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10 Things to Keep in Mind to Have a Clean Tax Record
Ashish and Noni have recently started trading and earning money. The only constant fear they have is the fear of taxes. Their tax guru tells them trading taxes in India isn't quite as complicated as you may fear. Your initial task will be to determine which of the above categories best describes your trading activities. Such as, will you fall under the ‘capital gains’ or ‘business income’ umbrella? It’s important to be aware of the benefits or drawbacks. Although it can look daunting initially, the challenging part comes in keeping a track of all your profits and losses, so you can total them up at the end of the tax year.
Let’s see what all these things are!
1. Types of income
The first point of consideration is that trading taxation in India can be classified into four types, based on the form of trading activity as well as the type of income generated by the trade. Given below are each of these types of taxation for traders as well as their features, benefits and examples.
- Long Term Capital Gains are the form of tax levied by the Government if an asset, such as investments, are held by an individual for a specific long period of time. In India, if an investment is held for a year or longer, the purchase or sale profits from it would be subject to Long Term Capital Gains taxes.
- Short Term Capital Gains are similar to Long Term Capital Gains except that their duration of holding is shorter. As a trader in India, you should be informed that an investment held for longer than a day but shorter than a year is subject to Short Term Capital Gains tax. In terms of tax on trading income via equity, any gains generated by selling a stock within a year are subject to trading taxation of 15%.
- Speculative Business Income is generated through intraday trading is recognised in trading taxation as speculative business income. It is defined as income generated through trades in which the security is bought and sold within the same trading day, without the expectation of its delivery.
- Non-Speculative Business Income is generated by futures and options contracts that have been specifically defined to fall under the umbrella of non-speculative business income. This includes earnings generated by trading in either or both futures and contracts in recognised exchanges.
2. Tax on intraday trading profits:
Now that we know that intraday trading is largely classified as business income – equity or derivatives, we should keep in mind that business income doesn’t have a fixed rate of taxation.
For instance, if you made Rs 1,00,000 from intraday equity trading, Rs 50,000 from intraday F&O trades and Rs 10,00,000 from your salary, then your total income liability is Rs 11,50,000. The income tax payable by you will be dependent upon your tax slab and applicable deductions.
3. Tax-loss Harvesting
Tax-loss harvesting strategy involves selling off loss-making stocks in your portfolio. You can realise the losses and adjust them against capital gains and in doing so, reduce your tax liability and improve post-tax returns on your portfolio. With the realised sum, you can buy a stock from a similar sector to maintain the overall valuation of the fund.
Here are the broad steps involved in tax loss harvesting
- Spot the assets in your portfolio that have continuously been underperforming, and where chances of price reversal are slim.
- Sell these stocks and realise the losses.
- These losses can be offset against the overall capital gains made from the portfolio.
- This will reduce your taxable capital gains.
4. Taxability of Intraday Trading
Income gained from intraday stock trading is regarded as speculative business income. According to section 43(5) of the Income Tax Act, profits gained from intraday trading are added to taxable business income as taxed according to total income slab.
However, taxpayers (traders) have the option to consider the speculative business income under two different heads, which again has different tax implications.
5. Save tax using a demat account
If you’re wondering about how to save tax using a demat account, here are two of the most sought-after ways using which you can significantly bring down your tax liability.
- A Unit Linked Insurance Plan (ULIP) is a great investment vehicle that offers you the dual benefits of insurance cover as well as wealth creation. These investments get credited to your demat account, where you’re required to hold them for a minimum of 5 years as part of the mandatory lock-in period.
- Equity Linked Savings Scheme (ELSS) is another great tax-saving investment option. Compared to other traditional forms of investment, ELSS has the lowest lock-in period of just 3 years. The returns offered by this scheme are also typically much higher than other investments.
6. Tax Audit
An audit is required if you have a business income and if your business turnover is more than Rs 5 crore for a financial year (from FY 20-21). In the case of digital transactions (equity transactions are 100% digital), this turnover limit is Rs 5 crores. For equity traders, an audit is also required as per section 44AD in cases where turnover is less than Rs.5 Crores but profits are lesser than 6% of the turnover and total income is above the minimum exemption limit.
7. Claim expense
One can claim the benefit of all expenses incurred for the business of trading. For example, brokerage charges, STT, other statutory taxes while trading, internet, phone, newspapers, depreciation of computers and electronics, research reports, books, advisory, etc.
8. Carry forward the F&O loss
If there is net loss any year (non-speculative F&O + any income other than salary), and if income tax returns are filed before the due date, the loss can be carried forward for the next 8 years. During the next 8 years, this loss can be set-off against any other business gain.
9. Maintain Books & records
Books of accounts including vouchers and receipts are required to be maintained under different statutory laws – Income Tax Act, Companies Act 2013 and GST Act. Books to be maintained, retention period and compulsion requirements are different under all the 3 laws.
10. Hire a Professional to Handle Your Taxes
Many people try to save money by doing their taxes themselves. In reality, if you don’t hire a tax professional, not having access to their accounting expertise can cost your business a lot of money down the road.
It is possible that you could miss a deduction you qualify for or underpay your bill, leading to penalties. If you spend the money for a professional, they know what they are doing and will use accounting tips to put you in the best financial situation.
As a trader, it is important to stay informed about the market and its various risks and rewards. However, it is just as important to know how to navigate the trading taxation challenge when it presents itself every financial year. Hopefully, this guide will help you determine the overall classification that your specific type of trading falls under. The key is to stay updated with the latest tax-related news as well as how it applies specifically to your trading style and strategies, present and future.
A quick recap:
- The first point of consideration is that trading taxation in India is a type of income.
- Tax-loss harvesting strategy involves selling off loss-making stocks in your portfolio.
- Books of accounts including vouchers and receipts are required to be maintained under different statutory laws – Income Tax Act, Companies Act 2013 and GST Act.
- One can claim the benefit of all expenses incurred for the business of trading.