Tax Treatment of Gains from Equities: FO and EDO as Business Income or STCG

When filing your Indian Tax Return (ITR), you often encounter questions about how to classify your income and gains. One of the common inquiries revolves around whether the gains from equity delivery order (EDO) and frequency of option (FO) trades should be treated as business income or short term capital gains (STCG).

Classifying Gains as STCG or Business Income

Yes, you can treat the income from FO trades as STCG, similar to gains from EDO trades. However, it's important to note that if the frequency of trading is high, the Assessing Officer (AO) may classify these gains as business income rather than capital gains. The distinction between high and low frequency trading is not explicitly defined in the Income Tax Act. Therefore, it is subject to common interpretation and may depend on the circumstances of each individual case.

For instance, if an individual engages in frequent trading activities, the AO may consider this a business activity. Conversely, if trades are infrequent, they are more likely to be treated as capital gains. This subjectivity means that the classification can be complex and should be carefully considered.

Intent and Consistency in Classification

A critical aspect to remember is the intent behind the classification of gains. If you classify gains from shares as either business income or capital gains, you must be consistent in your approach. For example, if you decide to treat the profits from FO trades as business income in one year, you should not claim these as STCG in another year. This inconsistency can lead to complications and potential disputes with the tax authorities.

As per the Central Board of Direct Taxes (CBDT) circular, individuals can maintain two separate accounts for the sale and purchase of shares: one for investment purposes and another for business purposes. The nature of the gain in these accounts depends on the holding period of the shares. For investment purposes, gains can be either short-term or long-term based on the holding period. For business purposes, gains are considered business profits, and regular auditing may be required if the turnover exceeds the specified limits.

It’s also worth noting that some individuals have suggested that gains from both EDO and FO transactions can be treated as business income. However, according to Sujit Bangar, Founder, such gains from FO investments are treated as income from business speculation and cannot be classified as STCG. This further emphasizes the importance of adhering to the formal regulatory framework and maintaining consistency in your transaction classification.

Conclusion

The classification of gains from EDO and FO trades as business income or STCG is critical for tax planning and compliance. While there is some flexibility, it is advisable to maintain a consistent approach and stay within the guidelines set by the Income Tax Act and the instructions from the CBDT.

For a comprehensive understanding and to avoid potential disputes, it is recommended to seek professional advice from a tax consultant or an authorized chartered accountant.