based on the premium paid or received for the options contracts, not the strike price or market value of the underlying asset.
• The formula is:
• Turnover = Number of Contracts × Premium per Option × Lot Size
  • Number of Contracts: The total number of option contracts traded.
  • Premium per Option: The price at which the option is bought or sold.
  • Lot Size: The number of underlying assets per option contract.

Yes, a tax audit may be required for individuals or entities involved in derivative trading, depending on the turnover and the nature of the income. Here's how it works:

Tax Audit Requirement for Derivative Trading

1. 1. For Individuals (Non-Business):

      • If derivatives trading is done as part of speculative income (such as intraday trading or futures and options), the income is treated as business income.
      • Tax Audit Requirement: If the total turnover from the business of trading exceeds ₹1 crore (for individuals, HUFs, or firms), a tax audit is required under Section 44AB of the Income Tax Act.
      • However, if the turnover is below ₹1 crore, a tax audit may not be required, but the individual is still required to file income tax returns.

   2. For Businesses:

      • For businesses engaged in derivatives trading, if the turnover exceeds ₹1 crore (or ₹10 crore if 95% of the receipts are through digital modes), a tax audit is mandatory under Section 44AB.
      • This applies to businesses dealing in derivatives as part of their normal operations, and such businesses must maintain books of accounts and undergo a tax audit.

   3. Presumptive Taxation Scheme (Section 44AD):

      • If you are trading in derivatives and your turnover is below ₹1 crore, you may opt for the presumptive taxation scheme under Section 44AD. This allows you to declare 8% of your turnover as income and does not require a tax audit, but you still need to maintain record

Derivative losses can be set off as follows:

• • Business losses (from active trading) can be set off against other business income.
  • Speculative losses (from intraday or futures trading) can only be set off against speculative income.
  • Losses can be carried forward for up to 8 years to offset future business or speculative income.

Yes, you can claim business expenses against derivative income if your derivative trading is treated as business income. Here’s how it works:

Claiming Business Expenses Against Derivative Income:

1. Business Income Classification:

   • If you are actively trading derivatives (such as in futures and options or intraday trading), the income is typically treated as business income under the head "Profits and Gains from Business or Profession (PGBP)".

2. Allowable Expenses:

   • As a business, you can deduct expenses incurred to earn that income. These expenses may include:
     • Brokerage fees and transaction costs for trading.
     • Interest on loans taken to fund your trading.
     • Office expenses, if applicable, such as rent, utilities, and office supplies.
     • Depreciation on computers, laptops, or other assets used for trading.
     • Professional fees for accountants or tax consultants.
     • Software and data subscription fees for trading platforms or market data.
     • Other incidental expenses related to your trading activity.

3. For Speculative Trading:

   • If the trading is classified as speculative income (e.g., intraday trading), you can still claim expenses, but they must be linked to the speculative business activity and not any other source of income.

4. Net Income Calculation:

   • Your net income will be calculated after deducting the allowable expenses from the derivative income. If your expenses exceed your income, you may have a loss that can be carried forward for up to 8 years to offset against future business income.

If you're actively trading derivatives, you need to maintain the following key records for tax purposes:

1. Trade Confirmation Slips: Keep copies of trade confirmations or contract notes from your broker for each trade.
2. Transaction Statements: Monthly or quarterly statements showing all trades and balances.
3. Bank Statements: Statements to verify fund transfers to/from your trading account.
4. Contract Notes for Options: Keep records of each option trade, including premiums received or paid.
5. Brokerage Fees: Invoices for brokerage fees and other charges like exchange fees or GST.
6. Profit and Loss Statements: Statements to track your net profit or loss from derivative trading.
7. Margin Funding Records: Documentation for any loans or margin funding used for trading.
8. Income Tax Returns (ITR): Copies of past ITRs, especially for carrying forward losses.
9. TDS Certificates: Certificates for TDS deducted on your derivative income.
10. Loss Records: Keep track of speculative and non-speculative losses for future set-off.
11. GST Records: Documents for GST on trading-related services.
12. Subscription Details: Records of subscriptions for trading software or market data.

No, derivatives trading does not qualify for the presumptive taxation scheme under Section 44AD. This scheme is for businesses involved in trading goods or providing services.  Traders must maintain proper books and calculate income based on actual profits and expenses.