Which ITR form should you use to report F&O income?
To be sure, tax authorities treat earnings from F&O as business income, be it gains or losses. So, under which section of the Income-Tax Act should traders file this income? A lot of F&O traders declare F&O income under section 44AD of presumptive taxation scheme. Income tax return (ITR) form 4, or ITR-4, is applicable in this case. However, some chartered accountants are of the view that F&O income does not fall under presumptive taxation scheme. Traders should rather file ITR-3 and pay taxes on the same as per their slab rates. ITR-3 also allows you to declare short-term and long-term capital gains from the cash segment. ITR-2 is filed in case of only capital gains and no F&O income.
Presumptive taxation
The presumptive taxation scheme under sections 44AD, 44ADA and 44AE of Income Tax Act, 1961, gives relief to small taxpayers from maintaining accounting books and doing audits. Section 44ADA is for specified professions such as legal, medical and accountancy, etc. Section 44AE is for those into transportation business.
Any other business with a turnover of less than ₹2 crore can take advantage of the presumptive taxation scheme and declare profits or losses under section 44AD. Owners can presume their business income at 8% of the turnover in case of non-digital transactions and 6% in case of digital transactions.
Does F&O income qualify for section 44AD? A section of tax experts is of the view that it can be declared under this section if F&O gains are treated as business income.
Aakash Uppal, partner and leader (north)-corporate tax, tax & regulatory services, BDO India, says that salaried employees cannot declare F&O transactions under section 44AD, while the self-employed can do so if the total turnover of their primary business including F&O turnover does not cross ₹2 crore. “If an assessee has multiple businesses, then the turnover of those businesses shall be clubbed to determine the limit for the purpose of applying presumptive taxation under section 44AD of the Act,” he says
Naveen Wadhwa, vice-president, Taxmann, however, says this is a wrong interpretation. Neither self-employed nor salaried class should file their F&O income under section 44AD, he says. “This section was introduced for small business owners who lack sufficient resources to maintain books and get audits done. Calculating net profits or losses in F&O trades is quite straightforward. Your broker’s statement will have this information quite clearly. There is no need to presume your F&O profits or losses when actual figures are readily available,” says Wadhwa.
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Why is choosing between ITR-4 and ITR-3 a big deal? Read on.
Let’s take the example (see graphic) of a trader and assume that he transacts 8 times in F&Os in a financial year. Consider that he makes a profit of ₹5.6 lakh and a loss of ₹60,000 from these transactions. Thus, his net profit of ₹5 lakh is his business income. If he files his returns using ITR-3, he will be liable to pay tax on his business income as per his slab rate. Considering that he is in the 30% tax lab, his tax liability would come in at ₹1.5 lakh.
If the trader files taxes as per section 44AD (ITR-4), he can presume his profits at 6% of total turnover (since F&O transactions are digital). The turnover in case of F&O transactions comprises all profits and losses. So, as per his transactions, his turnover will be ₹6.2 lakh. The presumed profits for the year, at 6%, is ₹37,200. The tax liability on this, even in the 30% tax slab, will be just ₹11,160. That is a huge difference from the ₹1.5 lakh that he will have to pay with ITR-3. This is the reason why F&O traders prefer section 44AD.
However, tax authorities can question the steep difference in your tax liability and what you have actually paid. In many cases, the tax department has already started sending out notices to traders who filed ITR-4.
“A Kanpur-based businessman approached me after the tax department sent him a notice saying there was a discrepancy in the way he reported his F&O trading income. The department asked for actual profits on his F&O trades. The businessman then submitted the broker’s statement. The extra tax liability came in at ₹70,000 on which he also had to pay 100% penalty,” says Ankur Goyal, chartered accountant (CA) who deals in assessment cases.
“Technically, CAs can put forth the point that section 44AD does not define what an eligible business is, even though it does mention all exceptions quite clearly. F&O is not among exceptions. Be that as it may, the I-T department will not buy this logic,” adds Goyal.
Goyal referred to a 1985 Supreme Court case where the apex court rejected the appeal of the assessee by stating thus: “Where the plain literal interpretation of a statutory provision produces a manifestly unjust result which could never have been intended by the legislature, the Court might modify the language used by the legislature so as to achieve the intention of the legislature and produce a rational construction.”
Goyal says, “this ruling may be applicable in cases where there is an unjust difference in tax liability between what is applicable profit to be shown under ITR-3 and profits shown under section 44-AD. The I-T Department may consider it as tax evasion and may impose penalty.”.
The way out is to maintain proper books of accounts and file your F&O trading income in ITR-3. “The taxpayer can claim deductions against expenses such as telephone, electricity and internet bills incurred while trading in F&Os,” Vivek Jalan, partner, Tax Connect Advisory, a multi-disciplinary tax consultancy firm, says.
Moreover, one cannot switch between ITR-4 and ITR-3 every year. Section 44AD has a provision that says if you switch from ITR-4 to any other ITR forms, you will not be allowed to go back to ITR-4 for the next five years. “This provision keeps a check on people who may misuse section 44AD. You cant go one year with it to reduce your tax liability and then switch to another ITR the next year. You need to be consistent,” says Uppal of BDO India.