Tax Audit | How to Calculate the Turnover in the Case of Derivatives?

The Income-tax Act does not contain any provision or guidance for the computation of turnover in F&O trading. Para 5.14(b) of the Guidance Note on Tax Audit under Section 44AB of the Income-tax Act, 1961 (Revised 2022) provided the following guidance on how turnover or gross receipt in respect of transactions in derivatives, futures and options is to be determined:

• The total of favourable and unfavourable differences shall be taken as turnover.
• The premium received on the sale of options is also to be included in turnover. However, where the premium received is included for determining net profit for transactions, the same should not be separately included.
• In respect of any reverse trades entered, the difference thereon should also form part of the turnover.

The above guidance left a lot of doubts. For instance, what is to be done in respect of open positions (i.e., trades not squared up as at year-end and settled in the next financial year)? What if there is a delivery-based settlement in derivative contracts? What about treatment in the hands of the transferor of the underlying asset in case of delivery-based settlement in derivative contracts?

The new guidance in Para 5.10(b) of the Guidance Note on Tax Audit under Section 44AB of the Income-tax Act, 1961 (Revised 2023) provides that the turnover or gross receipt in respect of transactions in derivatives, futures and options is to be determined as follows:

• In the case of squared-off transactions, the total of favourable and unfavourable differences shall be taken as turnover.
• Premium received on the sale of options is also to be included in turnover. However, where the premium received is included for determining net profit for transactions, the same should not be separately included.
• In respect of any reverse trades entered, the difference thereon should also form part of the turnover.
• In case of an open position at the end of the financial year (i.e., trades which are not squared off during the same financial year), the turnover arising from the said transaction should be considered in the financial year when the transaction has been actually squared off.
• In case of delivery-based settlement in a derivatives transaction, the difference between the trade price and the settlement price shall be considered as turnover. Further, in the hands of the transferor of the underlying asset, the entire sale value shall also be considered as business turnover where the underlying asset is held as stock in trade.

For example, Mr A enters into the following transaction during the financial year 2022-23:

Note 1 – Mr A has an open position in underlying put option as on 31^st March 2023. Thus, the turnover from such options shall be computed in the financial year in which the transaction is squared off or settled for delivery.

Note 2 – Delivery-based settlement in a Call (Long) option transaction can be made only if the option is “in the money”, which means the market price (settlement price) is above the strike price (trade price). However, if there is a profit/loss in the option premium amount, then it shall be considered in the calculation of turnover.

Thus, the turnover of Mr A shall be as follows:

Para 5.10(b) of the 2023 Guidance Note clarifies that the above guidance for the determination of turnover “is only and only for the purpose of computing ‘turnover’ for tax audit”

Is a salaried employee required to get accounts audited if he is also trading in derivatives (futures and options)?

The gains or losses arising from trading in F&O are always taxable under the head ‘Profits and Gains from Business or Profession’. Income or loss from dealing in F&O shall be deemed as normal business income (non-speculative business) even though delivery is not affected in such transactions.

To check the applicability of tax audit in such cases, the turnover from trading in derivatives must be computed first. The computation of turnover is an essential factor, as the applicability of a tax audit is determined based on turnover. If total sales, turnover, or gross receipt from the business during the previous year exceeds Rs. 1 crore, the tax audit shall be required in such cases. However, the increased threshold limit of Rs. 10 crores shall be applicable if cash receipts and cash payments during the year do not exceed 5% of the total receipt or payment, as the case may be. In other words, more than 95% of business transactions should be done through banking channels.

For example, during the year, Mr. A has earned salary income and incurred losses from trading in futures and options (F&O). The details of his transactions are as follows:

The turnover, in this case, shall be Rs. 2,75,00,000, and the loss from F&O shall be Rs. 55,00,000. The tax audit requirement arises if the business turnover from F&O exceeds Rs. 1 crore. However, the tax audit shall not be required if more than 95% of business transactions are done through banking channels and turnover is less than Rs. 10 crores. Since in F&O transactions, the trading shall be through digital means only, the enhanced limit of Rs. 10 crores shall apply to determine the applicability of tax audit. Thus, the tax audit shall not be required in this case.