Dabbled in F&Os? Making these tax filing mistakes can cost you dearly

Retail participation in the derivatives market exploded during the covid-19 pandemic. According to a report by the Securities and Exchange Board of India (Sebi), the number of individual traders in futures & options (F&O) soared by about 540% from FY19 to FY22.

More than 4.5 million people traded in equity F&Os in FY22, and they need to mandatorily file their income tax return (ITR) in the current assessment year, irrespective of whether they are individuals with total taxable income below the ₹2.5 lakh exemption limit or are salaried individuals.

There’s a misconception that F&O trades have to be reported only when profits are made and not otherwise. But, these trades are not captured in the Annual Information Statement (AIS) and so some taxpayers believe it need not be reported in the ITR.

“They think there’s no income to show so it doesn’t have to be reported. Some even avoid filing it as they don’t want to spend on a CA (chartered accountant) after having lost money already. Not reporting F&O trade will definitely get you a notice from the IT department. The government doesn’t know whether you have made gains or losses, it just knows that you have made several high-value transactions and not disclosed them in your ITR,” said Karan Batra, founder, Charteredclub.com. It may be noted that 89% F&O traders made losses in FY22, as per the Sebi report.

Trading in F&O is treated as business, which means even salaried individuals who dabbled in the derivatives market have to file tax returns in the more complicated ITR-3 or ITR-4, in place of ITR-1 and 2 applicable to them.

Audit or not?

Taxpayers who have F&O trades to report are mandated to get a tax audit done by a CA under any of the following two conditions: turnover is over ₹10 crore or they opted out of presumptive taxation within five years of opting in. “The ₹10 crore limit is applicable only when at least 95% of the total payments towards trades is made through digital payment methods. If the cash payments exceed 5%, an audit has to be done for turnovers above ₹2 crore,” said Prakash Hedge, a Bangalore-based CA.

Turnover in the case of F&O is not absolute profit made on all trades done in a year. It is calculated by adding both the profit and loss. Until last year, for options contracts, sale amount (premium received on sale) was also included along with profits and losses to calculate the turnover. The Institute of Chartered Accountants of India (ICAI) removed this saying that sale amount is not to be added if it has already been considered to calculate net profit. Essentially, for options trades that are squared off, sale amount is not included in turnover calculation, but where the trades are settled physically, the sale amount will be included in the turnover calculation.

This will provide major relief to most individual retail traders as including sales amount in turnover calculation would easily push it over the ₹10 crore threshold of mandatory audit.

For many, this may also lift the mandatory condition to maintain books of account which kicks in after the turnover exceeds ₹25 lakh (in any three preceding years). However, it is not binding to get the books made by a CA, unlike audit. “The P&L statements that brokers give would suffice,” said Batra.

ITR form has been tweaked this year that requires taxpayers to separately report intra-day trading and delivery-based trading. Nitesh Buddhadev, founder, Nimit Consultancy said this year, turnover and profit/loss from trading have to be separately reported. “The IT department wants to identify how much of the total business income is from trading, hence these have been added as two separate line items,” he said.