3.1Investor or Trader or Both?

To file your income tax returns, you must first identify yourself as either a trader or investor.

It may seem easy, but this circular by CBDT (Central Board of Direct Taxes) states: "If you purchase shares with the intention of earning income via dividends, you are an investor. If you buy and then sell shares with an intent to profit, you're a trader ":).

Yes, it is that vague. This circular was issued in 2007, 18 years after the original circular. This highly controversial issue has been the subject of numerous judicial pronouncements, as well as government. The circular's vagueness has allowed the AO to have too much power, especially when considering that stock purchases are made to gain from price appreciation.

Revised 2 March 2016.

The CBT circular from the income tax department clarifies how to classify yourself as either a trader (equity delivery trades), or an investor (trader) in this CBT circular.

The law now allows an individual to decide whether to show stock investments as capital gains (trading) or business income (trading), regardless of how long they have been listed. The taxpayer will continue to follow the same stance no matter what the original stance was.

Before you can file income tax returns, it is necessary to determine whether you are an investor, trader or both. This chapter will help you to figure this out, in line with what most AOs would expect. I refer to income as both profit and loss.

You need to categorize your income when trading or investing. In general, they are:

1. Long-term capital gain (LTCG).
2. Short term capital gain (STCG).
3. Speculative business income
4. Non-speculative business income

Let's find out what each one means.

Long-term capital gain (LTCG).

You can make a long-term capital gain of Rs.5,000/ if you buy stocks or mutual funds now at Rs.50,000/- and then sell them after 365 day for Rs.55,000//. LTCG is any profit or gain from investing in stocks, equity mutual funds. After one year, selling is permitted. India exempts any gains that are classified as LTCG or equity & MF for the first Rs. 1lk. Additional Rs 1lk are exempted from tax by 10%. You must sell and buy shares through an exchange that is recognized..

You don't pay taxes on any gain or profit exceeding Rs 99,000. Taxes on capital gains over a long period of time equal Rs 99,00,000.

LTCG above Rs 1lk will now be subject to a 10% tax. This tax will only be applied from the date of its announcement (Union Budget, February 1st 2018, Tax Bill). A grandfather clause was created to ensure that the acquisition cost for computing capital gains is the greater of the actual purchase price and the maximum traded price on January 31.

If the sale and investment were made off-market,

• Unlisted stocks – 20% tax on LTCG (example, buy and sell shares of startups  by Venture Capitalists).
• Listed stocks - No Tax on the First Rs 1lk, and a 10% tax on LTCG above Rs 1lk

Short term capital gains (STCG)

If you purchase listed stocks or equity-oriented mutual fund shares today at Rs.50,000/-, and then sell them within 12 months, say at Rs.55,000/–, the short term capital gain (STCG) is what you will be taxed on.

The STCG category covers gains or profits from stocks and equity mutual funds that are held for longer than one day (also known as delivery based). These can then be sold within twelve months of their purchase date.

Current tax in India on STCG is flat 15% for gains or profits from equity-oriented mutual funds or shares.

If you purchase Infosys shares in the amount of Rs 100,000/- and then sell them 10 days later for Rs.120,000//, you will be liable to 15% on Rs. 20,000 (STCG), or Rs. 3000// as taxes.

Tax on short-term capital gains = flat 15% (listed stocks).

Speculative Income

Section 43(5) of 1961's Income Tax Act, 1961 defines profits from trading stocks or equity for intraday delivery or non-delivery as speculative income. Currency trading is also considered speculative, unless you use currency derivatives to hedge.

If you have business income, there is no fixed rate such as the capital gains tax rate. You must add your business income to all other income. Tax has to then be paid according to the tax bracket you are in.

As an example, let's say that my intraday stock trading profit for the year was Rs. My salary for the year was Rs.400,000/+, and my profit from intraday stocks trading was Rs. 100,000/-. My total income for the year was Rs 5,00,000. I must pay taxes as per my tax bracket, which is Rs 25000.

The point is to combine speculative income from business with other sources of income and determine the tax amount. After this, tax must be paid according to the tax slab that one is a part of.

Non-speculative Business Income

Income from trading futures and options on recognized exchanges (equity or commodity) falls under the non-speculative business income category as per section 43(5), Income Tax Act, 1961.

As we discussed, income from business has no fixed tax rate. You are required to add non-speculative business income into all other income and to pay taxes according the applicable slab.

As an example, let's say a trader cum hotelier makes Rs.500,000 trading F&O. Assume he also makes Rs.20,00,000. His total income for the year amounts to Rs. 25,00,000. (Rs.500,000 + Rs.20,00,000.) Therefore, his tax obligation is as follows

Essentially, the businessman is taxing 30% of his F&O profits.

It might be a puzzle to you why intraday trading in equity is considered speculative, but F&O trading is considered non-speculative.

Intraday trading is not intended to take delivery and is therefore considered speculative. F&O can be used to hedge and take/give delivery of the underlying contract. (Equity and currency derivatives in India, however, are cash-settled at the moment, but they do give rise to delivery). Some commodity F&O contracts, such as gold, have delivery options.

3.2 - The advantage / disadvantage of declaring trading as a business income

Let's look at the bright side. Here are some benefits of trading as a business income.

1. Low tax If your total income (trading and any other) is below Rs.250,000/, there is no tax implication. However, if you earn less than Rs.500,000/, you may be eligible for a rebate.
2. Claim expense- You can claim all expenses incurred in the business of trading. Capital gains can only be claimed for charges other than STT. Brokerage charges, STT and other statutory taxes when trading, internet, telephone, newspapers, depreciation computers and electronics, research report, books, advisory, among others.
3. You can offset the loss with any gains. If you have any F&O trading losses that are not speculative, it can be used against your salary. If I lose Rs 5,00,000.00 in trading F&O, and my other income (rent & interest excluding salary), I will only have to pay taxes on Rs 5,00,000.
4. Carry forward F&O losses If there is a net loss in any year (nonspeculative F&O + income other than salary), the loss can be carried forward for up to 8 years if income tax returns have been filed prior to the due date. This loss can be offset against any other business gain over the next 8 years (non-speculative income). If you have a net loss of Rs 5,00,000. This is a result of trading F&O. You can carry this loss forward to next year. Assuming you make a profit of Rs 200,00,000. Next year, you will be able to deduct the Rs 5,00,000.
5. You can carry forward your intraday loss If returns are filed in time, speculative losses can be carried over for four years. Assume an equity intraday trader loses Rs.100,000. This cannot be offset against other business income. He can, however, carry the loss forward for up to four years. If he earns a profit of Rs.50,000/year by trading equity intraday and then he can use his previous year's loss of Rs.100,000. This will offset all gains this year (Rs.50,000). You can carry the Rs.50,000 balance loss forward for the next three years. Note that partial compensation of losses is possible.

The following table summarises the points made above.

Here are some drawbacks to declaring your business income.

1. High taxes You will pay 30% of your trading profits if you fall within the 30% tax bracket

1. ITR forms Declaring business income requires you to use an ITR3 or 4 (ITR 4S up to 2016) which will require assistance from a CA in order to file your IT returns. This can add effort and cost, especially for salaried workers who may have used the ITR 1 or ITR 2 more easily (we will cover this topic in the chapter about ITR forms).

3.3 - Who are you? Are you a Trader, Investor or Both?

We'll return to the original discussion according to CBDT.

Investor: Anyone who invests in order to earn dividends

Trader: A person who purchases and sells in order to profit from the price increase.

You can claim your equity-based profits/delivery gains as capital gains if you are an investor. It becomes your business income as a trader. This has its pros and cons, as we have discussed.

Intraday equity trading is subject to the same rules as F&O trading . F&O trading must be treated as a business that is not speculative, and intraday capital as a business that is speculative. You must use ITR 3 to file your IT returns if you trade these instruments. Even if you're salaried, ITR3 must be used and this income (profit/loss) must be declared as a business.

It is not common for losses to be declared, contrary to popular belief. Hide trading activity from the IT department can spell trouble, especially in the case of any IT scrutiny. This is when the assessing tax officer (AO), demands that you meet him and provide an explanation for your IT returns. Higher chances of being called for scrutiny are when the IT department/algorithms picks up trading activity on you PAN but not on your ITR.

Equity delivery based investments: If you have held stocks for over a year, any dividends would be paid. Even if they didn't, all your investments can be shown as investments to claim an exemption from the long-term capital gain. It is better to declare stock purchases and sales for shorter periods as non-speculative income than STCG.

Keep in mind that you should not consider your income from equity trading as capital gains if it is your only source. If you have a primary source of income, such as a salaried job or a business, it is easier to classify your equity trades in capital gains, even though the frequency may be slightly lower.

The circular clarified that traders and investors can both be involved in the trading of stocks. You can have stocks that are meant to be long-term investments and stocks that are meant for short-term trades. Even if you engage in many short-term trades, it doesn't mean that all of your long-term investments or holdings will be converted into trades. This would not result in long-term gains under business income. It is crucial to clearly define your trading and investment portfolio when filing returns.

Similarly, intraday equity trading or trading F&O requires you to be classified as a trader. However, you can still show long-term investments under the capital gains heading to receive the tax exemption.

You can either be an investor or trader. However, it is important to remember the following points and consult a chartered accountant before you file returns.

Although it may seem complicated, these rules are designed for 1% of those who want to break them. It is easy as long as you have the right intent, are familiar with the IT department's basic concerns, and remember these when filing your IT returns. Keep your classification consistent. Don't switch between investor and trader just to declare short-term equity trades.

These simple rules will ensure that you don't have to worry about the taxman.

These are some links you might find interesting before we close this chapter.

The distinction between investments and trades is made in the CBDT Circular.

Business Standard: Is your return on capital gains or business income greater than that of stocks?

Economic Times: Are you a  trader, or an investor?

Taxguru: Income through share trading – Capital gain /Business ?

Moneycontrol - Investor or trader

Economic Times- Budget 2014 clarifies that commodity trades on recognized exchanges are not speculative

Economic Times - A new data mining tool could access PAN-based taxpayer information, helping to check evasion

 Keypoints  

1. Audit- Maintaining the book of accounts that will need to audit if you have a turnover exceeding Rs 5 crore (was Rs 2.50 crore up to FY 19/20), or if you make less than 6% of the turnover. (We will cover this topic more in the chapter on Turnover).
    
   1. F&O trading (Equity and currency, commodity, etc.) is non-speculative.
   2. Intraday equity trading is considered speculative.
   3. Stocks held for longer than one year are considered long term capital gains (LTCG).
   4. A short term capital gain is equity holdings that are less than 1 day in duration and have low trade frequency. In the other case, it should be considered non-speculative income.