Chapter Notes

Chapter 9: Accounting & Taxation

NISM Series VIII — Equity Derivatives | 5% weightage | ~5 exam questions

What this chapter is about

Most students dread this chapter — accounting and tax sounds complicated. But for the exam, it's actually 5 very specific, very memorisable facts. The questions are almost always the same: how do you account for option premiums, what's the STT rate, how many years can you carry forward derivative losses? Know these cold and move on.

Key concepts

Taxation of Derivatives — the big picture:

• F&O trading income = treated as BUSINESS INCOME (not capital gains)
• This applies regardless of how frequently you trade
• Since it's business income, it's subject to normal income tax slabs
• STT (Securities Transaction Tax) is applicable

STT Rates — must memorise:

The most tested: futures STT = 0.02%

Loss treatment — carry forward rules:

• F&O losses = non-speculative business losses
• Can be set off against any other income EXCEPT salary income in the same year
• If not fully set off → can be carried forward for 8 assessment years
• Carried forward losses can be set off ONLY against non-speculative business income in subsequent years
• Key: F&O is NOT speculative (unlike intraday equity which IS speculative)

Accounting for options:

For the option BUYER:

• Premium paid = treated as a DEBIT (expense/asset)
• On exercise: favourable difference received = recognised as INCOME
• If option expires worthless: premium written off as expense

For the option SELLER (writer):

• Premium received = treated as INCOME (credit to P&L)
• On exercise: adverse difference paid = recognised as LOSS

Accounting for forward contracts (hedging):

• If forward is for HEDGING: premium/discount (difference between spot rate and forward rate) should be amortised over the life of the contract (not recognised upfront)
• Exchange differences recognised in P&L of the relevant period
• Profit/loss on cancellation/renewal = recognised in P&L of that year

Real market example — Tax calculation

Trader buys 2 lots of Nifty futures at 24,000 and sells at 24,500. Lot size = 75.

Profit = (24,500 − 24,000) × 75 × 2 = ₹75,000

This ₹75,000 is BUSINESS INCOME, taxed at applicable income tax slab (30% if he's in highest bracket = ₹22,500 tax).

STT on sale = 24,500 × 75 × 2 × 0.02% = ₹3,675 × 0.02% = ₹735

Loss scenario: If he made a ₹2 lakh loss in F&O this year. He has ₹5 lakh salary income and ₹3 lakh income from a business.

• F&O loss cannot be set off against salary (₹5L untouched)
• F&O loss CAN be set off against business income: ₹3L − ₹2L = ₹1L taxable
• Remaining ₹0 (all offset). If any remained, could carry forward 8 years.

Trap Alert

Trap 1: "F&O losses can be carried forward for 5 years" → FALSE F&O losses carry forward for 8 assessment years. Not 5, not 10. 8.

Trap 2: "F&O income is taxed as capital gains" → FALSE F&O income = BUSINESS INCOME. Capital gains applies to delivery-based equity transactions.

Trap 3: "Option seller treats premium received as a liability" → FALSE Option seller treats premium received as INCOME (credit to P&L immediately).

Trap 4: "Option buyer treats premium paid as income" → FALSE Premium paid by buyer = EXPENSE/ASSET (debit). Income comes only on favourable exercise.

Trap 5: "STT on futures is 0.1%" → FALSE STT on futures = 0.02% on turnover. 0.1% is for options premium. Don't mix these up.

Trap 6: "Forward contract premium for hedging is recognised upfront" → FALSE For hedging forwards, the premium/discount is AMORTISED over the contract life — not recognised all at once.

Must-remember rules

• F&O income = Business Income (NOT capital gains)
• STT on futures sale = 0.02% on turnover
• STT on options sale = 0.1% on premium
• F&O loss carry forward = 8 assessment years
• F&O losses CANNOT be set off against salary income
• F&O losses can be set off against other non-speculative business income
• Option seller: premium received = INCOME
• Option buyer: premium paid = expense (income on exercise)
• Hedging forward: amortise premium/discount over contract life
• F&O = non-speculative business (unlike intraday equity = speculative)

Weightage note

5% = ~5 questions. Typically 2 questions on tax/carry forward, 2 on option accounting, 1 on STT rates. All very specific facts — know the numbers exactly (8 years, 0.02%) and you score full marks.

Quick revision — 60 second scan

• F&O = business income, NOT capital gains
• STT futures = 0.02% | STT options = 0.1% on premium
• Loss carry forward = 8 assessment years
• Cannot set off F&O loss against salary
• Option seller: premium = INCOME
• Option buyer: premium = expense, gain on exercise = income
• Hedging forward: amortise premium over contract life
• F&O = non-speculative business loss