Lottery-Like Taxation On F&O Trading: Why Is Govt Likely To Impose Higher Tax In Upcoming Budget 2024?

As Finance Minister Nirmala Sitharaman is scheduled to present the Union Budget 2024-25 next month, reports are floating that the government is planning to impose higher tax on futures and options (F&O) trading. According to a Financial Express report citing sources, the government is considering two significant steps — reclassifying F&O income from ‘business income’ to ‘speculative income’, and introducing a tax-deducted-at-source (TDS) mechanism.

According to the experts, shifting F&O trading from ‘business income’ to ‘speculative income’ will stop such investors from offsetting losses from other business losses, much like cryptocurrencies. This reclassification would categorise earnings from these derivatives similarly to lottery winnings or cryptocurrency investments, which are currently subject to a flat tax rate of 30 per cent.

TDS will, however, help the government keep track of investors in the F&O market. Such a provision was introduced in the Budget 2023-24 also for cryptocurrencies.

Here’s what is F&O trading and why the government might impose higher taxes on this in the upcoming Budget 2024-25:

What is F&O Trading?

Futures and options (F&O) are financial instruments that allow investors to trade contracts based on the future price of an underlying asset, such as stocks, indices, commodities, or currencies.

Futures Contracts: These are agreements to buy or sell an asset at a predetermined price on a future date. Both parties are obligated to fulfill the contract at expiry unless they close their position beforehand.

Options Contracts: These give the holder the right, but not the obligation, to buy (call option) or sell (put option) an asset at a set price before or at the contract’s expiry.

F&O trading enables investors to hedge against potential market movements, speculate on price changes, and leverage their investments. However, the high leverage involved can lead to substantial losses, making it a high-risk activity for investors.

Why the Government Might Impose Higher Taxes on F&O Trading?

Even as the stock market investments have become popular with the online trading apps, retail investors are more and more falling into high-risk F&O trading. This is leading to huge losses for them, leading to overall dampening of sentiments.

In view of this, the government and regulators have been worried for quite some time about the increased participation of retail investors in the derivatives market.

According to a stock market analyst, “Retail investors usually participate in the futures and options market by getting information on social media platforms, instead of substantive expert advice or research. This leads to huge losses for them as has been witnessed recently.”

Rajarshi Dasgupta, executive director (tax) of AQUILAW, said, “Since the nature of F&O is to transact on a ‘future price of a stock’ at a pre-determined price, this involves more of a speculation like any other speculative transaction i.e., lottery etc. with a pre-determined price set to trade in the future, therefore it would be a bold move to categorise F&O transactions as ‘speculative income’ rather than ‘business income’.”

He added that the government aims to deter excessive speculative activity and promote more cautious trading practices and the retail investors might be encouraged to shift towards more stable investment options like mutual funds, stocks, and bonds, fostering financial stability and wealth creation.

“There will be a hit in the tax perspective as the rate of Income Tax under speculative income will be straight 30% (plus 4% cess) instead of applicable slabs of 5%, 20% or 30% on different slabs of income plus applicability of TDS and profit out of F&O transactions can be offsetted against loss of F&O transactions only resulting in lesser margins in the hands of the dealers,” Dasgupta added.

An investment expert also said the government favors long-term investments over short-term speculation.

“By reclassifying F&O income and introducing TDS, retail investors might be encouraged to shift towards more stable investment options like mutual funds, stocks, and bonds, fostering financial stability and wealth creation,” he added.

He added that the move might also rein in market volatility as leveraged F&O trading often results in high market volatility. Also, excessive speculative trading poses systemic risks to the financial system.

The expert also said the move will also align India’s F&O trading with global F&O trading rules. “In many developed countries, F&O trading income is treated differently from regular business income. For example, the US IRS Section 1256 categorises certain futures and options with distinct tax rules.”