We are all aware that income from salary, rental income and business income are subject to taxation. But what about stock-related transactions that result in a profit? Many homemakers and retired people supplement their income by trading stocks, but they don’t know how to properly report their transactions on their tax returns. As the Tax Season arrives every year, it’s time to start thinking about your income tax return. The Income Tax on Share Trading – Applicability & Rates is the most common and perplexing topic on which a CA is questioned. Let’s discuss about the tax on stock market transactions.
Investor or Trader
Let’s find out if you are an investor or a trader, it’s first step is to understand the taxation section. Because traders and investors are subject to various rules, it’s crucial to know.
Let’s jump into the conversation, The Income Tax Department issued a circular on 2nd March 2016 on categorizing a person as an investor or dealer, clearing up a lot of the confusion that had existed before 2016.
A few of the most universal themes of the circular were as follows:
- Profits from F&O trading are legitimate business gains and not subject to risk.
- Intraday Equity is a form of corporate income that is viewed as very speculative.
- Investments in equity delivery vehicles qualify as Long-Term Capital Gains (LTCG) if held for more than a year, or Short-Term Capital Gains (STCG) otherwise; nevertheless, it is suggested that such transactions be reported as non-speculative income rather than STCG if they occur frequently.
- If trading is all you do for a living, you should report your earnings as business income rather than capital gain.
Taxpayers have now been offered a choice of how they want to treat such income. Once they decided, though, they must keep doing the same thing in following years, unless something big changes in their lives. Note that the choice is only for shares or securities that are mentioned. No matter how long someone has owned listed shares. The AO must agree with the position that the customer has chosen.
- If the taxpayer chooses to count the income as capital gains, the AO can’t argue about it. This is true for stocks that have been on the market for more than a year. But if a taxpayer takes this stance in a certain assessment year, it will also be used in future assessment years. And the taxpayer won’t be able to change his or her mind in future years.
- In all other cases, the type of transaction (whether it’s a capital gain or a business income) will still be based on the idea of “significant trading activity” and whether the taxpayer plans to hold the shares as “stock” or as “investment.” The above advice would stop Assessing Officers from asking too many questions about how income is classified.
Meaning of Trader and Investor
An Investor in the stock market is an individual or entity that commits capital to purchase securities, such as stocks, with the expectation of generating a financial return. Stock market investors hope their investments will rise in value over time.
Investors evaluate stock market prospects. Financial performance, industry trends, management experience, and market conditions determine equity selection. To profit from corporate growth, investors may hold onto their investments.
Stock Traders buy and sell equities to make short-term profits. Unlike investors, traders frequently purchase and sell securities, taking advantage of short-term price changes and market volatility.
Trading strategies vary. Technical analysts use charts, patterns, and market indicators to anticipate price moves. Moving averages, trend lines, and oscillators help them determine trade entry and exit locations. Other traders use fundamental research to determine a stock’s value by examining a company’s financial statements, earnings reports, industry trends, and other factors.
Difference between Trader and Investor
In financial markets, traders and investors differ in their methodology, time horizon, and goals:
- Approach: Traders actively buy and sell securities to profit from short-term price changes. Technical analysis, charts, and indicators guide their trading. Investors focus on long-term plans and hold their shares for a long time.
- Time Horizon: Traders usually deal in days, hours, or minutes. They profit from price swings and market instability. Investors invest for months, years, even decades. They want long-term investment growth and value appreciation.
- Objectives: Trader’s profit from market price fluctuations. They try to profit from short-term market inefficiencies by trading often. Investors want long-term riches. They invest in companies and the economy to generate income, construct retirement funds, or support long-term financial goals.
- Strategies: Day, swing, and high-frequency traders profit from short-term market changes. Technical analysis, charts, and indicators help them timing transactions. Investors choose investments based on basic analysis and keep them for a long time, periodically reviewing performance.
- Involvement: Traders actively watch the market, analyse charts, and place trades. Market news, economic indicators, and other factors that affect short-term price changes must be monitored. Investors tend to evaluate their portfolios sometimes but not regularly.
Taxation for Investors
For investors there are only two types of taxation STCG and LTCG. This categorization is based on how long the shares have been held. The time from when an investment is purchased until it is sold or transferred is known as the holding period.
Gains on assets held for more than a year that are predicated on the delivery of equity are considered LTCG. Gains on investments held for less than a year are considered STCG.
Different types of capital assets have varying minimum and maximum holding periods for stocks and bonds. For federal income tax purposes, the holding periods of debt mutual funds and listed equity shares are distinct from one another. They’re also subject to separate taxes.
Taxation for Traders
Trading is counted as business income, which can be classified as either speculative or non-speculative business revenue, depending on how it was earned.
When you treat the sale of shares as revenue from your business, you can deduct expenses that were incurred in the process of earning such income from your firm. If this were the case, the earnings would be added to your overall income for the fiscal year, and as a result, you would be subject to the applicable tax rate slab.
Taxation on Long – Term Capital Gain
Taxes on long-term capital gains for equity and mutual funds are discussed below:
- Stock/Equity: The first 1 lakh is tax-free, while the next 1 lakh is taxed at 10% with STT. If no STT is paid, the long-term capital gains tax rate is 20%. The only trades that don’t have to pay STT are the ones that don’t happen on official stock exchanges.
- Mutual Funds: Long-term capital gains are taxed at a fixed rate of 20% for funds that are not equity-oriented but are exempt for the first 1 lakh invested. At least 65% of the total assets of an equity-oriented mutual fund must be invested in stock or shares of domestic enterprises for the fund to be classified as one.
For mutual funds that don’t focus on equities, the minimum investment period for long-term capital gain purposes is three years. You receive the indexation benefit when computing your net capital gain in the case of non-equity-oriented mutual funds, property, gold, and others subject to LTCG taxation.
Taxation on Short – Term Capital Gain
Taxes on long-term capital gains for equity and mutual funds are discussed below:
- Stock/Equity: STT of 15% applies to stocks and equities. STCG is subject to taxation at the standard rate if STT is not paid.
Loss from Equity shares
There are two types of loss:
- Short-Term Capital Loss: Equity share sales can mitigate short-term capital losses. The loss can be carried forward for eight years and adjusted against short-term or long-term capital gains.
A taxpayer can only carry forward losses if he files his income tax return on time. Thus, to carry forward losses, you must file an income tax return even if your total income is less than the minimum taxable income.
- Long – Term Capital Loss: The Budget 2018 changed the law to tax gains exceeding Rs 1 lakh at 10% and notified those losses from listed equities shares, mutual funds, etc. will be carried forward. The Act allows long-term capital loss from transfers made after 1st April 2018 to be taken off and carried forward.
Thus, any long-term capital gain can offset the loss. Long-term capital losses cannot be offset by short-term capital gains. Long-term capital losses can be carried forward for eight years to offset long-term gains. File the return on time to set off and carry forward these losses.
Speculative and Non-Speculative Business Income/Loss
- Speculative income: Income from intraday stock trading is a speculative business income.
- Non-speculative business income: Income from trading F&O on all exchanges, both during the day and overnight, is called non-speculative business income.
Speculative losses can be rolled forward for four years, but they can only be used to offset speculative gains made during that time. Non-speculative business losses can be used to offset any other business income in the same year, except for pay income.
So, they can be used to reduce income from bank interest, rent, and capital gains, but only in the same year. Non-speculative loses are carried over to the next 8 years. Since a trader must show his income as business income, he must maintain books of accounts, as required by section 44AA of Income Tax Act, 1961 Maintenance of Accounts.
Securities Transaction Tax (STT)
All purchases and sales of equity shares on a stock exchange are subject to a tax known as the STT. The tax considerations apply exclusively to publicly traded shares. STT applies to all stock market transactions. Therefore, these tax implications discussed above are only for shares on which STT is paid.
How to Treat the Sale of Unlisted Shares?
The department has said the sale of unlisted shares, which can’t be bought or sold on an official market. The income from the sale of unlisted shares would be taxed under the “Capital Gain” head, no matter how long the shares were held, to avoid disagreements or lawsuits and keep things consistent (according to CBDT circular Folio No.225/12/2016/ITA.1I dated May 2, 2016).
Crypto Taxation
The standard rate of taxation for cryptocurrency profits is 30%. A Bitcoin loss cannot be offset by an Ethereum gain. Bitcoin losses can only be compensated by Bitcoin gains.
ITR to be filed by Investor and Trader
Following are the Income Tax Return to be filed by Investor and Trader:
- Trader: ITR 3 as a person have only business income.
- Investor: ITR3: When you have business income and capital gains.
ITR 2: When you have a salary and capital gains or just capital gains.
Takeaway
When you profit from the stock market, just as with any other types of income, you are obligated to pay income tax on that money. The amount that you are responsible for paying tax is determined by the kind of investment income that you have earned. The day that you have earned it, the length of time that you have owned the asset, as well as the amount that you got from selling the asset.
