Trading in stocks during Covid-19? Here are the tax rules you should keep in mind

Many retail investors have taken to trading on the stock markets during the lockdown period. For these investors and those who have been trading in stocks for a while, the manner in which their gains are taxed is an important aspect to be kept in mind.

There are many factors that go into how your income from trading in stocks is taxed. It could be taxed as business income or capital gains — short-term or long-term. There is also the option of using a presumptive taxation scheme to calculate income from trading in case it is treated as business income. Here is a look at the different options.

Business versus investment

Trading in shares can lead to income from capital gains, which can be either short-term or long-term in nature. In case you trade in shares and derivatives frequently, you have an option of classifying such income as business income under Profits and Gains from Business or Profession or as capital gains. Intra-day trading in shares is classified as speculative business, while trading in futures and options (F&O) and trading in shares where you take delivery is non-speculative business.

In case you have been trading in stocks, you will have to pay tax on short-term capital gains or long-term capital gains depending on how long you hold the shares. You also have an option to declare a part of these gains as business income. Based on circulars from the Central Board of Direct Taxes, you can segregate your portfolio by earmarking a portion of it to your trading activity (business income) and the rest to investing activity (capital gains).

Any income from the portfolio that pertains to the trading activity can be shown as income from business. While declaring business income, incidental expenses such as depreciation on computer, rent for office, internet costs, brokerage, securities transaction tax paid, etc. can be deducted from your turnover.

The other portion of your portfolio from investing activity can be shown as capital gains or losses. Income from this portfolio will be taxed as short-term capital gains if you have held the shares for 12 months or less, or long-term capital gains if held for more than 12 months. Tax on short-term capital gains on listed shares is taxed at 15 per cent, while tax on long-term capital gains is taxed at 10 per cent after an exemption limit of ₹1 lakh a year.

It is advisable to keep detailed records of your trading activities and investing activities. The taxman requires you to maintain books of accounts in case your annual income from business exceeds ₹1.2 lakh or if your annual turnover or revenues from business exceeds ₹10,00,000 in the three preceding financial years. If this is the first year where you have started stock trading business, then you need to maintain books of accounts only if you expect your income and turnover to cross the same limits mentioned above. There is no specific need to maintain books of accounts for income from capital gains.

Calculation of income

When you declare trading income as business income, you are allowed to deduct incidental costs such as brokerage costs, connectivity costs and book-keeping expenses from your turnover from trading. The net amount is attributable as income from trading. There is also an option available to declare income from business through the presumptive taxation scheme. More on that later.

To calculate the tax on trading income, one has to start with calculation of the turnover from such trading in shares and derivatives. According to the Institute of Chartered Accountants of India’s Guidance Note on Tax Audit, for intra-day trading in shares, i.e. speculative business, the turnover is calculated by using the sum of the absolute net amount of the buy and sell transactions. Say, you buy 100 shares of Company X at ₹50 and sell them at ₹52 during the day, then the amount that will be considered your turnover would be ₹200 (100 X ₹2).

Even if you make a loss while doing intra-day trading, that amount too will be considered your turnover. In the previous example in case you sold the 100 shares of Company X for ₹47, then your turnover would be ₹300 (100 X ₹3). The absolute values of your settlement amount, whether loss or gain, is considered while calculating your turnover from intra-day trading. It is better to calculate the absolute value of these losses or gains at the level of each transaction executed. Your broker sends a contract note for each executed trade through which you can get this data.

In case of F&O transactions completed without taking physical delivery of shares, the turnover amount will be the amount for which the contract is settled in cash. The contract note given by the broker will contain the full transaction value, say 5 lots of 1 lakh shares each of Company Y at ₹100 per lot, i.e. ₹5 crore. When the derivative contract is sold before or on the expiry date, for say, ₹5.2 crore, the difference of ₹20 lakh will be considered part of the turnover.

Similar to intra-day trading, the absolute values have to be considered for calculating the turnover. In the previous example, if the contract was sold for ₹4.5 crore, then even though the trade resulted in a loss, the ₹50 lakh will be considered part of the turnover.

For delivery-based trades in shares, if you buy a share and then sell it, the sale value of the shares will be considered part of the turnover. If you buy 100 shares of Company Z for ₹500 and sell it for ₹520, then ₹52,000 (100 shares X ₹520) will be considered part of your turnover. If you sell the shares for ₹450 per share, your turnover will be ₹45,000 (100 shares X ₹450.)

Calculation of income tax

You have the option of choosing to declare your business income under normal provisions of the Income Tax Act, 1962 by deducting the expenses or by using the presumptive taxation scheme. In case you are opting for a presumptive taxation scheme (individuals, HUF, and partnership firms, excluding LLPs are eligible), then business income from trading activity is calculated differently. If your turnover is up to ₹5 crore then your income from business under presumptive taxation is calculated at 8 per cent of this turnover. In case you do your transactions digitally, then this comes down to 6 per cent of your turnover. The expenses are deemed to have been already deducted under this method.

You have to make a choice of the presumptive taxation scheme and stick to it for five years. If you switch from the presumptive taxation scheme to the usual way of calculating tax in any subsequent year till the initial five years are up, you will not be able to opt for the presumptive taxation scheme for the next five consecutive financial years.

Business income is taxed at slab rate for individuals and Hindu Undivided Family (HUF) assessees.

In case you are liable to pay advance tax, pay them on the due date to avoid interest cost; this is applicable whether you classify the gains as business income or capital gains.

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Did you know?

Under presumptive taxation of business income, income is calculated at 8 per cent of turnover for usual transactions and 6 per cent of turnover for digital transactions

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