This post is part of our series on Taxation for Investors in India by Sandeep Koonaparaju. Sandeep is a practicing Chartered Accountant based out of Bangalore.
three frequently asked questions by F&O Traders
- How is the turnover of the F&O business calculated?
- When should I get my books audited?
- Is audit mandatory if I declare income or loss below the estimated rate?
In this post, we try to answer these questions in plain English, avoiding technical jargon as much as possible.
So let’s start with the first question, How is turnover calculated?
Most F&O traders already know the answer and if you are one of them you can skip this part.
The method of calculation of turnover is different for futures and options. Let us understand them separately.
Promise: Turnover for trading in futures is calculated by adding the absolute value of the profit or loss made from each trade. Absolute value is the value of profit or loss that ignores signage (where negative indicates loss). The table below explains it.
the option: Moving on to the options. We need to add the premium received on the sale of options to the absolute value of profit/loss. To understand this let us look at the table given below.
As you can see in the first trade, the premium received (9,00,000) is added to the absolute value of the loss (1,00,000) to arrive at the turnover.
When is an audit required?
For ease of understanding, let us separate audit terms into turnover based and non-turnover based situations.
Turnover Based Conditions
The general rule is that businesses whose turnover is more than 1 crore require an audit.
There are exceptions to this rule:
- If the cash receipts and payments do not exceed 5% of the total receipts and payments respectively, the limit is raised to 10 crores
- 2 crore for taxpayers declaring income under presumptive taxation under 44AD (8% / 6%) (discussed in detail later in the article)
Non-Turnover Based Terms
- a person “engaged inspecified profession” Declaring profit less than 50% of the turnover.
- Person engaged in business who has opted for Estimated Taxation (8%/6%) in any of the last 5 years but has not opted for it in the current year.
- some other “specified business” Not declaring minimum profit under presumptive taxation (F&O trading does not fit into this category)
Presumptive Taxation and Audit
While there are several sections in the Income Tax Act that refer to presumptive taxation, the present discussion is limited to presumptive taxation under section 44AD (applicable to most businesses including F&O trading).
44AD provides an option to small businesses to declare income at a predetermined percentage of turnover (8%/6% for non-cash/cash turnover respectively) provided the turnover does not exceed Rs 2 crore. As an F&O trader, if your turnover does not exceed Rs 2 crore, you can choose to declare income at the estimated rate. Here is a word of caution, if you have opted for presumptive taxation in a particular year, and wish to declare loss or income at less than the estimated rate in the next five years:
- You cannot opt for presumptive taxation for five years subsequent to the year in which you declared such loss or reduced income and
- If your total income exceeds the basic exemption limit, the audit will be mandatory for that year.
A question that is commonly asked is, is audit applicable if you declare loss or profit at less than the estimated rate even if the turnover is within the prescribed limit of 1 crore or 10 crore?
Till the year 2016, Section 44AD had a clause which required the taxpayer to maintain the books and get them audited if he declared income less than the estimated rate or declared loss. This section was replaced with a new section in the Finance Act 2016. The audit under the new clause is required only if the taxpayer has declared income at the estimated rate in any of the previous five years, but wishes to declare loss or income at less than the estimated rate in the current year, provided the current year his total income exceeds the basic exemption limit.
Is this getting too complicated? Let me explain this through some examples:
Mr X started trading in F&O for the first time during FY 2020-21. The turnover during the year is 75 lakhs and he has made a loss of 2 lakhs.
Audit is not required in such cases as the turnover is within the specified limits.
Mr X started trading in F&O for the first time during FY 2020-21. Turnover during the year stood at 4 crores and made a loss of 20 lakhs.
If the 5% condition relating to the cash transaction specified above is met, the audit is not required.
Mr X started trading in F&O for the first time during FY 2020-21. The turnover during the year is 12 crores and he made a profit of 10 lakhs.
Audit is required as the turnover is more than the permissible limit of 10 crores.
Mr. X started trading in F&O for the first time during FY 2019-20 and declared profit at an estimated rate of 8% / 6% (for F&O traders it is usually 6%). The turnover from F&O trading during the year 2020-21 was 10 lakhs and he had a loss of 2 lakhs and Mr. X did not have any other income during the year.
Mr. X wants to declare and claim damages of 2 lakhs. This would have the following implications:
- Audit is not applicable as his total income for the year does not exceed the basic exemption limit.
- He cannot declare profit at the projected rates for 5 more years, i.e. till 2025-26.
Same fact as mentioned in Example 4 except that Mr. X has an income of 10 lakhs during the year.
The implications are:
- Audit is applicable as his total income for the year is more than the basic exemption limit.
- He cannot declare profit at projected rates for 5 more years, i.e. till 2025-26
And all. As an F&O trader, keep these things in mind, and you’ll be well into the tax-filing season.
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