Investor Vs Trader: How is income tax imposed on stock market earnings? Know all the important rules of STCG, LTCG and F&O

For crores of people active in the Indian stock market, correct classification of their earnings is the most important step in terms of income tax. In the eyes of the Income Tax Department, not every person who invests money in the stock market is the same. If you buy and hold shares for long or medium term, you are considered an ‘Investor’, whereas if you buy and sell shares on a daily basis (Intraday) or deal in Futures & Options (F&O), you are counted as a ‘Trader’. The rules for calculation of income, tax rates, applicable ITR forms and exemption on expenses are completely different for these two categories. Taxpayers may have to face heavy penalties and income tax notices if they do not know the correct rules.

Tax rules for investors: Complete mathematics of STCG and LTCG

When a person buys shares and takes delivery in his demat account for the purpose of wealth creation or dividend, the profits on the same are considered as ‘Capital Gains’. It is divided into two parts based on the holding period:

• Short Term Capital Gains (STCG – Section 111A): If the listed equity share or equity mutual fund is sold within 12 months (1 year) of purchase, flat tax on profits 20 percent Tax is levied at the rate of Rs. Your normal income tax slab has no impact on this.

• Long Term Capital Gains (LTCG – Section 112A): If shares are sold after holding them for more than 12 months, it is called long term capital gain. The total LTCG up to ₹1.25 lakh in a financial year is completely tax-free. Flats on net profits above ₹1.25 lakh 12.5 percent Tax is payable at the rate of (no benefit of indexation).

• Dividend Income (Dividend Tax): There is no flat tax on dividends received from companies; This is added to the total annual income of the investor and is taxable as per his tax slab.

Tax Rules for Traders: Business Income and Slab Rates

For traders, income from stocks and derivatives is not treated as capital gains, but “Profits and Gains of Business or Profession” (PGBP) That is, it is considered business income. It is divided into two categories:

• Intraday Equity Trading (Speculative Business Income): The profit made by buying shares on the same day and selling them on the same day is considered ‘speculative income’. There is no flat tax rate on this income; This is added to your total taxable income and is taxed as per your applicable tax slab (5%, 10%, 20% or 30%).

• Futures and Options / F&O Trading (Non-Speculative Business Income): Income from derivatives segment (F&O) and commodity/currency trading is considered as ‘Non-Speculative Business Income’ under Income Tax Law. This income is also directly taxable based on your tax slab.

The biggest benefit traders get: Tax deduction on business expenses

Investors can only add the buy-sell brokerage to their costs, excluding STT, but traders are allowed to deduct all their legitimate expenses like a real business:

• Brokerage, Exchange Transaction Charges, GST, Stamp Duty and SEBI Turnover Fees.

• Depreciation on computers, laptops, multi-screen monitors and mobiles used in trading setup.

• Bills for high-speed internet, broadband connection and mobile calling.

• Expenses for trading software, charting tools (TradingView etc.), news subscriptions and financial books.

• Rent of office/room rented for trading, electricity bill and advisory/research consultancy fees.

Selection of ITR form and necessity of tax audit

• ITR Form for Investors: If your income is only from salary, house property and capital gains from shares/mutual funds, then you ITR-2 will fill.

• ITR Form for Traders: If you do intraday or F&O trading, you must ITR-3 will fill. If you are a small trader and choose presumptive taxation (Section 44AD), then ITR-4 Can select.

• Tax Audit Rules (Section 44AB): If your total business turnover (F&O turnover is calculated by summing up profits and losses) exceeds ₹10 crore in case of digital transactions, or if you have shown profits or losses less than the prescribed percentage of turnover by opting out of 44AD, then it is mandatory to get a tax audit done by a Chartered Accountant (CA).

Rules for compensation of losses and carry-forward

It is important to file ITR on time (before July 31) to properly set-off and carry-forward stock market losses:

• Short Term Capital Loss (STCL): This can be adjusted against any short-term or long-term capital gains for the next 8 years.

• Long Term Capital Loss (LTCL): This can be set-off only against long-term capital gains for the next 8 years.

• Intraday Loss (Speculative Loss): It can be adjusted only against ‘Intraday Profit’ (Speculative Profit) for the next 4 years.

• F&O Trading Loss (Non-Speculative Loss): This can be adjusted against any business or capital gains profits other than salary in the same year, and the remaining losses can be carried forward against business profits for the next 8 years.