If you have invested in the Index Long Term Strategy, then you must be aware of how your gains will be taxed when the financial year ends in March. In this article, we will explain the provisions of the income tax law to you and give you full clarity about the tax provisions applicable to Index Long Term Strategy (ILTS).
In ILTS, we primarily invest in three segments as follows:
- 30% in equity (i.e., in Index Exchange Traded Funds)
- The remaining amount is invested in debt (i.e., in Bharat Bonds etc.).
- Hedging positions are taken in futures and options segment.
These three are taxed in different ways in India. Let us understand each in detail.
Taxation of Equity
The equity component of your portfolio attracts a long-term capital gains tax of 10% if you hold it for one year or more. However, you will get the first Rs 1 lakh of the gain as a deduction.
Therefore, if you have held your portfolio for more than 1 year and sold it this year, then you will be liable to long term capital gains tax on the profit that you make.
Taxation of Debt
In the case of debt, you get the benefit of long-term capital gains if you hold your portfolio for more than 3 years. Therefore, if you have sold your holdings in Debt or Bonds which you have held for three years, then you will have to pay long term capital gains tax.
You will be subject to indexation and the gain will be taxed at 20%.
However, due to the indexation benefit that you get, you will save by paying tax on almost 50% of the gains. Keeping this in mind, your actual tax liability will come to around 10%.
Taxation of Futures & Options
We buy futures or synthetic futures in your portfolio and hedge the positions by buying long Put Options. Any gains made from all these trades done in the derivatives segment will be taxed as business income.
How To Calculate Turnover of Futures And Options Trades?
According to section 44AB of the Income Tax Act 1961 any person whose business turnover exceeds 10 crore needs to get his/her accounts audited.
To understand this, we need to first understand how turnover is calculated in the case of derivative trades.
As per the guideline of the income tax act, turnover will be the total of
- Profit and loss: This is calculated as total profit – total losses in the derivative trades.
- Premium received on sale of options
Let us understand this with the help of an example.
Suppose you did the following transactions:
| Script | Open Qty | Open Rate | Buy Qty | Buy Rate | Sell Qty | Sell Rate | Close Qty | Close Rate |
| 10500 CE | 0 | 0 | 75 | 100 | -75 | 200 | 0 | 0 |
| 11500 CE | 75 | 300 | 0 | 0 | -75 | 100 | 0 | 0 |
| 11500 CE | 75 | 300 | 75 | 100 | -150 | 300 | 0 | 0 |
In the case of the first trade, you bought 75 lots of 10500 CE at 100 and sold them at 200.
For the purpose of calculating turnover, the buy side of the state will not be considered and only the sold premium of Rs 15000 (i.e., Sell Quantity x Sell Rate) will be treated as a turnover.
Along with that the profit from the trade, i.e., (75 * (200-100)) = Rs 7500 will also be taken as the turnover
Therefore, the total turnover will be Rs (15000 + 7500) = Rs 22500.
The same will be done with all the other trades. The calculation will be as follows:
| Script | Sold premium | Profit/loss | Turnover |
| 10500 CE | 15000 | 7500 | 22500 |
| 11500 CE | 7500 | -150000 | 22500 |
| 11500 PE | 45000 | 15000 | 60000 |
| 105000 |
The good news is that for all the customers of Index Long Term Strategy this turnover will be very small since they are not trading directly in futures.
If they would have traded in futures, then the turnover per lot would be close to Rs 10 lacs. However, in the case of options, the premium is only considered. Hence the turnover value is quite reasonable.
Documentation For Taxation
You should keep Ledger, Contract notes, profit and loss calculation report, Finideas fees invoice for maintaining proper documents for taxation purposes. We will send you profit and loss calculation report that you will need in due course of time after 31st March.
Provisions for Tax Audit
As mentioned earlier, the Income Tax Act says that you need to get your tax audit done if your turnover exceeds Rs 10 crores per year.
Will You Be Subject to The Presumptive Taxation Scheme of Sec 44AD?
Many of our customers often ask us whether they will be taxed if they do not show their profit at a flat rate of 6% of the total turnover.
The answer is ‘no.’ Section 44AD of the income-tax act has introduced this presumptive taxation scheme specially for retail traders. It says that if a retail trader has a turnover of less than 2 crores then they can pay taxes at the rate of 6% and will be exempt from a tax audit.
The condition for availing of this benefit is that not more than 5% of the total transaction should be made in cash. The rest must be through bank transactions.
Our customers will never have to go for a tax audit since the turnover in your portfolio will never go beyond Rs 10 crores. Let us understand this with a few examples:
Example 1:
| First trading year: 2020 – 21 |
| Turnover: 75 lacs |
| Loss: 2 lacs |
| Result: Audit not required |
| Reason: Turnover is within specified limits |
In this case, you can carry forward your losses for 8 years and set it off in the year when you make a profit. There is no need for a tax audit.
Example 2:
| First Trading Year: 2020 – 21 |
| Turnover: 75 lacs |
| Profit: 5 lacs |
| Result: Audit not required |
| Reason: Turnover within specified limits |
In this case, also you need to pay the tax on the profit of Rs 5 lacs. There is no need for an audit.
Example 3:
| First Trading Year: 2020 – 21 |
| Turnover: 4 crores |
| Loss: 20 lacs |
| Result: Audit not required |
| Reason: if the 5% condition related to cash transaction specified above is fulfilled. |
In this case, the turnover is of Rs 4 crore, so it does not fall within the provisions of section 44AD. You can carry forward the loss of Rs 20 lacs for the next 8 years and set it off against the profits that will be in the future.
Example 4:
| First Trading Year: 2020 – 21 |
| Turnover: 12 crores |
| Profit: 1 crore |
| Result: Audit Required |
| Reason: turnover exceeds the permissible limit of 10 crores. |
As you can see in this case you have exceeded the permissible limit of Rs 10 crores. Hence you will have to get your accounts audited.
We hope that this discussion was useful, and it cleared all the doubts that you had regarding how Index Long Term Strategy is taxed. Feel free to get in touch with your relationship manager if you have any further queries.
Happy Investing!
This article is for education purpose only. Kindly consult with your financial advisor before doing any kind of investment.