Back to Chapter List
Chapter 9

Taxation of Commodity Derivatives

Index of Contents:

When an individual trades in equities or F&O, there is taxation at 2 levels. Firstly, when the transaction is executed there is taxation at the transaction level. This is irrespective of whether the trader makes a profit or loss. For example, the exchange charges you Securities Transaction Tax (STT), you pay GST to the government and stamp duty to the state.

However, when you trade in commodities, there are additional taxes because the goods involve actual physical movement and transfer of ownership. Hence apart from GST and the transaction tax, the commodity derivatives also attract other levies like VAT, cess and sales tax.

ROLE OF TAXES IN COMMODITY DERIVATIVE TRANSACTIONS

Taxes are imposed on commodity derivatives for a variety of reasons.

Firstly, it is a source of revenues for the government at the centre and the state. The regulator has been trying to put commodity trading at par with equity trading in terms of incidence of taxation. Taxes are of a direct and an indirect nature.

Secondly, these taxes can be used to direct and adjust volumes. For example, higher taxes and levies can be used to reduce the speculative build up of volumes in a commodity. This is more so if the commodity is one of mass usage.

Thirdly, taxes on commodities are used to make the profit making traders pay a little more by way of taxes.

Last, but not the least, the imposition of a flat CTT creates an audit trail of transactions and makes exercises like Dabba trading almost difficult to implement. This is the same reason for which STT was levied on equities and equity futures & options.

COMMODITY TRANSACTION TAX (CTT)

What do we understand by commodity transaction tax (CTT)? CTT is levied on non-agricultural commodities futures contracts at the same rate as on equity futures that is at 0.01% of the value of the trade. Here again the value of the trade refers to the notional value of the trade based on lot size and applicable transaction price.

  • CTT is payable by both parties—buyer & seller of contract—depending on the contract value in notional terms.
  • Agricultural commodities are exempted from CTT, the tax will be applicable on precious metals like gold, silver; base metals like copper, zinc and energy products like crude oil, natural gas.
  • Trading in spot commodities continue to be exempt from CTT.
  • CTT will apply to commodity futures and exercised options at the notional value while options transactions will attract CTT at the premium value.

CTT is an additional cost to the commodity futures trade and will be part of the contract note prepared by the broker for the same.

WHAT IS STATE VAT AND HOW IT IMPACTS COMMODITY MARKETS

Value Added Tax (VAT) and Sales Tax were charged on physical goods movement by the state. Currently, most of the goods have seen VAT and Sales Tax subsumed into the integrated GST effective from July 01st 2017. Some very specific goods continue to remain outside the ambit of GST, which means that the application of VAT and Sales Tax by the states still continues. Hence it would be instructive to look at the impact that VAT / Sales Tax imposed by states will have on the commodity futures transactions.

Implications of Sales Tax / VAT for commodity futures are broadly as under:

  • Futures contracts are essentially an agreement to buy or sell an underlying commodity at a future date and hence are not liable for payment of VAT/sales tax. What this means is that if the futures contract is settled between the buyers and the sellers prior to settlement date without actually buying or selling the commodities (square up transaction), there is no liability for payment of VAT/sales tax
  • When the commodity futures contract fructifies into a sale and culminates into delivery, liability for payment of sales tax will arise in the State in which the warehouse (into which the goods are lodged by the Constituent) is situated when the commodities delivered to the buyer.

Exchange only regulates the VAT/Sales Tax system not the collection

The Exchange prescribes procedures for payment of sales tax/VAT or other mandi/state local fee applicable to the deals culminating into sale with physical delivery of commodities. These taxes are not applicable to square up transactions that are cash settled.

Clients and brokers must ensure that parties intending to take or give delivery of the commodity are registered with sales tax / VAT authorities in the relevant states where the Exchange has a delivery centre for a particular commodity. Such list of delivery centres is available on the website of the commodity exchanges. In case of non registration, they can appoint a Carrying and Forwarding (C&F) agent who would undertake the activities related to the physical delivery of the commodity.

Brokers who execute delivery deals must maintain records of sales tax/VAT registration of constituents/agents and furnish to the Exchange when required. For the purpose of VAT / sales tax, the seller and the buyer are deemed to have given and taken delivery at the delivery centre accredited by the Exchange. The sales tax/ VAT of the state where the delivery centre is located are applicable to the delivered quantity. The liability of such taxes is on the seller and the exchange or the clearing corporation does not take any responsibility.

Raising sales tax/VAT invoices

Once the sales tax/VAT obligations are determined, the seller has to raise the invoices. Sales tax/VAT will be based on quantity delivered by seller. Delivery value for sales tax/VAT =

Delivered quantity X (Final settlement price + or - Premium/discount for grade).

Here are few key things to remember about the invoicing:

  • Invoice must clearly specify the delivery receipt number, client name and address, trading member-id of the seller and buyer member and if Composite scheme is availed.
  • VAT component of sale consideration must be segregated and clearly specified in the invoice value.
  • Seller clients must generate and send invoices through their buying members within 8 business days of the settlement date. There is penalty for late invoicing.
  • If buyer avails exemption from tax against declaration, certificate must be forwarded to the seller through clearing members within 5 business days after VAT settlement.

HOW GST HAS AN IMPACT ON THE COMMODITY MARKETS

Effective July 01st 2017, India has officially shifted towards a central / all India GST system. The GST is further sub-divided into CGST, SGST, IGST and UGST depending on the location of the buyer and the seller. Unlike the multiple levels and state levies in case of sales tax and VAT, which were subsumed into GST the new system will assist participants of the exchange from different locations to easily take and give delivery at various locations without opening offices in each State. This will reduce operational costs substantially.

Some of the key benefits of the introduction of GST to trading in commodity futures would be as under:

a) GST will catalyze the implementation of the National Agricultural Market (NAM) as it pre-supposes a unified tax structure of goods and services, including agricultural produce. NAM envisages smooth flow of goods across states leading to competitive and transparent prices.

b) These are still early days in the GST learning curve but it could help in resolving bottlenecks creating a unified common agricultural market. These will benefit the exchanges and member brokers to increase business volumes.

c) A lot of the tax arbitrage between states is likely to disappear with GST implementation. Traders don’t require tax registration on the borders of each State. Goods can move across the country smoothly without being stopped at inter-state borders.

GST is definitely a positive step forward as it smoothens the flow of commodities across India and enables seamless movement and pricing of products on an all-India basis.

HOW ARE COMMODITY MARKET PROFITS TAXED

The taxation of trading in commodity derivatives will largely depend on whether we treat it as a business income or capital gains or speculative transaction. In the case of equity derivatives, it is quite clear that the income generated will be in the nature of business income and not speculative income. Can we apply the same logic to commodity derivatives too? Is the tax treatment of commodity derivatives the same as the tax treatment of security derivatives? Here is what we need to know.

  • There are some basic differences between commodity derivatives and security derivatives. Commodity derivatives are traded on commodity exchanges and not on stock exchanges with transactions routed through commodity brokers.
  • While the commodity market transactions were formerly regulated by FMC, currently, both the commodity futures trading and stock futures trading comes under the purview of SEBI only.
  • There is one more aspect of difference. Commodity derivatives can be settled by delivery, unlike security derivatives, which could only be settled by payment or receipt of differences. Even now, the delivery of shares against stock futures is only differentiated by the higher impost of delivery based STT.

Before we get into the speculative income aspect, let us first consider whether the commodity futures income should be capital gains or business income?

Are transactions in commodity derivatives a business with income from transactions taxable as business income, or whether such transactions can amount to investments, with the income taxable as capital gains? The classification would largely depend on the facts of each case. Almost the same set of factors, as in the case of equity futures transactions, will be considered. Some of the key factors include; Are commodity derivatives transactions linked to other business of the individual, frequency of transactions, volume of transactions etc.

The thumb rule is that unless the transaction is one-off, commodity derivatives being short-term products should be regarded as business income only. Of course, one can get the added benefit of expense set-offs including the amount of CTT paid. The benefit of adjusting CTT against income is not available if you consider the commodity market income as capital gains.

CTT and classification of transactions in commodity futures

In the case of equities, the Income Tax Act has linked the concessional rate of tax on capital gains to whether the original transaction was executed on the recognized exchange and STT was paid. Similar logic has been applied to commodity derivative transactions too. Union Budget 2014-15 clarified that an 'eligible transaction' in respect of trading in commodity derivatives carried out in a recognized stock exchange shall not be considered as a 'speculative transaction'.

The logic now is that if the original transaction (buy or sell) was executed in a recognized commodity exchange and CTT was paid on the same, then it would be treated as business income and not speculative income. That raises the issue of what happens to transactions in agricultural futures since it does not attract CTT. The Income Tax has specifically exempted agricultural commodities from the payment of CTT (since they are not levied) and only insists that they be executed on a recognized commodity exchange to be eligible as business income.

SET OFF AND CARRY FORWARD OF LOSSES ON COMMODITY MARKET TRANSACTIONS

Here are some key pointers to know about setting off losses in case of commodity market transactions.

  • The set off and carry forward will depend on whether it is classified as business income or as speculative income. Business losses can be set off against business income and can be carried forwards for a period of 8 years post the assessment year in which the loss arises. However, any delay in tax filing will make you ineligible for the set off.
  • In case of speculative losses, they can only be set off against speculative income and such losses can only be carried forward for a period of 4 years instead of 8 years.
  • Classification of business will largely depend on whether the CTT has been paid at the time of the first leg of the transaction. If the CTT has been paid then the transaction profits or loss becomes business income or loss. The only exception is agricultural income which has been specifically exempted from CTT.

    The above cases pertain to cases where the commodity futures transactions are squared off before the settlement date and there is no physical delivery of the commodity. What happens in case there is physical delivery of the commodity?

  • If transactions in commodities derivatives are settled by taking or giving delivery of the commodity, bifurcation would need to be made between delivery-based and non-delivery-based transactions. Then the profit or loss on each set of transactions would need to be computed separately. Since loss from non-delivery-based transactions in commodity derivatives which are regarded as speculation losses and cannot be set off against any income other than speculation income, such loss cannot even be set off against the profit from delivery-based transactions in commodities, though both may have been transacted at the same time and through the same broker.
  • Since security derivatives transactions are not regarded as speculative transactions by virtue of the explicit exemption, loss from commodity derivatives transactions settled without delivery cannot be set off against the gains made from security derivatives transactions, though both series of transactions may have been made with the same speculative intent. So also such loss cannot be set off against any capital gains, whether from shares or from any other asset.
  • However, day trading losses on shares cannot be set off against commodity profits as the day trading in shares is regarded as speculative in nature and will not classify as business income. It is important to note that the prohibition on set off applies only to loss of a speculation business and not to speculation loss if they are considered as income from other sources.
  • In a case where commodity derivatives are settled by delivery, just as in the case of security derivatives, the date of acquisition or sale of the commodity would be the date of delivery, while the cost or sale price would include the amount paid or received under the derivatives contract. It is important to keep the difference from security derivatives in mind when transacting in commodity derivatives, so that you are not caught unawares when you realise that you have to pay tax on income higher than your actual income, on account of the inability to set off certain losses from commodities derivatives against your other derivatives trading income.

UNDERSTANDING THE COMMODITY MARKET CONTRACT NOTE

The contract note issued by the broker on a daily trading day basis is the official and legal document that the trades have been executed at the said price. For all future reference purposes, for calculation of your tax liability and for any disputes that may arise in the future, it is the contract note that will be the pivotal document. Traders in commodity future are required to scrutinize the contract note details thoroughly and bring any discrepancy to the notice of the broker immediately. There are two parts to the contract note in commodity derivatives. Here is the first part of the contract note.

The first part of the contract contains details of the trade. This includes the details like the exchange where the trade was executed (MCX, NCDEX), the specific settlement number, details of the order no. / trade no / security description with a clear time stamp specifying the time for future audit trails. This section lays out the details of specific trades with the rate per unit, the brokerage cost and the total cost. These must be verified with your own records in the order book / trade book and weekly with the ledger of your account. We now move to the second part of the contract note, which is the portion that covers the charges applicable.

The second section of the contract note puts out the details of the totally cost that will be debited to the trading account. Apart from the brokerage and the CTT at extant rates, this second section will also contain details of other costs like the CGST, SGST, IGST, SEBI Turnover fees, stamp duty (if applicable), exchange charges etc. Along with the item wise and exchange wise breakup, you also get the total payable for the contracts. It is this total amount that gets debited to the commodity trading account and also reflects in your ledger against the specific settlement.

1 2 3 4 5 6 7 8 9