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.
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.
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 an additional cost to the commodity futures trade and will be part of the contract note prepared by the broker for the same.
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:
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:
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.
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.
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.
Here are some key pointers to know about setting off losses in case of commodity market transactions.
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?
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.