Big relief for option writers - change in tax audit criteria
We've written about the problems associated with loss from F&O and tax audit before. The ICAI has gone and given a small relief to F&O traders.
Option premium for option writers is no longer included in turnover. Read on to understand the implications.
What's the big change?
Traditionally, the option premium on sale of options was included for "Turnover" calculation for income tax purposes. This meant that F&O turnover often showed a ridiculously high amount (and we were forced to explain this to unsuspecting traders).
Now, life is easier - option premium is no longer considered for calculating turnover.
Here's how turnover for F&O purposes will be calculated:
The total of positive and negative or favorable and unfavorable differences
Reverse trade difference
Premium received on sale of options - only in case of physical settlement (accordingly, not applicable to F&O trades on the stock market).
Direct Impact on Tax Audit
Year after year, unsuspecting F&O traders were forced to get a tax audit if their turnover exceeded INR 10 crore.
While this limit of INR 10 crore remains unchanged, F&O traders might not need a tax audit now that premium on sale of options is not included.
Considering that only positive and negative differences will be considered (in most cases), turnover from F&O transactions will be significantly lower. This means no tax audit.
Don't forget the implications under 44AD though. That might still result in a tax audit. Read our article on loss from F&O to know more.
What is Section 44AD?
Section 44AD is the presumptive taxation scheme for businesses.
A resident individual or partnership firm can opt for the presumptive taxation scheme on business income. They can declare 6% (or 8%) of their total receipts as Income from business.
Why does Section 44AD affect F&O transactions?
First up, it's important to note that futures and options (F&O) transactions are treated as business income under the Income tax act.
Now, this is where it becomes dicey. If your actual profit is less than 6% of turnover, there's no way to show lower than 6% as profit without getting a tax audit done. This is because of the language of Section 44AD:
(4) Where an eligible assessee declares profit for any previous year in accordance with the provisions of this section and he declares profit for any of the five assessment years relevant to the previous year succeeding such previous year not in accordance with the provisions of sub-section (1), he shall not be eligible to claim the benefit of the provisions of this section for five assessment years subsequent to the assessment year relevant to the previous year in which the profit has not been declared in accordance with the provisions of sub-section (1).
(5) Notwithstanding anything contained in the foregoing provisions of this section, an eligible assessee to whom the provisions of sub-section (4) are applicable and whose total income exceeds the maximum amount which is not chargeable to income-tax, shall be required to keep and maintain such books of account and other documents as required under sub-section (2) of section 44AA and get them audited and furnish a report of such audit as required under section 44AB.
We know you didn't even bother reading the above sections. Don't worry - we're here to explain.
If your turnover from F&O transactions is less than INR 2 crore, you fall under Section 44AD
If your actual profit is less than 6% of turnover (or you have made a loss), you would obviously not want to show excess income in your ITR
If you don't show 6% of turnover as profit, you are an "eligible assessee" who has not declared profits from business in accordance with Section 44AD.
Considering the above, you will need to get a tax audit done.
How does the change affect Section 44AD?
If you made an F&O loss, nothing changes. You still need a tax audit.
If you made a (small) profit, you might be in luck. Due to the earlier regulations, turnover would often be a ridiculously high amount. 6% of this amount was often much higher than the profit you made. To show your actual profits, you would often need a tax audit to ensure you didn't pay too much tax.
Let's see how this plays out with an example:
Mr Future made F&O trades in FY 2022-23 as under:
Positive and negative differences - INR 1 Lakh
Option writing premium - INR 1 crore
Reverse Trades - INR 0
Actual Profit - INR 60,000
Under the original regulations: Turnover = INR 1.1 crore
Profit under 44AD = INR 6.6 lakh
Actual Profit = INR 60,000
You need a tax audit to show your actual profit
Under revised regulations:
Turnover = INR 1 lakh
Profit under 44AD = INR 6,000
Actual Profit = INR 60,000
No more Tax Audit
Need help sorting out your F&O transactions and figuring out if you need a Tax audit? Contact us! Our team will be happy to help.