Lottery-like taxation: Fear grips F&O traders as 30% tax likely on transactions in budget

It appears that the government has taken a serious note of the increasing number of retail investors losing their hard-earned money in futures and options (F&O) trading, influenced by social media influencers who promote F&O trading and mislead them about potential profits.

According to a recent report in the Financial Express, the Modi government is considering reclassifying futures and options transactions from ‘business income’ to ‘speculative income’. This reclassification would place earnings from these derivatives in the same tax category as lottery winnings or cryptocurrency investments, which currently attract a flat tax rate of 30%.

If the government implements this proposal in the budget, it would mean that profits from futures and options (F&O) trading can only be offset against F&O losses and not losses from any other business income.

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The F&O trading community, especially retail traders, has expressed dissatisfaction with this potential change, saying that it could unfairly burden traders. However, there are others who think such measures could be beneficial especially because over the last couple of years there has been a significant increase in speculative retail participation in F&Os.

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What is F&O trading?

Futures and Options are derivative contracts that offer investors the ability to take substantial positions in stocks, commodities, or currencies with a relatively small amount of capital. This leverage provides the potential for significant profits, but it also entails higher risks. Sometimes, gains can accumulate rapidly like building a castle of money, but losses can also occur swiftly, akin to the castle crumbling like sand.

Derivative contracts, such as futures and options, derive their value from underlying assets. In futures and options trading, when you purchase a derivative, its value is tied to the underlying asset, such as a share. These contracts have fixed durations during which their prices fluctuate based on changes in the price of the underlying asset. Thus, the value of a futures or options contract mirrors the value of the asset it represents during the contract period.

How will a potential hike in taxes on F&O trades impact traders?

The proposed increase in taxes on F&O transactions is likely to have a significant impact on the market and the trading community. Currently, F&O transactions are taxed as business income, which allows traders to offset gains against other business losses.

Commenting on the development, Sakchi Jain, CA, said, “Reclassifying these transactions as speculative income with a flat 30% tax rate would not only increase the tax burden but also restrict the offsetting of losses to other speculative activities like cryptocurrencies.”

By this move, the government aims to discourage retail participation in the F&O segment, which has seen a surge in recent years, she added. “Many retail investors enter the market without adequate research to make quick profits quick profits. By imposing a higher tax rate, the government wants to promote more informed investment decisions,” Jain said.

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Concerns over retail investor participation

For the past some time, there have been concerns over the rise in the number of retail investors participating in the derivatives market. There are apprehensions being raised that in the event of market corrections, retail investors might face substantial losses. This is the main reason why the Centre might hike tax on F&O transactions.

On this, CA Jain said that this could also lead to reduced liquidity and trading volumes in the F&O market, as higher taxes may deter active traders. “The introduction of tax deducted at source on F&O trades would further tighten regulations, helping the government monitor trading activities more closely,” she added.

However, there is a concern that increased taxes could drive retail investors towards unregulated and potentially riskier investment avenues, where they may seek higher returns without the oversight provided by formal markets. This shift could undermine the initial goal of protecting retail investors.

Institutional investors, constituting a substantial segment of the F&O market, may reconsider their strategies in light of these developments. The heightened tax burden could influence their risk-reward assessments, potentially impacting market dynamics and volatility. Additionally, this may lead to increased operational costs and complexities, particularly for smaller market participants.

Conclusion:

Overall, while the aim of this proposal will be probably safeguarding retail investors and ensuring market stability, it will be crucial to strike a balance with maintaining a dynamic and liquid derivatives market.