Classification of Income from stock market

Income tax department has brought in clarity in classifying yourself as a trader or an investor (equity delivery trades) through this CBDT circular.

It now says that an individual can decide on his own to either show his stock investments as capital gains or as a business income (trading) irrespective of the period of holding the listed shares and securities. Whatever is the stance once taken, the taxpayer will have to continue with the same in the subsequent years.

So before filing income tax returns, you will have to first classify yourself as an investor, trader, or both.  We will in this chapter help you figure this out in line with what most AO’s would be expecting. By income, I mean both profits and losses.

When trading or investing you need to classify your income under one of these heads, broadly speaking they are –

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

Let us understand what each of these means.

Long-term capital gain (LTCG)

Assume you buy stocks or Mutual Funds today for Rs.50,000/- and sell the same after 365 days at Rs.55,000/-, then the profit or gain of Rs.5,000/- is considered as Long-term capital gain. Generally speaking, gain or profit earned by investing in stocks or equity mutual funds, and selling after 1 year from date of purchase can be categorized under LTCG. Currently, in India any gains realized and categorized as LTCG (equity & equity MF) is completely exempt from taxes for the first Rs 1lk and at 10% if LTCG for the year exceeds Rs 1lk (from FY 2018/19). Do note – the purchase and sale of shares have to be conducted via a recognized exchange.

Until FY 2017/18 – if you had bought Infosys shares worth Rs.1,00,000/- 10 years ago, and sold the same today for Rs 1 crore, you don’t have to pay any taxes on your gain or profit of Rs 99,00,000. So, taxes on the long-term capital gain of Rs 99,00,000 = 0 (Zero) or would have been exempt.

Going forward, LTCG exceeding Rs 1lk will be taxed at 10%. To ensure that this tax is applied only from the date of announcement of this tax (Union Budget, Feb 1st, 2018), a grandfather clause was introduced – for all stocks held before Feb 1st, the acquisition cost for the purpose of computing capital gains will be the higher of the actual purchase price or the maximum traded price on Jan. 31.

If the investment and the consequent sale were done via an off-market transaction,

  • Non listed stocks – Tax on LTCG is 20% (for example purchase and sale of shares belonging to startup companies by Venture Capitalists)
  • Listed stocks – No tax on first Rs 1lk, Tax on LTCG at 10% exceeding Rs 1lk

Short-term capital gain (STCG)

Assume you buy listed stocks or equity oriented mutual funds today for Rs.50,000/- and sell the same within the period of 12 months, say at Rs.55,000/-, then the profit or gain of Rs.5,000/- is taxed as a Short-term capital gain(STCG) .

Generally speaking, gain or profit earned by investing into stocks or equity mutual funds holding for more than 1 day (also called delivery based) and selling them within 12 months from the date of purchase can be categorized under STCG.

Currently, the tax on STCG in India is flat 15% on the gain or profit from the sale of shares or equity oriented mutual fund.

Therefore, if you buy Infosys shares worth Rs 100,000/- today and sell the same 10 days later for Rs.120,000/-, then you are liable to pay 15% on Rs 20,000 (STCG) or Rs 3000/- as taxes.

So, tax on short-term capital gain = flat 15% of the gain/profit (listed stocks).

Speculative Business income

As per section 43(5) of the Income Tax Act, 1961, profits earned by trading equity or stocks for intraday or non-delivery is categorized under speculative business income. Currency trading is also considered as speculative since there is no STT (unless you are using currency derivatives to hedge).

There is no fixed rate like the capital gains tax rate when you have a business income. If you have a business income, it has to be added to the rest of your other income and tax has to be paid as per the tax slab you fall in.

For example, assume for the financial year my profit from trading intraday stocks was Rs. 100,000/-, and my salary for the year was Rs.400,000/-. So my total income for the year is Rs 5,00,000, and I have to pay taxes on this as per my tax slab, Rs 25000 in this case as shown below.

SL No. Slab Taxable Amount Tax Rate Tax Amount
1 0 to Rs.250,000 2,50,000 0% Nil
2 250,000 to 5,00,000 2,50,000 10% 25000
Total Tax applicable Rs. 25,000

So the point here is that one needs to club the speculative business income with other income source and identify the taxable amount. Once this is done, the tax has to be paid based on the tax slab one belongs to.

Non – speculative Business income

Income from trading futures & options on recognized exchanges (equity, commodity) is categorized under non-speculative business income as per section 43(5) of the Income Tax Act, 1961.

Like discussed earlier, business income has no fixed tax rate, you are required to add the non- speculative business income to all your other income, and pay taxes according to the slab applicable to you.

For example, assume a trader cum hotelier earns Rs, 500,000 by trading F&O. Besides this assume he also earns Rs.20,00,000/- from his hotel business. Therefore his total income for the year is Rs 25,00,000/- (Rs.500,000 + Rs.20,00,000) and therefore his tax obligation is as follows

SL No. Slab Taxable Amount Tax Rate Tax Amount
1 0 to Rs.250,000 2,50,000 0% Nil
2 250,000 to 500,000 2,50,000 5% 12500
3 500,000 to 1,000,000 5,00,000 20% 1,00,000
4 10,00,000 to 25,00,000 15,00,000 30% 4,50,000
Total Tax applicable Rs.562,500

Effectively the business man here is paying 30% of his F&O profits as taxes.

You would be wondering why trading equity intraday is considered ‘speculative’ but trading F&O is considered ‘nonspeculative’?

When trading intraday there is no intention of taking delivery, and hence it is considered speculative business. F&O is defined as non-speculative by the government, maybe as they can be used for hedging and also for taking/giving delivery of the underlying contract (even though currently equity and currency derivatives in India are all cash settled, but by definition, they give rise to giving/taking delivery. Certain commodity F&O contracts like gold have the delivery option to it).

What are you? Trader, Investor, or Both?

Coming back to our original discussion, according to CBDT

Investor: anyone who invests with the intention of earning through dividends

Trader: anyone who buys and sells with the intention of profiting from the price rise.

As an investor, you can claim all your delivery based equity gains/profit to be capital gains. But as a trader, it becomes your business income which has its own pros and cons as discussed above.

The rule is very clear with respect to F&O trading, and intraday equity trading. F&O trading has to be considered as a non-speculative business, and intraday equity as a speculative business. So if you trade these instruments, you have to use ITR 3 for filing IT returns. So even if you are salaried, you have to compulsorily use ITR3 and declare this income (profit or loss) from trading as a business.

Unlike what most people think, losses also is recommended to be declared. Hiding trading activity on the exchange from the IT department could mean trouble, especially in case of any IT scrutiny (IT scrutiny is when the assessing income tax officer (AO) demands you to meet him and give an explanation on your IT returns). The chances of getting a call for scrutiny is higher when the IT department systems/algorithms pick up trading activity on your PAN, but the same not declared on your ITR.

For equity delivery based investments, if you are holding stocks for more than a year, you would have received some kind of dividend and even if you didn’t, you can show them all as investments and claim exemption under the long term capital gain. If you are buying and selling stocks frequently (yes it is an open statement, but there is no rule which quantifies ‘frequent’) for shorter terms, it is best to declare that as non-speculative business income instead of STCG.

Another thing to keep in mind is that if investing/trading on the markets is your only source of income, and even if your trading activity is moderate, it is best to classify income from all your equity trades as a business income instead of capital gains. On the other hand, if you are salaried or have some other business as your primary source of business, it becomes easier to show your equity trades as capital gains even if the frequency is slightly higher.

Thankfully one thing that the circular clarified was that you can be a trader and investor both at the same time. So you can have stocks meant as an investment for long-term, and stocks meant for shorter term trades. Just because you indulge in a lot of shorter-term trades, wouldn’t necessarily convert all your longer-term holdings or investments into trades and therefore bring those long-term gains under business income. But it is important to clearly demarcate your trading and investment portfolio while filing returns.

Similarly, if you are trading F&O or intraday equity trading, you compulsorily have to classify yourself as a trader, but you can still show your long-term investments under the capital gains head to get the benefit of LTCG being exempt from taxes.

So, you can be an investor, trader, or both, but make sure to keep the above points in mind, and do consult a chartered accountant before filing returns.

Even though this might seem confusing, rules are made for 1% of the population that is trying to break them. As long as your intent is right, you know the basic concerns of the IT department and keep those in mind while filing IT returns, it is quite simple. But stay consistent with the way you classify yourself, don’t keep switching between being an investor or trader to declare your equity short term trades.

If you follow these simple rules, let me assure you – there is no need to fear the taxman.

Before we wrap this chapter, here are some interesting links that you should read through.

CBDT circular on distinction between trades and investments.

Business Standard – Is your return from stocks capital gains or business income?

Economic Times – Are you a stock trader or an investor?

Taxguru – Income from share trading – Business or capital gain?

Moneycontrol- Investor or trader: The argument continues

Economic Times – Budget 2014 clarifies that commodity trading on recognized exchanges is non-speculative

Economic times – New data mining tool may access PAN-based information of taxpayers, help check evasion