Explained: Earn passive income from F&O trading? This is when you need to file an ITR & how to calculate your income tax liability

Passive income, as the name suggests, refers to income earned with minimal ongoing effort, or in other words, money generated in a manner that requires little to no daily effort to maintain. From investing in stocks, bonds, ETFs to engaging in futures and options (F&O) trading, there are myriad ways to earn passive income.

Earning passive income through F&O trading

Futures and Options (F&O) are financial instruments used by investors to earn income and hedge their investments against market risks. Trading in these instruments involves buying and selling derivatives based on underlying assets like equity, commodity, or currency. F&O trading can be a source of passive income, given you have a well-established system and risk management strategies in place.

Filing an Income Tax Return for F&O trading

In terms of taxation, it is crucial to know that the income or loss generated from F&O trading needs to be reported in your Income Tax Return (ITR). As per the tax regulations, the F&O trading income should be considered as a business income, and ITR-3 form should be used for reporting it. This allows traders to claim expenses related to their business such as brokerage, commissions, and consultancy fees.

Tax liability calculation for F&O trading

When it comes to calculating your tax liability from F&O trading, the first step is to calculate your F&O turnover. This turnover is the total income from F&O trading and includes all profits, losses, and expenses like broker commission and rent. After the turnover based on transactions is calculated, you should deduct expenses such as electricity bills and broker commissions to arrive at the final turnover.

Once you have computed the turnover, the next step is to calculate the tax on the profits from F&O trading. Profits from F&O trading are taxed at normal rates. Tax audits are mandatory if F&O turnover exceeds Rs 1 crore, regardless of profit or loss. Advance tax must be paid if total tax liability exceeds Rs 10,000 in a financial year.

The role of losses in F&O trading

Interestingly, not just the profits, but the losses from F&O trading also play a significant role when it comes to filing taxes. As per the Income Tax Act, F&O transactions are treated as non-speculative, allowing losses to be considered as business losses. Such losses can be set off against other sources of income, thus reducing your overall tax liability. Certain expenses incurred in F&O trading, such as rent, administration expenses, salaries, and brokerage, can be claimed as deductions. Maintaining proper records and proof of these expenses is crucial.

Filing ITR even with loss in F&O trading?

According to Taxmann, a tax research and advisory firm, ITR filing is still mandatory if income exceeds the maximum exemption limit. If investors instead make a loss on their F&O activity through the financial year, they have no income to report and as such do not need to file an ITR. 

“However, filing an ITR becomes essential if you wish to carry forward these F&O losses. Therefore, ensure to file your return of income on or before the due date to facilitate this process,” writes Taxmann.

Deadline for filing ITR if engaged in F&O?

Income, and loss, from trading activity in F&O is reported under the 'Profits and Gains from Business or Profession' head and are usually considered as normal business income (non-speculative business). If the turnover for these activities is below the threshold then the deadline remains July 31. 

According to Taxmann, if your turnover exceeds the specified limit, you must get your accounts audited, and the deadline for filing your ITR becomes October 31.

How to calculate turnover in case of F&O?

According to the 'Guidance Note on Tax Audit' issued by the ICAI, the method to calculate turnover is as follows, explains Taxmann:

- Aggregate all the favourable and unfavourable differences to calculate turnover.

- Premiums received on the sale of options are also included in the turnover but if the premium received has been considered in determining the net profit for transactions, it should not be added again.

- In case of any reverse trades, the differences should also form part of the turnover.

Take the following example to understand. For instance, Mr B engages in the following transactions during the financial year:

In derivative transactions, the sum of both favourable and unfavourable differences (i.e., income and loss) is taken into account as the turnover. The premium received on the sale of options is also included in turnover if it has not been considered while calculating the net profit or loss from the transaction. Therefore, Mr B's turnover would be calculated as follows:

In the table example, Mr B made trades on various securities like Infosys, Nifty50, L&T, TCS, ICICI Bank, Wipro, and HDFC Bank. Each of these trades resulted in either a profit or loss, and when these are added together, we get Mr B's turnover for the year.

One additional detail to remember is about premiums received on selling options. If such a premium has already been considered when calculating profit or loss for that particular transaction, it won't be included again in the turnover. This prevents the same amount from being counted twice.

So, simply put, to calculate the turnover from Futures and Options trading, you add up all your profits and losses from your trades during the financial year, keeping in mind not to double-count premiums already factored into profits/losses.