Currency Chapter Notes

Chapter 9: Accounting & Taxation of Currency Derivatives

NISM Series I — Currency Derivatives | ~6% weightage | ~42 questions

What this chapter is about

Almost identical to Series VIII CH9 — same tax treatment, same carry forward rules, same ICAI guidance. The key differences: currency derivatives have additional accounting standards (AS 30 for hedging), and the presumptive taxation rates are 6%/8% (same as equity F&O). Know the speculative vs non-speculative distinction cold — it's the most tested concept here.

Tax treatment

Exchange traded currency derivatives = NON-SPECULATIVE BUSINESS INCOME

Even though physical delivery doesn't happen (cash-settled), exchange-traded currency derivatives are specifically excluded from the definition of "speculative transaction" under Section 43(5) of the Income Tax Act.

This means:

• Income is taxed as profits and gains from business and profession
• Losses can be set off against any NON-SPECULATIVE business income
• Losses CANNOT be set off against salary income
• Unabsorbed losses can be carried forward for 8 assessment years
• Carried forward losses set off ONLY against non-speculative business income in future years

What IS speculative: A transaction settled otherwise than through actual delivery or transfer — EXCEPT derivatives on recognised exchanges. Intraday equity trading is speculative.

Carry forward rules summary

Presumptive taxation (Section 44AD)

For small traders with turnover ≤ Rs 2 crores, can declare profit as percentage of turnover instead of calculating actual P&L:

• 6% of turnover — if receipts are in cheque or digital modes
• 8% of turnover — if receipts are in cash

This declared profit is treated as taxable income without requiring detailed books of accounts.

ICAI Guidance Notes on Accounting

ICAI (Institute of Chartered Accountants of India) issues guidance notes on accounting for derivatives contracts. NOT SEBI, NOT RBI, NOT ICSI.

Key accounting principles:

All derivatives recognised on balance sheet at fair value — derivatives cannot remain off-balance-sheet items.

For speculative/trading derivatives:

• Reported as CURRENT ASSETS and CURRENT LIABILITIES (marked to market, short-term)

For hedging derivatives: Three types of hedge accounting recognised:

1. Fair value hedge — hedging changes in fair value of recognised assets/liabilities or firm commitments
2. Cash flow hedge — hedging cash flow risk of future transactions or foreign currency firm commitments
3. Net investment hedge — hedging net investment in a foreign operation

Accounting heads for clients: Two separate accounting heads must be maintained:

1. Initial margin — Currency futures (the margin deposit)
2. Mark to market — Currency futures (the daily P&L)

MTM accounting treatment

For brought forward futures positions: Computational methodology = difference between PREVIOUS day's settlement price and CURRENT day's settlement price × contract size × number of contracts.

NOT using original trade price for brought forward positions — always prior day's settlement vs current day's settlement.

Real market example

A Hyderabad exporter uses USDINR futures to hedge USD receivables. They sell 100 lots at Rs 84. By end of quarter, the position is up Rs 5 lakhs (favourable MTM). This Rs 5 lakhs is:

• Recognised as business income (non-speculative)
• Taxed at normal business income rates
• Can be offset by losses in the same or future years from F&O activity

If instead they had a Rs 3 lakh loss:

• Not a speculative loss — it's non-speculative business loss
• Can be set off against their export income (which is also business income)
• If unutilised, carried forward for 8 years

Trap Alert

Trap 1: "F&O loss can be set off against salary income" — FALSE F&O losses are non-speculative business losses. Cannot set off against salary. Only against other business income.

Trap 2: "F&O loss carry forward = 4 assessment years" — FALSE F&O = 8 assessment years. Speculative (intraday equity) = 4 years. Don't mix these up.

Trap 3: "All derivatives = speculative transactions" — FALSE Exchange-traded derivatives on recognised stock exchanges = NON-speculative. OTC cash-settled = potentially speculative.

Trap 4: "SEBI issues guidance notes on accounting" — FALSE ICAI issues guidance notes on accounting. SEBI issues regulations, not accounting guidance.

Trap 5: "Derivatives remain off-balance-sheet" — FALSE All derivatives must be recognised on balance sheet at fair value per ICAI guidance.

Trap 6: "Presumptive taxation = 8% for digital receipts" — FALSE Digital receipts = 6%. Cash receipts = 8%. The higher rate is for cash.

Must-remember rules

• Exchange traded currency derivatives = NON-speculative business income
• Carry forward loss = 8 assessment years (not 4)
• Cannot set off against salary income
• ICAI issues accounting guidance (not SEBI, not RBI)
• All derivatives on balance sheet at fair value
• Speculative/trading derivatives = current assets/liabilities
• Three hedge accounting types: fair value, cash flow, net investment
• Two accounting heads: Initial margin + Mark to market
• MTM for brought forward = today's settlement − yesterday's settlement
• Presumptive taxation: 6% digital, 8% cash (Section 44AD, turnover ≤ Rs 2Cr)

Weightage note

~6% = ~42 questions. Speculative vs non-speculative appears 2-3 times per exam. Carry forward period (8 years) appears 1-2 times. ICAI accounting guidance appears 1-2 times. Presumptive taxation rates appear 1-2 times. Hedge accounting types appear occasionally as harder questions.

Quick revision — 60 second scan

• Exchange traded F&O = non-speculative business income
• Loss carry forward = 8 years (F&O) vs 4 years (intraday equity)
• Cannot set off F&O loss vs salary
• ICAI = accounting guidance (not SEBI/RBI)
• All derivatives on balance sheet at fair value
• Speculative = current assets/liabilities
• Hedge types: fair value, cash flow, net investment
• Presumptive: 6% digital, 8% cash