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Taxation for the Trader and Investor



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Earlier this evening, Raju was asking about taxation on dividends.

Dividends from equity shares are tax free in the hands of investors.

However, understand that when a dividend is paid to you, the company pays a *Dividend Distribution Tax* to the Govt. from the funds that are earmarked as Dividend.

So, you are indirectly paying the tax on dividend.

Further, dividend can be paid only from profits.

A company cannot sell an asset and then use the money from it as dividend.

So understand that dividends are not free money as conceived by many. It is your money (or that of the company in which your money is invested).

So, do not keep dividend factor the sole criteria in stock picking.

Tax paid by companies is called *Corporate Tax*.

This is just like Income-tax of Companies

Should dividend be declared in our individual income tax returns?

Ideally Yes. But most people neglect because it is any ways tax exempt.

I strongly suggest you to show all your income and expenses in a fair manner at all times in your IT returns failing which we will get unnecessary trouble.

For instance, in the last few years, Income Tax Dept has upgraded its Information Technology infrastructure.

They how have the infrastructure to cross check ur equity share transaction data with that of what ur broker has filed.

And computers pick PAN card numbers randomly and there is a random possibility of u getting an IT Notice.

And we know how IT Dept treats its assesses.

Who know, you may have to go to their office 10 times or even more to prove your innocence or ignorance or both.

The case hearing will spread over a year or so

And the worst part is that the assessee cannot for sure know the status of the case and only hope it got closed unless they again asks for some more information after few months.

And ultimately some loophole emerges and you will have pay some tax to the Department.

So, better to file your returns properly

Not that everyone will get notices and will have troubles.

There are several millions of transactions happening in stock exchanges.

But we could be the unluck one on some day.

So, prepare and maintain all proper documents related to all your financial activities.

It is always better to keep all your trade / investment related documents offline.

These come handy when you quit your broker, when you file your tax returns or when your get a notice from the IT Dept.

Important documents / records to be maintained

Irrespective of whether you are ..

a profit-making or a loss-making person or ..

a high/low turnover making person, ..

there are some important documents to keep offline in your PC / Laptop are:

1. Contract Notes

2. Day Bills

3. Ledgers

4. Trade Analysis documents (Delivery and Speculation)

It is better to save these documents in your computer on a daily / weekly basis.

Do not feel that since they are emailing you, you can have access to them at all times.

Maintain an Excel file of ur daily trading transactions, both as to what you have done and what the broker has given

There will be small differences between your records and broker records.

There is a higher STT to be paid for ur delivery trades.

I will give a small example.

For instance, u bought a share for Rs. 100 and sold it for Rs. 105

So u earned an intraday gain of Rs 5

Later, the stock fell to Rs. 102

You felt Rs. 102 is a good price to take delivery and took its delivery

So, in ur records, u might write that u got Rs. 5 intraday profit and took the delivery of share for Rs. 102

What the broker actually does is..

He will write the record as ur bought for intraday at Rs. 102 and sold for Rs. 105. So u made intraday gain of Rs. 3

And that you took delivery for Rs. 100

Why does the broker do like this?

Intraday is speculative income. taxed higher.

So because of the adjustment, u will be taxed on Rs. 3 profit rather than the earlier Rs. 5 profit

Further, higher STT applies on delivery trades. So instead of on Rs 102, it is applied on Rs. 100

So u pay lesser STT because of the adjustment.

So, his adjustments are actually for ur advantage only.

There are several things like this to discuss.

Accounting for Equities

Let us continue with our discussion on *Accounting for Equities*

In yesterdays class, we discussed about

1. Dividend, source of dividend and its tax treatment

2. Necessity to maintain records of our equity transactions particularly Contract Notes, Day Bills and Ledgers

3. How our stock broker adjusts our transactions to make them tax efficient.

Any questions about them?

In today's session, I will touch a very small but important topic.

When we trade or invest in equities, there will be certain situations in which a tax audit is mandatory.

Remember, there will be several types of Auditing that a Chartered Account will do.

Example: Stock Audit, Branch Audit, Accounting Audit, Tax Audit etc.

For this session, we are interested in the need of tax audit only

Tax Audit

Tax Audit answers the following question:

Are calculations done properly to determine the amount of tax being paid or not?

Now, in which situations should we need our equity accounts audited?

There are two situations in which a tax audit is required:

1. Turnover for financial year is > Rs 1 crore

2. If turnover < 1 crore and profitability is less than 8% of turnover (Section 44 AB)

Read the above two points again.

Also note that if your total gross total income (trading + Salary or other business) is lesser than Rs 2 lks, you don’t need an audit even if your profit is less than 8% of your turnover or if turnover for the year is > Rs 1 crore

I will explain the terms in detail

Turnover according to equity

Now, in the above text we used a word called turnover

It is not the usual commerce term.

Turnover in taxation is a little different.

  • For Intraday equity — absolute sum of settlement profits and losses per scrip
  • For Delivery equity — sell side value of the stock
  • For F&O (Equity, Currency, Commodity) — absolute sum of settlement profits & losses for F&O) per scrip and the sell side value of option contracts

In fact, we need to use a more specific term called *Profit turnover*

Now, let find out how profit turnover is calculated.

Lets say, you got a profit of Rs. 100 on Day 1

And then, on second day, you got a loss of Rs. 50

So, the net profit is + Rs 100 - Rs 50 = Rs 50

But, for the sake of calculating profit turnover,

u need to take absolute values of the above two transactions

So, Profit Turnover on Day 1 = Rs. 100

Profit Turnover on Day 2 = Absolute value of - Rs. 50 = Rs. 50

So, total Profit Turnover = Rs 100 + Rs 50 = Rs 150

This means that as we keep trading day by day,

the profit turnover only keep increasing

irrespective of you making profit or loss.

This means, our pressure will only keep going upwards

ignore the sign and take it as a positive value.

So, -50 is treated as just 50

On Day 1, it is 100

on Day 2, it is 50

So, total is 100+50 = 150

This is profit turnover

Now, on Day 3, i again got a loss of Rs. 40

What will be Profit turnover for Day 3?

Profit Turnover is 190

But what is the actual P/L ?

Yes. 10.

Yes. Profit is Rs. 10

Now, let us calculate 8% of our Profit Turnover

Rs 190 * 8%

Rs 190 * 8 / 100

Rs 15.2

Now, lets read the tax audit conditions

1. Turnover for financial year is > Rs 1 crore

In this case, we have not taken the values of input cost and output cost. So let us ignore this condition.

Lets take the second condition

2. If turnover < 1 crore and profitability is less than 8% of turnover (Section 44 AB)

We can ignore the part "turnover < 1 crore"

Focus on "profitability is less than 8% of turnover"

In our case,

profitability is Rs. 10

8% turnover is Rs. 15.2

So, profitability is less than 8% of turnover

Minimum 8% profitability condition needs to fulfilled even if turnover is above 1 cr. only than audit is needed sir?

If turnover is above 1 cr. audit is compulsary

If turnover is less than 1 cr. , we need to check Minimum 8% profitability condition

Also, if trading + Salary or other business profits are less than Rs. 2 lakhs, no audit is necessary

So, if ur trading + salary income > Rs 2 lakh, which is usually the case with most of us,

Provided turnover is less than 1 Crore?

Minimum 8% profitability condition needs to be checked

Rs 1 crore criteria is not required in trading + sal < Rs 2 lakh case

Understood?

Turnover and Taxation for F&O Transactions

The total of favourable and unfavourable trades would be taken as the turnover

Premium received on the sale of options is also to be included in the turnover

In respect of any reverse trade entered, the difference thereon, should also form a part of the turnover.

Example:

This can be explained with the help of an example. Assuming an F&O Trader enters into the following 2 transactions:-

Purchases 1 Lot of Futures of Reliance worth Rs. 5 Lakhs and sells it for Rs. 5.50 Lakhs thereby receiving a profit of Rs. 50,000.

Purchases 1 Lot of Futures of Tata Motors worth Rs. 2 Lakhs and sells it for 1.90 Lakhs thereby incurring a loss of Rs. 10,000.

In case of the above 2 transactions:-

Total profit = Rs. 50,000 – Rs. 10,000 = Rs. 40,000

Turnover for the purpose of Tax audit = Rs. 50,000 + Rs. 10,000 = Rs. 60,000

Is the Tax audit turnover level changed to Rs. 2 crores?

The change to Rs 2 crore is for business income under presumptive taxation

Starting financial year FY 2016-17 (income tax return filing for AY 2017-18), the turnover limit for businesses which can opt for presumptive income scheme has been increased from Rs 1 crore to Rs 2 crore. For financial year FY 2016-17, audit will apply for businesses with turnover in excess of 2 crore.

There is no change in audit requirement for professionals NOT covered under presumptive scheme.

Anyways, pls contact your auditor for more clarity on this. This is important because not everyone can go for presumptive taxation.

Assignment

Create a new Excel file, name it Accounts

Put the following headers:

Date SpecIn SpecOut TotCharges PL TPL

Here, SpecIn is the total of all ur buys for the day

SpecOut is the total of all ur sells for the day

You can get the above data from the contract notes that your brokers send.

Got it?

We will stop here for today.

In our previous classes, we have dealt with the topics of *Taxation*

Some of our friends asked for a continuation of the topic.

We will discuss few words about them in today's class

Assessment Year

Actually, tax rules are changing almost every year.

So, what apples last year might not be applicable this year in exact manner.

Similarly, what tax rules are applicable this year might not be applicable next year.

The first important thing that we need to consider is Financial Year.

The present financial year starts from April 1, 2016 and ends on March 31, 2017.

So, this FY 2016-17

Well, everyone knows this.

But, in taxation, there is another term used.

It is called *Assessment Year*

The meaning of the term *Assessment* is to check our accounts and *assess* the amount of tax to be paid.

The assement of our accounts can be done only after the completion of financial year.

So, after March 31, 2017, we will check the accounts of FY 2016-17 and then determine the taxes paid / to be paid and then file our returns.

Hence, for the purpose of taxation, there is a term called *Assessment Year*

In general, *Assessment Year* is the *next year for the financial year*.

So, for FY 2016-17, AY will be 2017-18.

Y assessment year. What is the purpose?

It is used to determine our taxes for the business done and file our income tax returns

The idea behind the term is that tax calculations can be correctly arrived only after completion of the financial year.

Question on Assessment year

Question #1

What is the Assessment year for business done in the year 2000-01 ?

Question #2

What is the financial year for the assessment done in the year 2000-01 ?

Taxation is a huge topic that we have so many people involved in the job.

Tax Assistants, Chartered Accountants, Income tax inspectors, Income Tax Officers etc.

And here we are dealing with Income tax. Other taxes such as VAT, Cevnat, Service tax etc. exists as well.

For this class, we shall deal with *taxation for equity* only.

From this year a new and useful tax rule has come.

You can decide on your role - either you are a trader or an investor.

If you are a trader, trading will be treated as your business.

Of course, you can be doing other forms of business as well.

So, when you are transacting in stock markets, you should decide your role.

Capital Gains

Now, there is a new term to be used here - *gains* or more precisely *capital gains*

  • Capital Gains* (CG) is nothing but the profits or losses that come in your business.

For equity shares (and equity mutual funds), the period of holding of the asset is important to determine what tax applies for it.

For instance, i bought a share on 1 July 2016 and sold it on 1 August 2016.

What is the period of holding the share?

More than 1 year? or Less than 1 year?

If the period of holding is less than a year, it is called *Short term*

So, the profits we get in that period are termed *Short term capital gains*

So, tax will have to be paid on the profit according to *Short term capital rates*

Assume that i bought the share for Rs. 1000 and sold it for Rs. 1500

What will be the gain or profit i made?

The *Short term capital gains tax* to be paid is *15% of profit amount*

So, STCG = 15% of Rs 500

= 15 * 500 / 100

= 75

Now, lets see this scenario

For instance, i bought a share on 1 July 2014 for Rs. 1000 and sold it on 1 August 2016 for Rs 1500.

What is the period of holding?

More than 1 year or Less than 1 year?

If the period of holding is MORE than a year, it is called *Long term*

Long-term capital gains on stocks and equity mutual funds are not taxed.

That is, they are exempted from computation of taxation and hence called tax-free.

What is the amount of gain or profit in the above case?

What is the *Long term capital gains tax* to be paid for it?

Now, lets proceed further

It appears to be simple in terms of computing taxes.

But in real practise this is very difficult and sometimes confusing.

For instance, i bought a share on 1 July 2016 for Rs. 1000 and sold it on 1 August 2016 for Rs. 800.

What type of gain do i get?

Yes. It is a *Short Term Capital Loss*

Now, look at these transactions.

In April 2016, i got a *STCG* of Rs. 500

In May 2016, i got a *STCL* of Rs. 200

  • STCG* and *STCL* can be offset with eachother.

So, Rs 500 - Rs 200 = Rs 300.

So, my net is a STCG of Rs. 300

This process of adjusting STCG and STCL is called *Set-off*

We know taxes are to be paid when there are gains or profits.

If, in a financial year, we did several transactions and ultimately, we got a loss. STCL

There is no tax to be paid on a loss. Right?

So, what we do is, we can *carry forward* the loss to the next financial year.

In this case, we are carry forwarding a STCL to the next year.

There are certain rules in regard to be allowed to carry forward.

One most important rule is: You should file ur returns on time!

Our laws give importance to those who are innocent than to punish the troublemaker.

So, if u do not file ur tax returns on time, you cannot claim a carry forward of loss.

Then in the next financial year, if you get an STCG, you can offset the previous years STCL

Of course, provided you carry forwarded and specified so in your tax returns.

Understood?

Carry forward of losses

Now, can i carry forward a STCG to the next year?

The carry forward can be done for up to 8 years.

This is because the taxman knows we make more losses than gains.

Yes. 8 years but if there is a tax audit in any year, you have to show the STCG accounts of all the years.

So, when you make STCG or STCL, better keep a perfect record of your transactions.

Role of indexation

When does Indexation is taken into account?

Indexation doesnt apply on equities. Only on debt securities.

Similar to carry forward of STCL, there is LTCL as well.

But remember, STCL and STCG can be offset. And LTCL and LTCG can be offset.

But, Short Term L/G cannot be offset with Long Term L/G

STT is a totally different tax. It is not related with Income tax. Hence, STT refund is not possible.

If you rarely do intraday, you can try hide and seek and claim as STCG/STCL

But if you are doing it every day on all trading days, better to claim it as your profession / business.

Indexation does to apply to equity shares because:

Long term capital gains from equities are not taxed if shares are sold through recognized stock exchange and Securities Transaction Tax, or STT, is paid on the sale.

The concept of Indexation was brought because it helps to counter the erosion in the value of the asset over a period of time.

I am not aware of indexation applicable on F&O etc.

In my cases, F&O gains/losses are taken as STCG / STCL only.

LTCG cannot be applied on F&O because the contract expires on F&O Expiry date!

I think he just got his accounts audited.

Because, Audit is compulsary if you do even one single F&O transaction.

Foreign stocks, even though equity in nature, are treated as debt securities in India. So on long term debt gains, indexation can be applied.

Whether you make profit or loss, it is important to note the following data in your excel records.

Date of sale transaction

Name of the security

Total Input cost (or cost price)

Total Output price i.e sale proceeds

P/L

PL%

In our previous clasess, we have discussed about turnover profit.

And the situations in which we need to get our accounts audited.

Keeping all these things in mind, go for the appropirate trading / investing that suits you.

We will end the class here today.

Tax Harvesting

Assume that you made pretty good short term gain this year.

You may have to pay a hefty tax on this.

Assume further that you have some share that you purchased this year that is currently in a notional loss.

But you are pretty optimistic that this share will catchup soon.

Now, there is a possibility by which you can reduce your short term capital gains burden.

This method is called Tax Loss Harvesting.

In this method, just before March 31, say on March 28, you sell your optimistic loss making share.

You book a short term capital loss.

We know, that short term capital loss can be offset with short term capital gain.

So you do the offset and thereby reduce your overall short term capital gain and hence pay lesser tax.

Now, on April 1, you buy back the same quantity of the optimistic share and get it back to your demat.

By doing this, you are not losing the share of the company.

Related Topics

Are you an investor or a trader in the eyes of tax authorities? http://prosperotree.com/mrmarket/259-are-you-a-trader-or-an-investor-in-the-eye-of-tax-authorities.html

http://zerodha.com/z-connect/traders-zone/taxation-for-traders/tax-loss-harvesting