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Why does being an investor or a trader matter to your tax liability?

11 Sep 2023

Today, there is taxation levied on every financial transaction made. Whether you purchase or sell products or services, taxation applies to every aspect of life. Taxation also applies to investment, and may affect how you invest in any instruments. For instance, your investment holding duration is indicative of the tax you may have to pay and how you may have to deal with taxation in general.  For instance, if you are engaged in intraday trading, you may not be taxed in the same way as an investor who holds a stock for a longer tenure. 

How to Approach Share Trading, Investing and Taxation

The common and intuitive approach is to consider a person with a long term perspective as an investor and a person with a shorter term perspective as a trader. But from a taxation standpoint, there is a deeper significance to this distinction. Taxes on intraday share trading are very different from delivery trading. Similarly, intraday trading taxation classifies it as speculative business income while a BTST is classified as non-speculative business income. Taxation for investors in equities is quite straightforward and has been well documented although we will also look at that for understanding purposes. This is more a tax guide for traders, who need to understand a plethora of nuances pertaining to taxation of equities.

First, how are equity investments taxed?

It is a commonly known fact that any income that is earned out of a salary, an income from rent, and a business is due to be taxed. The question is, is the selling or the buying of shares taxed too? Several retirees and homemakers buy and sell shares, but they seem confused about how the transactions are taxed. In this sense, it is important for any investor to know that any loss or income from the sale of stocks is viewed within the taxation header of “Capital Gains”. If you happen to come across an investment or day trading guide, you will discover that taxation will be linked to the header of “Capital Gains”, classified further into two kinds - long-term and short-term capital gains. The main categorisation is done on the basis of how long an investor holds equity for. This duration is measured as the date of the start of holding until the transfer or sale date. 

It is important to note that the period of holding of stocks and securities matter. These periods of holding have different and distinctive implications for various classes of assets. For the purpose of the levying of income tax, the periods of holding of equity shares (listed shares) and mutual funds of equity are different from those concerning mutual funds of debt. Taxability, hence, changes too. 

Equity investments are fairly straightforward. All profits made within a period of 1 year will be treated as short term capital gains and will be taxed at the rate of 15% of the profit. However, if the stock is held for a period beyond 1 year then it is classified as long term capital gains. In that case the profits are entirely tax-free. Since long term gains are tax free, there is no question of carry forward of long-term capital losses. However, short term capital gains are taxable and hence short-term capital losses can be carried forward for a period of 8 years from the financial year in which the losses arise. This is the simplest form of treating profits / losses on shares. When you file your income tax returns every year, these profits or losses under LTCG and STCG can be shown under the capital gains section and the tax will be paid on the appropriate amount.

What is the Securities Transaction Tax (STT)?

In case you are an investor in stock, you should additionally know about the STT, the Securities Transaction Tax. This may be applicable to both traders (who essentially carry out a transaction, even for the short term) and investors in the share market for the long haul. The STT stands applicable to any equity stocks which are purchased or sold by way of a stock exchange. These are listed stocks. This tax is something that no investor or trader can avoid. So, tax on intraday trading and that on investing for the long term has some commonality with respect to STT. 

Adding the complication of business income versus capital gains

The mention of showing capital gains as part of your income statement is the simplest way of filing your capital gains returns. But there are cases when the profits or losses from your share trading cannot be shown under the capital gains segment of your Income Tax Returns. When you are predominantly a trader or most of your equities are held as stock-in-trade, then these profits / losses from shares will have to be shown as business income and returns must be filed accordingly. While there are no hard and fast rules to distinguish between normal capital gains and capital gains as business income, there are some basic parameters that the Act has laid out.

If the volume of digital share trading transactions exceeds Rs.2 crore in any financial year then you have to get an audit done and then your auditor may insist that you file this income as business income.

There is also a profit threshold that has been fixed of 6%. If the profit is below 6% of the total volumes done, then that is also considered as a fit case for treating the incomes from stocks and shares as business income rather than as regular capital gains.

Lastly, the principle of materiality is applied. If the income from share market activity accounts for a significant chunk of your overall income, then you will have to show your share market activity as business income rather than as capital gains.

Speculative Income versus non-speculative business income..

Once the above criteria are applied and you are clear that your income from shares and stocks has to be classified as business income, the next step is to distinguish between speculative income and non-speculative business income. Let us consider the following points here.

All intraday trades will be classified as speculative income. Whether you buy in the morning and cover by evening or whether you sell in the morning and cover in the evening, the transaction remains a speculative transaction. That is because an intraday transaction does not result in delivery of shares and therefore becomes speculative by definition.

BTST (Buy today and sell tomorrow) and STBT (sell today and buy tomorrow) exist in a slightly grey area. While they are speculative in nature they do result in delivery of shares although the trader does take on the short delivery risk in BTST and STBT trades. Hence BTST and STBT can be classified as non-speculative business income.

We come to the all-important subject of trading in F&O. While F&O does not result in delivery, they are intended to hedge the risk of your underlying. Hence it has been specified that income from F&O shall be classified as non-speculative business income.

Why this classification is important from a practical point of view

When you are filing as business income, there is no fixed rate of tax payable. You are taxed at your peak rate applicable. Both the speculative income and non-speculative business income are clubbed under the head of business income and added to your salary and the gross figure is taxed. However, the difference arises in carry forward and set-off. For example, accumulated non-speculative business losses can be written off against non-speculative business profits or even against speculative income. But the reverse does not hold true. Speculative losses can only be written off against speculative profits and not against non-speculative business income.

Subtle classifications of business income and speculative transactions lie at the core of this tax guide for traders. Taxes on intraday share trading are in the form of speculative income. When you understand intraday trading taxation, it helps you better understand the concept of effective returns.

Taxation is a Must

The Central Board of Direct Taxation has offered taxpayers the facility of choosing how to treat any income that is earned by them. However, once the investor selects how their income is to be treated, then the taxes that are applicable have to be mandatorily paid by the investor. Additionally, the same process of taxation has to continue for subsequent years in which the investor is taxed, unless it can be shown that there is a predominant change in case circumstances. This choice is made and is applicable to securities and shares that are listed shares on stock exchanges. 


Related Articles: How to Open a Demat Account Without a Broker | Factors to Keep in Mind While Opening a Demat account | Factors to Consider When Opening a Demat Account | 10 Points to Remember When Operating your Demat Account 


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