Accounting Entries and Taxation for Stocks & F&O-A thread for settling these issues.

#1
Hello All

I intend this thread to be the bible for book-keeping auditing and taxation of stock and F&O trading operation. Please add your questions and answer whatever you can from the questions below.

Can someone please advise regarding the following:

  1. In case, one buys or sells a futures lot, does one show the full value of the lot as purchase or sale, in the books of account or does one show only the margin money paid as sale/purchase?
  2. In case, one buys or sells an option, what accounting entry does one do at the time of buying or selling the option AND what entry if the option expires unexercised AND what entry if the option is exercised?
  3. What about taxation? How is a natural person taxed for buying & selling shares, futures and options? Is a partnership firm taxed any different? And what about Pvt. Ltd. Company or Corporate body?
  4. Can a person be an investor (Long Term/Short Term Capital Gain based tax) and a Trader (Normal Tax with transaction considered as Purchase/Sale/Stock) at the same time? Any specific issues for bookkeeping to get this treatment like separate books of account &/or separate demat account etc.?
  5. On F.Y. end, if one holds a short position in a stock (under stock lending & borrowing mechanism), or future lot or an option....how does one show it in stock or whatever? I have never seen a negative stock, but then I have never done bookkeeping for stock market.
  6. Is it advisable for a person engaged in another business to maintain separate books of account for his shares business? If so, why? What may be the negative aspects that an ITO may add back to income, in such a case?
  7. In case of trading, does one need to keep track of FIFO/LIFO stocks? In such a case only sales & purchases only need to be totaled and one subtracted from the other to derive P&L, there should be no need to keep track of FIFO/LIFO.
  8. Does statutory audit for a stock trading operation, whether in conjunction with another business or being the only business, need to cover any additional specific area?

Sanjay.
 

Sunil

Well-Known Member
#2
Re: Accounting Entries and Taxation for Stocks & F&O-A thread for settling these issu

1. One shows only the amount debited / credited in the margin account everyday.
Derivatives trading (intra or positional) does not amount to actual delivery, as everything is cash settled.
The journal entry (which I do) in our books is:

For credit to margin/profit:
XYZ Broker Margin A/c - Dr
STT paid A/c - Dr
To Mark-to-Market Equity Futures A/c (cr)

For Loss:
Mark-to-Market Equity Futures A/c - Dr
STT paid A/c - Dr
To XYZ Broker Margin A/c (cr)



2.
For option, I follow the same entry as above.
At the end of the year, the MTM Equity Futures A?c & MTM Equity Options A/c will show your net profit & loss w/o taking STT into consideration.

STT is not to be taken as an expense, and has to be adjusted against your capital account.



3. Trading of Derivatives is to be taken as INCOME/LOSS FROM BUSINESS (whether intraday or positional)
If you trade in stocks (cash market) mostly intraday, then it is taken as INCOME/LOSS FROM SPECULATION BUSINESS
It is categorised as speculation, and hence any loss in such intraday cash stocks trading will have to be set-off ONLY against any income from other speculation business.
Whereas, any loss in derivatives trading can be setoff against income from other sources like interest recd. on FDs, Savings A/c, Interest on Loans advanced to others, etc
But cannot be setoff against any other head like salary, income from house property, capital gains.

If you have more of positional trading in stocks, then it goes under Short term capital gains/loss.
Holding period of more than one year qualifies as Long term capital gain

From taxation pt of view, following are different taxable entities:
YOU
YOUR HUF
YOUR PARTNERSHIP FIRM WITH Mr ABC or XYZ (or whatever)
YOUR PRIVATE LTD. CO.

IT DEPENDS ON WHOSE NAME YOU HAVE OPENED DEMAT/TRADING ACCOUNT
 

Sunil

Well-Known Member
#3
Re: Accounting Entries and Taxation for Stocks & F&O-A thread for settling these issu

Since I admire and respect the main purpose behind this thread, let me take various aspects separately.

They are extracts from various guiding websites and by CAs
 

Sunil

Well-Known Member
#4
Re: Accounting Entries and Taxation for Stocks & F&O-A thread for settling these issu

ACCOUNTING TREATMENT IN RESPECT OF EQUITY / INDEX FUTURES IN THE BOOKS OF THE CLIENT

Accounting at the inception of the contract

Every Client is required to pay to the Trading Member/Clearing Member, initial margin determined by the Clearing Corporation as per the bye-laws/regulations of the Exchange for entering into equity index futures contracts. Such initial margin paid/payable should be debited to Initial Margin - Equity Index Futures Account. Additional margins, if any, should also be accounted for in the same manner. It may be mentioned that at the time when the contract is entered into for purchase/sale of equity index futures, no entry is passed for recording the contract because no payment is made at that time except for the initial margin. At the balance sheet date, the balance in the Initial Margin - Equity Index Futures Account should be shown separately under the head Current Assets. Where any amount has been paid in excess of the initial/additional margin, the excess should be disclosed separately as a deposit under the head Current Assets. Where instead of paying initial margin in cash, the Client provides bank guarantees or lodges securities with the member, a disclosure should be made in the notes to the financial statements of the Client.

Accounting at the time of Daily Settlement - Payment/Receipt of Mark-to-Market Margin

Payments made or received on account of Daily Settlement by the Client would be credited/debited to the bank account and the corresponding debit or credit for the same should be made to an account titled as Mark-to-Market Margin - Equity Index Futures Account.

Some times the client may deposit a lump sum amount with the broker/trading member in respect of Mark-to-Market Margin Money instead of receiving/paying Mark-to-Market Margin Money on daily basis. The amount so paid is in the nature of a deposit and should be debited to an appropriate account, say, Deposit for Mark-to-Market Margin Account. The amount of Mark-to-Market Margin received/paid into/from such account should be debited/credited to Deposit for Mark-to-Market Margin Account with a corresponding credit/debit to Mark-to-Market Margin - Equity Index Futures Account. At the year-end, any balance in the Deposit for Mark-to-Market Margin Account should be shown as a deposit under the head Current Assets.

Accounting for Open Interests as on the balance sheet date

Debit/credit balance in the Mark-to-Market Margin - Equity Index Futures Account represents the net amount paid/received on the basis of movement in the prices of index futures till the balance sheet date. Keeping in view prudence as a consideration for preparation of financial statements, provision should be created by a debit to the profit and loss account, for anticipated loss equivalent to the net payment made to the broker (represented by the debit balance in the Mark-to-Market Margin - Equity Index Futures Account). Net amount received (represented by credit balance in the Mark-to-Market Margin - Equity Index Futures Account) being anticipated profit should be ignored and no credit for the same should be taken in the profit and loss account. The debit balance in the said Mark-to-Market Margin - Equity Index Futures Account, i.e., net payment made to the broker, may be shown under the head Current Assets, Loans and Advances in the balance sheet and the provision created there-against should be shown as a deduction there from. On the other hand, the credit balance in the said account, i.e., the net amount received from the broker, should be shown as a current liability under the head Current Liabilities and Provisions in the balance sheet.

Accounting at the time of final settlement or squaring-up of the contract

At the expiry of a series of equity index futures, the profit/loss, on final settlement of the contracts in the series, should be calculated as the difference between final settlement price and contract prices of all the contracts in the series. The profit/loss, so computed, should be recognized in the profit and loss account by corresponding debit/credit to Mark-to-Market Margin - Equity Index Futures Account. However, where a balance exists in the provision account created for anticipated loss, any loss arising on such settlement should be first charged to such provision account, to the extent of the balance available in the provision account, and the balance of loss, if any, should be charged to the profit and loss account. Same accounting treatment should be made when a contract is squared-up by entering into a reverse contract. It appears that, at present, it is not feasible to maintain the identity of the individual equity index futures contracts within the same series. Accordingly, if more than one contract in respect of the relevant series of equity index futures contract to which the squared-up contract pertains is outstanding at the time of the squaring up of the contract, the contract price of the contract so squared-up should be determined using First-In, First-Out (FIFO) Method for calculating profit/loss on squaring-up.

On the settlement of an equity index futures contract, the initial margin paid in respect of the contract is released which should be credited to Initial Margin - Equity Index Futures Account, and a corresponding debit should be given to the bank account or the deposit account (where the amount is not received).



Code:
Illustration
An example illustrating the accounting treatment of important aspects of equity index futures contracts is given in the Appendix to this Guidance Note.
Appendix
Illustration of Accounting for Equity Index Futures
(This Appendix does not form part of the Guidance Note and is merely illustrative.)
Suppose Mr. A purchases the following units of Equity Index Futures (EIF):
Date of Purchase 	Name of Future	Expiry Date/ Series	Contract Price per unit (Rs.)	Contract Multiplier (No. of Units)
28th Mar, 2001	EF1	May, 2001	1420	200
29th Mar, 2001	EF2	June, 2001	4280	50
29th Mar, 2001	EF1	May, 2001	1416	200
Daily Settlement Prices of the above units of Equity Index Futures were as follows:
Date 	EF1 May Series
(Rs.)	EF2 June Series
(Rs.)
28/03/2001	1410	-
29/03/2001	1428	4300
30/03/2001	1435	4270 
31/03/2001	1407	4290 
01/04/2001	1415	4250 
02/04/2001	1430	-
03/04/2001	1442 	-
For the sake of convenience, it has been assumed that the above contracts were settled on the following dates:
EF2 June Series on 1st April, 2001. 
A contract of 200 units of EF1 May Series on 2nd April, 2001. 
The other contract of EF1 May series on 3rd April, 2001. 
SUGGESTED ACCOUNTING TREATMENT
Financial Year 2000-01
Accounting at the inception of the contract
1. Initial Margin Money paid in Cash:
Initial Margin - Equity Index Futures A/c Dr. ----
To Bank A/c ----
Accounting at the time of Daily settlement
2. The amount of Mark-to-Market Margin Money received/paid due to increase/decrease in daily settlement prices is as below:
Date	EF1 May Series (Rs.)	EF2 June Series(Rs.)	Net Amount (Rs.)
	Receive 	Pay	Receive	Pay	Receive	Pay
28/03/2001 	-	2000	-	-	-	2000
29/03/2001	6000	-	1000	-	7000	-
30/03/2001	2800	-	-	1500	1300	-
31/03/2001	-	11200	1000	-	-	10200
01/04/2001	3200	-	-	2000	1200	-
02/04/2001	6000	-	-	-	6000 	-
03/04/2001 	2400	-	-	-	2400	-
3. The amount of Mark-to-Market Margin Money received/paid will be credited/debited to Mark-to-Market Margin - EIF A/c by passing the following entries:
Date 	Particulars	L.F.	Debit (Rs.)	Credit (Rs.
March,2001
28	Mark-to-Market Margin - EIF A/c Dr. To Bank A/c
(Being net Margin Money paid for day)	 	2000	

2000
29	Bank A/c Dr.
To Mark-to-Market Margin - EIF A/c (Being net Margin Money received for day)	 	7000	

7000
30	Bank A/c Dr.
To Mark-to-Market Margin - EIF A/c (Being net Margin Money received for day)	 	1300	

1300
31 	Mark-to-Market Margin - EIF A/c Dr.
To Bank A/c (Being net Margin Money paid for day)	 	10200	

10200
 	Total	 	20500	20500
On the above basis, Mark-to Market Margin - EIF A/c for the year will appear as follows in the books of Mr. A:
Mark-to-Market Margin - EIF A/c
 

Sunil

Well-Known Member
#5
Re: Accounting Entries and Taxation for Stocks & F&O-A thread for settling these issu

DERIVATIVES INCOME - UNDER WHICH HEAD TO BE TAXED?

Section 2(aa) of the Securities Contracts (Regulation) Act, 1956 defines derivatives in an inclusive manner as under:

"derivative" includes
A. a security derived from a debt instrument, share, loan whether secured or unsecured, risk instrument or contract for differences or any other form of security;

B. a contract which derives its value from the prices, or index or prices, of underlying securities.

Today, futures and options based on individual stocks or based on stock indices are the major derivatives traded on the exchanges. The focus of this article is therefore restricted to these futures and options.


Futures:
The ICAI Guidance Note on Accounting for Equity Index and Equity Stock Futures and Options describes futures as:

A futures contract, like a forward contract, is an agreement between two parties to buy or sell an asset at a certain time in future for an agreed price. Futures contracts are normally traded on an exchange. To make trading possible, the exchange specifies certain standardised features of the contract. The exchange may also provide for guarantee mechanism to ensure that each party to the contract meets its obligations and, consequently, risk from default by parties is minimised.


The difference between futures and options is also highlighted by the Guidance Note. Futures and options are both standardised derivative instruments traded on a stock exchange. The difference between these two types of derivative instruments is in respect of the rights and obligations of the parties involved in such contracts. In case of a futures contract, both the parties are under obligation to complete the contract on the specified date. However, in case of options contract, the buyer/holder has a right, but no obligation to exercise the Option, whereas the seller/writer has an obligation but no right to complete the contract.

Like options, futures are also for a maximum maturity of 3 months, expire on the last Thursday of the month and have to be cash settled on maturity. Unlike options, where the premium fluctuates for a particular strike price, the price of the futures itself fluctuates for a particular maturity. On maturity, the purchaser of a futures contracts receives (or pays) the difference between the market price of the underlying share/index on the maturity date and the purchase price of the futures, while the seller of a futures contract receives (or pays) the difference between the sale price of the futures and the market price of the underlying share/index on the maturity date.


Taxation of Futures & Options

Till Assessment Year 2005-06, the Income Tax Act, 1961 did not have any special provisions dealing with taxation of derivatives transactions in general, and dealing with futures and options in particular, though derivatives contracts have been traded on Indian stock exchanges since 2000. The Finance Act 2005 has amended the proviso to section 43(5), with effect from Assessment Year 2006-07, to provide that derivatives trading transactions would not be regarded as speculative transactions, subject to the fulfilment of certain conditions.

For the most part, therefore one needs to look at the normal provisions of the Income Tax Act and understand their applicability to derivatives transactions. Various issues do arise for consideration, more so, since there is also no case law on the subject, as futures and options transactions are of recent origin.

To understand the taxation, one also needs to understand the accounting treatment. The ICAI Guidance Note on Accounting for Equity Index and Equity Stock Futures and Options provides guidance as to how such transactions are to be accounted for.

In substance, the Guidance Note provides that the profit or loss on the transactions are to be recognised only on expiry of the future or option or on squaring up of the position (unless there is an intervening balance sheet). Till such time of expiry or squaring up, the initial margin, premium paid and mark-to-market margin is to be accumulated and shown as a current asset. If a balance sheet is prepared during the intervening period before expiry of the future or option, a provision is to be made for the notional loss, if any, as on that date on a mark-to-market basis, but no profit is to be recognised on such basis.


Whether Always Taxable as Business Income:

The most common issue that arises in taxation of derivatives transactions is that of whether derivatives transactions are always to be regarded as business transactions.

It is true that in most cases, derivatives transactions would be regarded as business transactions on account of the following factors:

1. The purpose behind entering into most derivatives transactions is to profit from short-term fluctuations in market prices.

2. The period of any derivatives transaction cannot exceed 3 months, and such transactions are invariably short-term transactions.

3. Often, the sheer volume of trades in derivatives transactions entered into by a person on an ongoing basis indicates that it amounts to a business.

4. Many people who trade in derivatives may be associated with the stock market in some way or the other they may be stock brokers or their employees, or regular day traders. For such people, derivatives trading is an extension of their normal business activities.

However, the issue of whether an activity amounts to a business or not depends upon various factors, and is not decided just because of the existence or absence of any one circumstance. There can be situations where derivatives transactions may not amount to a business. For instance, derivatives transactions may be carried on by an investor to hedge his investment portfolio. In such a case, the mere fact that the investor had to square up his derivatives position every 3 months and take up a fresh position, or pay mark-to-market on a daily basis, would not detract from the fact that the prime purpose of such transactions was to preserve the value of the investment portfolio.

Another common practice in the stock markets is arbitrage between the cash market and the futures market. It is a well known fact that the difference in prices between the futures market and the cash market is primarily dictated by the short-term interest rates, and such difference is normally equivalent to the interest that one would earn on short term lending. Therefore, a person having surplus funds may buy shares in the cash market, while simultaneously selling an equal amount of futures of the same share in the futures market. He would take delivery of the shares bought in the cash market. On maturity of the futures, the shares bought in the cash market would be sold in the cash market. Since the futures would be squared off at the cash market price, the profit on the transaction would normally consist mainly of the difference between the initial purchase price in the cash market and the initial sale price in the futures market, with small adjustments for expenses such as brokerage, securities transaction tax, service tax and the market spread between the buying and selling quotes in the cash market.

Are such arbitrage transactions business transactions, or are they really in the nature of interest seeking transactions? If one looks at the substance of these transactions, they are not motivated by a desire to earn profits, but just to avail of the benefit of the short term interest rates. There just two legs of the transaction the purchase and futures sale, and the expiry of futures and cash sale. The income element in the transactions is determined right at the outset, and does not fluctuate to any material extent, even if there is substantial volatility in the market. Going by the principle of the substance of the transaction, a view is possible, as was being taken in the past in the case of vyaj badla transactions, that such transactions are in the nature of earning of interest, though they take the form of arbitrage transactions.

It may be however noted that other factors, such as frequency of transactions, nature of other business carried on, etc., would also determine whether such transactions are business transactions or not.




Exclusion of Derivatives from definition of Speculative Transaction:

A new clause (d) has been added to the proviso to section 43(5), excluding certain derivatives trading transactions from the definition of speculative transaction. Such exclusion of derivatives transactions is however subject to certain conditions.

These conditions are:

a. the transaction should have been carried out electronically on a screen-based system. This condition does not pose any difficulty, as all derivatives transactions on the National Stock Exchange or the Bombay Stock Exchange (which today are the only stock exchanges in India offering derivatives transactions) are electronic screen-based transactions.

b. The transaction should have been carried out through a stock broker or sub-broker or other intermediary registered under section 12 of the SEBI Act, 1992 in accordance with the Securities Contracts (Regulation) Act, 1956, the SEBI Act, 1992 or the Depositories Act, 1996 and the rules, regulations or bye-laws made or directions issued under those Acts, or by banks or mutual funds. Since all derivatives transactions on NSE or BSE have to be routed through stock brokers, this condition also does not pose any difficulty.

c. The transaction has to be carried out on a recognised stock exchange.

d. The transaction has to be supported by a time-stamped contract note issued by such stock broker, sub-broker or other intermediary. This also poses no difficulty, as all contract notes now issued by NSE or BSE bear the time-stamp.

e. The contract note has to indicate the unique client identity number allotted under SCRA, SEBI Act or Depositories Act and the permanent account number of the client. The purpose of mention of UIN and PAN is to ensure that such transactions of one person are not recorded as the transactions of another. If, through PAN identification on the contract notes, such purpose is served, an assessee should not be denied the benefit for not complying with a requirement that is not otherwise mandatory for him.


Take for instance, a day trader who trades in shares and also trades in derivatives. If he has incurred a loss in his share day trading activities, and earned a profit on his derivatives transactions of an equal amount, only the day trading loss will be regarded as a speculation loss, and the derivatives profit will be taxable as normal business income.





What are the implications of derivatives trading transactions not being classified as speculative transactions?

This would permit losses in derivatives trading to be set off against any other business income, including share trading profits, failing which, such losses can be set off against any other income. This would encourage investors to try their hand at derivatives trading.
 

Sunil

Well-Known Member
#6
Re: Accounting Entries and Taxation for Stocks & F&O-A thread for settling these issu

SOME FAQs REGARDING TAXATION OF DERIVATIVES TRADING
(sourced from other websites)



Im a salaried individual. Last year, I made a profit of Rs 8 lakh from trading in the futures & options market. My salary income is Rs 2 lakh per annum. Under which head will I show my income from derivatives trading?
Income from derivatives trading is more likely to be shown under the head, Business income, due to the short duration and nature and sheer volume of transactions.

Once classified as business income, the next issue arises as to whether it is to be shown as speculative business income or non-speculative business income. Speculative transaction means a transaction in which a contract for the purchase or sale of any commodity, including stocks and shares, is periodically or ultimately settled otherwise than by the actual delivery or transfer of the commodity or scrips.

Derivatives are not capable of being delivered as they are financial contracts without any physical existence. So the question of non-delivery does not arise.
From FY 2005-06, trading in derivatives will not be treated as a speculative business if the following conditions are satisfied.

  • The transaction is carried out on a recognised stock exchange (BSE/ NSE are declared as recognised stock exchange with effect from 25 January 2006).
  • The transaction should be of trading in derivative as per section 2(aa) of the Securities Contracts (Regulation) Act, 1956 (SCRA). As per this section, derivatives include: i) a security derived from a debt instrument, share, loan, whether secured or unsecured, risk instrument or contract for differences or any other form of security; and ii) a contract which derives its value from the prices, or index of prices, of underlying securities.
  • The transaction is carried out electronically on screen-based systems through a stock broker/ sub-broker/ other registered intermediary in accordance with the provisions of the SCRA/SEBI Act, 1992/Depositories Act, 1996 or by banks or mutual funds.
  • A time stamped contract note is issued by the broker to the client. The contract note should indicate the unique client identity number allotted under SCRA / SEBI / Depositories Act and PAN allotted under the Income-Tax Act, 1961.
  • The stock exchange should have the approval of Sebi. It should ensure that the particulars of the client are stored in its databases. The stock exchange has to maintain complete audit trail of all transactions for a period of seven years on its system and ensure that transactions once registered in the system cannot be erased or modified.
There may be situations where the derivatives transaction may not amount to be business. It may be treated as capital gain or income from other sources. One may argue that an investor may undertake derivatives transactions to hedge his investment portfolio. The period of any derivatives transaction cannot exceed three months. So just because the investor has to square up his position every three months and then take fresh position does not mean that this is a business transaction.


There is also a view that derivatives are a right to acquire property. Thus, they are properties carrying a value and, hence, should be considered as a capital asset and subject to capital gains. The income from derivatives trading will be taxed as business income or capital gain depending on the nature of the asset held by a person i.e., whether the derivatives are held as stock in trade or capital assets. The dividing line between the two is very thin and it will depend on several factors like the length of the holding period, intention of purchase/sale, accounting treatment, frequency of transaction, administrative set up, and source of funds.

Although shown as capital gain and subject to the securities transaction tax (STT), derivatives transaction will not attract the concessional tax rate of 10% applicable to short-term capital gain (on which STT is paid). The benefit of concessional tax rate is applicable only to equity shares in a company or units of an equity-oriented mutual fund.

Whether the derivatives transaction is shown as business income or capital gain, the tax liability remains the same if one is in the highest tax bracket. It is preferable to show it as business as one can also claim rebate under sec 88E, in respect of STT paid and deduction of expenses when the transaction is shown as business income. Chances of litigation are also less when the derivatives transaction is shown as business income. However, if it is a business income and the turnover exceeds Rs 40 lakh, then a tax audit is required. Failure to get the accounts audited) invites penalty.




If the income generated from day trading is treated as Businees income, then can we deduct expenses such as
Rent on premises ?
Electricity?
Phone?
broadband?
Fee paid to Stock technical analysts?
fee paid to CA?
Investments made for Hardware and software?

All the expenses other than investments for Hardware and Software will be fully deductible. 60% depreciation on WDV basis will be allowed on investments for Hardware & Software every year.



If the day trading is done as a SOHO (Small Office/Home Office) set up how are the above expenses treated??
It would not make any difference. Except that only partial allowance for rent/electricity (related to office portion) will be allowed.




I am basically a trader in equity. I do normally settle the transaction on intra-day basis. Some time I take delivery for short term gain. I do have investment in share also which have holding period more than 12 months. Do I need to seperate three activities as (a) Business income (b) Short-Term Capital gain (c) Long term gain which is not taxable. I do these online from home.

What expenses could be deductible (internet charges/Demat charge/brokerage etc) to calculate such income and in what porpotion. I have strong doubt because demat charges includes for all the three activities and so can not be propotionised. Can that be adjusted fully against the income from business. What about the other charges such as society maintenance, electricity bill etc.
A: A person may have three activities namely a Business Income, a Long-term capital gain and a Short-term capital gain. The computation of income will have to be done separately for each item of income. The long-term capital gains on listed securities will, however, be fully exempted from income-tax. The short-term capital gains would be subject to tax @ 10% only. The business income from trading in shares will, however, be calculated by reference to income and loss from different transactions during the year and the tax liability will arise based on the tax slab as is applicable to an individual.

The expenses incurred by you on earning all the above income will be deductible pro-rata to the income earned by you in each separate activity. However, no expenses will be deductible in respect of long-term capital gains because in any case the income from long-term capital gains is fully exempt from tax. If you are maintaining a separate office for carrying out your business activities of stock market then the expenses incurred on society maintenance, electricity bills and telephone bills and all other expenses in connection with the earning of the income from business will be allowed as a deduction. If, however, you are not maintaining separate office then also you can claim pro-rata deduction of the expenses.
Subhash Lakhotia


In case of short-term capital gains from dealings in listed equity shares, can the following costs be reduced in arriving at the gain: Service tax on brokerage; education cess on the above service tax; STT paid on purchase/sale; stamp duty paid on daily turnover; DP charges on purchase/sale; annual DP maintenance charges; interest on borrowed capital; any other expenses such as travelling, consultancy fees etc.???
In computing short-term capital gains, all expenditure incurred wholly and exclusively for the purpose of the transfer can be claimed as deduction. Out of the expenses listed, those incurred by way of service tax on brokerage, education cess on the same and DP charges on sale of shares may satisfy this criterion. Interest on capital borrowed for investment cannot be reduced in computing the capital gains, but it may be possible for the same to be added to the cost of acquisition. Similarly, service tax on brokerage and education cess on the same incurred at the time of purchase can be added to the cost of acquisition of the shares. This would, in effect, reduce the capital gains.

Given the facts, particularly, that the capital was borrowed to invest in shares and that consultancy charges were incurred in connection with share dealings, it leads one to think that the gain itself may not be assessable as short-term capital gains but could be treated as business income. All the facts will have to be analysed to arrive at a definite conclusion on the matter. At any rate, any dealings in shares which is non-delivery based is most likely to be treated as business income and according to Section 43(5) has to be treated as speculative income/loss.

If assessable as business income, all expenditure incurred wholly and exclusively for the purpose of carrying on the business can be claimed as deduction. Such expenditure should, however, not be of the nature referred to in Sections 30 to 36, and should not be of a personal or capital nature.

Of the expenses listed, except STT on purchase and sale of shares, all other expenses will qualify as deduction in computing the business income when it is assessed as such.
 

Sunil

Well-Known Member
#7
Re: Accounting Entries and Taxation for Stocks & F&O-A thread for settling these issu

INTRADAY TRADING OF STOCKS IN CASH MARKET = SPECULATION BUSINESS



What is difference between speculative business and business income?

A speculative business is one specified under section 73 of the Income Tax Act. Trading in stock derivatives through NSE/BSE is not speculative business. Any profit from a non-speculative business is taxable as business income.


How is income from day trading in shares taxed? Is it added with the total income of the assessee and taxed as per slab, or does it have a separate structure?

The day trading involves transactions in shares purchase and sale without taking delivery. Under the Income tax Act, the transaction without delivery is called "Speculation.


How does it effect your total income?
While the speculation income of Day Trading is added as Normal Income and taxed as per tax slab, however the Speculation loss in day trading will only be adjusted with other speculation income.



For example, let us say you have transacted in Reliance Shares in following manner:
Purchase 1000 shares of RIL for Rs 1000 per shares on 24/1/07
You sold 500 shares on for Rs 900 same day ie. 24/1/2007 and rest of the shares you took delivery.
After one month you sold balance 500 shares of Rs 1100 .
You compute overall income you will find there is no profit or loss.

But for income tax purpose, computation will be , to your surprise, will be as follows:

Trading profit on Sale of 500 shares after one month Rs 50,000 (550000 - 500000)
Speculation loss on Same day trade Rs 50,000( 5,00,000-4,50,000)

You will have to pay tax on Rs 50,000 whereas Speculation loss of Rs 50,000 shall be carried forward for eight years and whenever you will get Speculation Profit , it (Speculation Loss carried from earlier years ) shall be adjusted.





The authority on the subject is the provision u/s 43(5) of the I T act , given as under :

"(5) speculative transaction means a transaction in which a contract for the purchase or sale of any commodity, including stocks and shares, is periodically or ultimately settled otherwise than by the actual delivery or transfer of the commodity or scrips:

Provided that for the purposes of this clause

(a) a contract in respect of raw materials or merchandise entered into by a person in the course of his manufacturing or merchanting business to guard against loss through future price fluctuations in respect of his contracts for actual delivery of goods manufactured by him or merchandise sold by him; or

(b) a contract in respect of stocks and shares entered into by a dealer or investor therein to guard against loss in his holdings of stocks and shares through price fluctuations; or

(c) a contract entered into by a member of a forward market or a stock exchange in the course of any transaction in the nature of jobbing or arbitrage to guard against loss which may arise in the ordinary course of his business as such member; [or]

(d) an eligible transaction in respect of trading in derivatives referred to in clause (ac) of section 2 of the Securities Contracts (Regulation) Act, 1956 (42 of 1956) carried out in a recognised stock exchange;"

Also note that there may be situation when even day trading may not be taken as Speculation Income or Loss . This is when the transaction is done to hedge the loss in investment . Read Section 43(5)(b) of the I T Act.



Is a speculative business also to be taxed under the head capital gains? Can expenditure, such as depreciation on assets such as computer, air-conditioner, furniture and postage, telephone, conveyance, and so on, be claimed against speculative income?
Any profits and gains from a speculative transaction is to be taxed under the head `profits and gains of business or profession'. In case of speculative transaction, all expenditure allowable under Sections 30 to 38 can be claimed since the charge arises under the head `profits and gains of business or profession'. You can claim expenses, such as postage, conveyance and telephone, incurred by you for carrying on the business. You can also claim depreciation on assets used for the business or profession.
 

Sunil

Well-Known Member
#8
Re: Accounting Entries and Taxation for Stocks & F&O-A thread for settling these issu

If a person has earned short-term capital gains out of investments made, given that the investments are gifted or provided by his or her spouse, will the earnings be treated as income in the hands of the person in whose name the transactions are done or in the hands of the donor/lender?
If income is earned from investment that was a gift from the spouse , the income from the investment will be clubbed in the hands of the donor spouse. If the source is not a gift but a loan or advance received from the spouse, the clubbing provisions will not be attracted and the income will be taxed in the hands of the person who has derived the income from the investment.
 

Sunil

Well-Known Member
#9
Re: Accounting Entries and Taxation for Stocks & F&O-A thread for settling these issu

WHEN IS AUDITING REQUIRED FOR DERIVATIVES TRADING?
If derivatives transactions are business transactions, the question then arises as to what constitutes the turnover in derivatives transactions for the purposes of section 44AB or for other purposes?
In the case of futures, the purchases of futures is not recorded as a purchase in the books of account, nor is the sale of futures recognized as a sale. Only the initial margin and mark-to-market margins are recorded as and when paid, and the profit or loss on the futures transaction is recorded as an income/expense on squaring up of the transaction or on expiry of the futures contract.

The margin paid is certainly not the turnover, and neither can the futures sale be regarded as a sale in the light of such accounting treatment. At best, only the difference (profit or loss on the futures transaction) can be regarded as turnover.

The question then is should one net off the profits and losses and is only the net profit or loss to be regarded as the turnover? This does not appear to be proper, as the net profit or loss would not reflect a measure of the actual volume of transactions. It should be the gross differences which would constitute turnover, and not the net differences. The scrip wise gross differences for each maturity should be determined, the negative signs of the losses within a scrip of each maturity ignored and such losses grossed up with the gains to compute the turnover.

In the case of options, only the premium and margins paid is reflected in the books of account at the inception of and during the currency of the option. The strike prices of the margins do not get reflected in the books of account, except for the limited purpose of identifying different sets of options. On the squaring up or expiry of the options, the value of the option on sale or maturity is received or paid, and the profit/loss on the options accounted for. There is a view that such value of the options on squaring up/maturity would constitute the turnover in case of options, though the better view seems to be that it would be the gross differences (taking the losses also as a positive figure) as in the case of futures, that would constitute the turnover.

The question that is then often asked and will continue to be relevant in the future will be are derivatives transactions speculative transactions, even in the absence of applicability of clause (d) of the proviso to section 43(5)? Can it be argued that index futures or index options are certainly not stocks and shares, and that the definition of speculation transaction, which requires the contract to be for the purchase or sale of any commodity, including stocks and shares, therefore does not apply? Even otherwise, can a transaction for purchase or sale of an equity stock future or an equity stock option be regarded as a transaction for purchase or sale of shares?

It is fairly clear that derivatives are securities which are distinct from the underlying securities. The definition of securities under SCRA very clearly shows that shares and derivatives are two distinct types of securities. Therefore, purchase and sale of derivatives cannot be equated with purchase and sale of stocks and shares.







Q. I want to know about audit of futures and options (F&O) transactions. My F&O loss was about Rs 38 lakh in the accounting year 2006-2007.
The transactions for the purchase and sale of F&O are completed without delivery of shares and securities. Contract notes are issued for the full value of the asset purchased and/or sold, but accounting is done only for the difference. The amount paid/received is this difference.

For applicability of tax audit under Section 44AB of the Income-Tax Act, 1961, on trading in F&O, the turnover should exceed Rs 40 lakh. Turnover in such types of transactions is the grossing up of the difference of all the trades entered, whether positive or negative. Premium received on sale of option is to be added. Difference on reverse trades is also to be considered. If the turnover so arrived is above Rs 40 lakh, then tax audit would be applicable.

The loss suffered by you from F&O transactions is around Rs 38 lakh. Hence, you will not be required to get your books of accounts audited, provided you have determined the loss as per the above guidelines




If a person is engaged in share trading and turnover of delivery based buying & selling is less than 40 lacs but speculation business in share trading where intra-day sale purchase is effected but delivery is not taken exceeds 40 lacs, is tax audit applicable ?
This issue was subject to controversial interpretation by assessee and income tax department.The issue had come up in case of Babulal Enterprise vs ACIT before Mumbai bench of ITAT [1999-2000] wherein it was held that where the actual delivery was not taken and difference in price was settled on the basis of contract note, the turnover can not include those transactions. Another decision of Mumbai Tribunal expressing similar views was in case of Growmore Exports Ltd vs ACIT [78 ITD 95] . Therefore , if you are involved in Day Trading, i.e. you are squaring off of the share deal same day, the contract value is not taken for the purpose of turnover, but the differential shall be taken for the purpose of turnover.



I am engaged in buying and selling of shares. I do not take delivery of the shares and these transactions are speculative in nature. What is to be taken as the turnover for the purpose of determining whether a tax audit is required in such cases?
In this case, since the transactions in shares are non-delivery based, it is only the net of the sales and purchases that is to be treated as turnover. Tax audit under Section 44AB would be required only if the turnover so computed exceeds Rs 40 lakh.






a case study.
I am currently doing four types of trading,
1. Delivery
2. Margin (Intraday)
3. Futures
4. Option

Eg:- During 1-April 31-March
1. I purchase Infosys worth Rs.100000 then sell it for 150000.
2. I purchase Infosys worth Rs.100000 then sell it for 105000(Intra day 5% gain).
3. I purchase 1 Nifty future 3000 sells it for 3100.(market lot 50)
4. I purchase 1 Nifty call 3000 premium 25, sells (square off) it for premium 50
(Strike price + premium is used to calculate brokerage and contract not also indicate that total amount)

What is the total turnover?
(The above 4 trades may be repeated several times for profit or loss, but for simplycity and catching the essence i redused it!)
Total Turnover will be as follows:

1. Infy Position Trade --- Rs. 1,50,000
2. Infy Intraday Trade --- Rs. 5,000
3. NIfty Future --- Rs. 5,000 (100*50)
4. Nifty Call --- Rs. 25 (50-25) multiplied by lot size of contract = 25*50 = 1250
 

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