Unlike capital gains there is no fixed taxation rate when you have a business income. Speculative and non-speculative business income has to be added to all your other income (salary, other business income, bank interest, rental income, and others), and taxes paid according to the tax slab you fall in. You can refer to chapter 1 for tax slabs as applicable for FY 2015-16.
Let me explain this with an example:
- My salary – Rs.1,000,000/-
- Short term capital gains from deliver based equity – Rs.100,000/-
- Profits from F&O trading – Rs.100,000/-
- Intraday equity trading – Rs.100,000/-
Gives these incomes for the year, what is my tax liability?
In order to find out my tax liability, I need to calculate my total income by summing up salary, and all business income (speculative and non-speculative). The reason capital gains is not added is because capital gains have fixed taxation rates unlike salary, or business income.
Total income (salary + business) = Rs.1,000,000 (salary income) + Rs.100,000 (Profits from F&O trading) + Rs.100,000 (Intraday equity trading) = Rs 1,200,000/-
I now have to pay tax on Rs 12,00,000/- based on the tax slab –
- 0 – Rs.250,000 : 0% – Nil
- 250,000 – Rs.500,000 : 10% – Rs.25,000/-
- 500,000 – Rs.1,000,000 : 20% – Rs.100,000/-,
- 1,000,000 – 1,200,000: 30% – Rs.60,000/-
- Hence total tax : 25,000 + Rs.100,000 + Rs.60,000 = Rs.185,000/-
Now, I also have an additional income of Rs.100,000/- classified under short term capital gains from deliver based equity. The tax rate on this is flat 15%.
STCG: Rs 100,000/-, so at 15%, tax liability is Rs.15,000/-
Total tax = Rs.185,000 + Rs.15,000 = Rs.200,000/-
I hope this example gives you a basic orientation of how to treat your income and evaluate your tax liability.
We will now proceed to find a list of important factors that have to be kept in mind when declaring trading as a business income for taxation.
Carry forward business loss
If you file your income tax returns on time July 31st for non-audit case and Sept 30th for audit case, you can carry forward any business loss that is incurred.
Speculative losses can be carried forward for 4 years, and can be set-off only against any speculative gains you make in that period.
Non-speculative losses can be set-off against any other business income except salary income the same year. So they can be set-off against bank interest income, rental income, capital gains, but only in the same year.
You carry forward non-speculative losses to the next 8 years; however do remember carried forward non-speculative losses can be set-off only against any non-speculative gains made in that period.
For example consider this – my hotel business income is Rs 1,500,000/-, my interest income for the year is Rs.200,000/-, and I make a non-speculative loss of Rs 700,000. In such case my tax liability for the year would be –
My gain is Rs 1,500,000/ from business and Rs.200,000/- from interest, so total of Rs.1,700,000/-.
I have a non speculative business loss of Rs.700,000/-, which I can use to offset my business gains, and therefore lower my tax liability. Hence
Tax liability = Rs.1,700,000 – 700,000 = Rs.1,000,000/-
So I pay tax on Rs.1,000,000/- as per the tax slab I belong to, which would be –
- 0 – Rs.250,000 : 0% – Nil
- 250,000 – Rs.500,000 : 10% – Rs.25,000/-
- 500,000 – Rs.1,000,000 : 20% – Rs.100,000/-,
Hence, Rs.125,000/- goes out as tax.
Offsetting Speculative and non-speculative business income
Speculative (Intraday equity) loss can’t be offset with non-speculative (F&O) gains, but speculative gains can be offset with non-speculative losses.
If you incur speculative (intraday equity) loss of Rs.100,000/- for a year, and non-speculative profit of Rs 100,000/-, then you cannot net-off each other and say zero profits. You would still have to pay taxes on Rs 100,000/- from non-speculative profit, and carry forward the speculative loss.
For example consider this –
- Income from Salary = Rs.500,000/-
- Non Speculative profit = Rs.100,000/-
- Speculative loss = Rs.100,000/-
I calculate my tax liability as –
Total income = Income from Salary + Gains from Non Speculative Business income
= Rs.500,000 + Rs.100,000 = Rs.600,000/-
I’m required to pay the tax on Rs.600,000 as per the slab rates –
- 0 – Rs.250,000 : 0% – Nil
- 250,000 – Rs.500,000 : 10% – Rs.25,000/-
- 500,000 – Rs.600,000 : 20% – Rs.20,000/-,
Hence total tax = Rs.25,000 + Rs.20,000 = Rs.45,000/-
I can carry forward speculative loss of Rs.100,000/-, which I can set-off against any future (upto 4 years) speculative gains. Also to reiterate, speculative business losses can be set-off only against other speculative gains either the same year or when carried forward. Speculative losses can’t be set-off against other business gains.
But if I had speculative gain of Rs 100,000/- and non-speculative loss of Rs 100,000/- they can offset each other, and hence tax in the above example would be only on the salary of Rs 500,000/-.
What is tax loss harvesting?
Towards the end of a financial year you might have realized profits and unrealized losses. If you let it be, you will end up paying taxes on realized profits, and carrying forward your unrealized losses to next year. This would mean a higher tax outgo immediately, and hence any interest that you could have earned on that capital which goes away as taxes.
You can very easily postpone this tax outgo by booking the unrealized loss, and immediately getting back on the same trade. By booking the loss, the tax liability for the financial year would reduce. We at Zerodha are the only brokerage in India presently giving out a tax loss harvesting report, which will spot all opportunities for you to harvest losses. Click here to
learn more.
BTST (ATST) – Is it speculative, non-speculative, or STCG?
BTST (Buy today Sell tomorrow) or ATST (Acquire today sell tomorrow) is quite popular among equity traders. It is called BTST when you buy today and sell tomorrow without taking delivery of the stock.
Since you are not taking delivery, should it be considered as speculative similar to intraday equity trading?
There are both schools of thought, one which considers it to be speculative because no delivery was taken. However I come from the second school, which is to consider it as non-speculative/STCG as the exchange itself charges the security transaction tax (STT) for BTST trades similar to regular delivery based trades. A factor to consider is if such BTST trades are done just a few times in the year show it as STCG, but if done frequently it is best to show it as speculative business income.
Advance tax – business income
Paying advance tax is important when you have a business income. Like we discussed in the previous chapter, advance tax has to be paid every year – 15% by 15th Jun, 45% by 15th Sep, 75% by 15th Dec, and 100% by 15th March. I guess the question that will arise is % of what?
The % of the annual tax that you are likely to pay, yes! When you have a business income you have to pay most of your taxes before the year ends on March 31st. The issue with trading as a business is that you might have a great year until September, but you can’t extrapolate this to say that you will continue to earn at the same rate until the end of the financial year. It could be more or less.
But everything said and done, you are required to pay that advance tax, otherwise the penalty is 12% annualized for the time period it was not paid for. The best way to pay advance tax is by paying tax for that particular time period, so Sept 15th pay for what was earned until then, and by March 15th close to the year end, you can make all balance payments as you would have a fair idea on how you will close the year. You can claim a tax refund if you end up paying more advance tax than what was required to pay for the financial year. Tax refunds are processed in quick time by IT department.
Balance sheet and P&L statements
When you have trading as a business income, you are required to like any other business create a balance sheet and P&L or income statement for the financial year. Both these financial statements might need an audit based on your turnover and profitability. We will discuss more on this in the next chapter.
Turnover and Tax audit
When is audit required?
An audit is required if you have a business income and if your business turnover is more than Rs 1 crore for a financial year. In case of digital transactions (equity transactions are 100% digital), this turnover limit is Rs 2 crores. For equity traders, an audit is also required as per section 44AD in cases where turnover is less than Rs.2 Crores but profits are lesser than 6% of the turnover and total income is above minimum exemption limit.
We will discuss this in detail in the next chapter.
However let us understand what audit really means.
The dictionary meaning of the term “audit” is check, review, inspection, etc. There are various types of audits prescribed under different laws like company law requires a company audit; cost accounting law requires a cost audit, etc. Likewise the Income-tax Law requires the taxpayer to get the audit of the accounts of his business/profession from the view point of Income-tax Law if he meets the above mentioned turnover criteria.
Audit can also be defined as having an accountant verify if you have prepared all your accounts right. In this case it is getting an accountant check if you have created a correct balance sheet and P&L statement for the year. Ideally this audit should be done by the IT department itself, but considering the number of balance sheets out there it is surely impossible for IT department to audit each one of them. Hence we need a Chartered accountant (CA), who is a qualified professional and authorized by Income tax department to perform audits on balance sheet and P&L statements. You the tax payer can use any CA of your choice.
What role should a CA play?
Ideally a CA is required to only audit and sign on the balance sheets and P&L statements. But a CA also typically ends up creating your balance sheets and P&L statements and will audit them only if required. We will in the next chapter briefly explain how a CA typically creates these two statements.
The importance of the audit process by a CA cannot be understated, apart from all the reporting requirements an audit also helps traders/investors know their financial health, ensure it faithfully reflects the income and claims for deduction are correctly made. It also helps lenders evaluate credibility, and act as a check for any fraudulent practices.
Which ITR form to use? – ITR3 (ITR 4 until 2016), we will discuss more on this in the last chapter. I have come across incidents where people have declared both speculative and non-speculative as capital gains to avoid having to declare business income, and not having to use ITR3. Taking a shortcut like this could mean a lot of trouble if called for an IT scrutiny.
Business expenses when trading – Advantage of showing trading as a business is that you can show all expenses incurred as a cost which can then be used to reduce your tax outgo, and if a net loss for the year after all these costs, it can be carried forward as explained above.
Following are some of the expenses that can be shown as a cost when trading
- All charges when trading (STT, Brokerage, Exchange charges, and all other taxes). I hope you remember that STT can’t be shown as a cost when declaring income as capital gains, but it can be in case of business income.
- Internet/phone bills if used for trading (portion proportionate to your usage on the bill)
- Depreciation of computer/other electronics (used for trading)
- Rental expense (if the place used for trading, if a room used – portion of your rent)
- Salary paid to anyone helping you trade
- Advisory fees, cost of books, newspapers, subscriptions and more…
Key takeways from this chapter
- Speculative business income if trading intraday equity.
- Non-speculative if trading F&O, or short term equity delivery actively.
- Speculative losses can’t be set-off against non-speculative gains.
- Advance tax has to be paid when trading as a business –15% by Jun 15th 45% by Sep 15th, 75% by Dec 15th and 100% by Mar 15th.
- Can claim all expenses if income from trading shown as a business income.
