F&O, Shares, Mutual Funds, and AIFs — Tax Audit, Turnover, and Reporting Guide under Section 44AB and Form 3CD
The New Investment Spectrum and Tax Audit Complexity
The tax treatment of income from securities has evolved beyond simple “capital gains vs business income.”
Today’s taxpayer may deal simultaneously in:
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Equity delivery transactions (shares held as investment or stock-in-trade),
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Intraday equity trading (speculative business),
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Futures & Options (F&O) (non-speculative business u/s 43(5)(d)),
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Mutual Funds (equity/debt),
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Alternative Investment Funds (AIF Category I, II, III),
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Portfolio Management Schemes (PMS),
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ESOP/ESPP/RSU gains, and
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Buyback, bonus, rights, OFS, and tender offers.
Each has distinct turnover logic, income head, and audit relevance under the Income-tax Act and Form 3CD.
Classification of Income — The Starting Point
Before evaluating tax audit applicability, classification of income must be determined:
| Activity Type | Legal Basis | Income Head | Remarks |
|---|---|---|---|
| Delivery-based share trading (investment) | Sec. 45 | Capital Gains | Short-term if held ≤12 months; Long-term otherwise |
| Delivery-based share trading (business) | Sec. 28 | Business Income | If frequency, intent, and volume indicate trading |
| Intraday equity trading | Sec. 43(5) | Speculative Business | Profit/loss under PGBP; Turnover = absolute sum of profits & losses |
| F&O (derivatives) | Sec. 43(5)(d) | Non-speculative Business | Treated as regular business |
| Mutual Funds | Sec. 10(23D), 115AD | Capital Gains / Dividend | Not business unless held as stock-in-trade |
| AIF Category I & II | Sec. 115UB, Rule 12CB | Pass-through income | Nature retained (business/capital) at investor level |
| AIF Category III | Sec. 10(23FBA)/(FBB) | Taxed at Fund Level | Investor taxed on distributions |
| PMS Portfolios | Judicial precedent (e.g., Radials International, ITAT Delhi) | Capital Gains (generally) | Unless trading characteristics dominate |
| ESOP/RSU/ESPP | Sec. 17(2)(vi), 49(2AA) | Salary (on exercise) & Capital Gains (on sale) | Separate computation under both heads |
Turnover Computation & Tax Audit Applicability (Section 44AB)
Delivery-Based Equity Trading
If shares are held as investment, sale is capital gain — not part of turnover.
If held as stock-in-trade, sale proceeds minus cost is business turnover.
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Turnover basis: Aggregate of sales value (not absolute profit) if frequent trading.
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Tax audit: Triggered if business turnover > ₹10 crore (if digital >95%) or ₹1 crore (if <95%).
Intraday (Speculative) Trading
Per ICAI Guidance Note (2023):
Turnover = Absolute sum of profits and losses.
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Example:
Profit ₹3L + Loss ₹1.2L → Turnover = ₹4.2L. -
Tax audit: If turnover > threshold or profit < presumptive % (6%/8%) and opted out of 44AD.
F&O Transactions
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Defined as non-speculative business u/s 43(5)(d).
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Turnover basis (ICAI GN Para 5.10(b)):
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Absolute profit/loss of each contract,
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Plus premium on sale of options,
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Plus any differences on open position settlement.
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No 6% or 8% presumptive condition where digital transactions >95%.
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Tax audit exempt if turnover ≤ ₹10 crore and digital payments exceed 95%.
Clause-wise:
| Clause | Particular | Implication |
|---|---|---|
| 8A | Nature of business | “Derivative trading (non-speculative)” |
| 40 | Turnover disclosure | Computed per ICAI GN |
| 44 | Mode of transactions | Verify >95% digital for exemption |
| 32(a)/(b) | Loss carry-forward | Non-speculative business loss up to 8 years |
Mutual Fund Investments
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Treated as capital asset; not included in turnover.
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Taxed as capital gains u/s 45 read with 111A/112A.
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Audit: Not applicable since not “business activity.”
Disclosures in Form 3CD:
| Clause | Disclosure |
|---|---|
| 14 | Investments in MF |
| 18 | Income not chargeable under business head |
| 32(b) | Carry forward of capital losses (if any) |
AIFs (Alternative Investment Funds)
Category I & II (Pass-through)
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Income taxed in hands of investor, nature retained.
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If AIF income = business, include in turnover.
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If AIF income = capital gains, no turnover impact.
Category III (Taxed at fund level)
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No pass-through; investor taxed on distribution only.
Reporting:
| Entity | Applicability | Reference |
|---|---|---|
| AIF (as Trust) | 44AB if total receipts > ₹10 Cr | Section 115UB(4) |
| Investor | Only disclose share under Clause 14/18 | Form 64C/64D |
PMS & Advisory Portfolios
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Gains from PMS-managed equity are generally capital in nature unless systematic churning is proven.
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Hence not part of turnover.
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Tax audit not applicable unless taxpayer has other business income.
ESOP / RSU / Buyback / Rights
| Event | Tax Head | Basis | Audit Impact |
|---|---|---|---|
| ESOP exercise | Salary (u/s 17(2)(vi)) | FMV – exercise price | P&L impact (not business) |
| Sale of ESOP shares | Capital Gains | Sale – FMV at exercise | Disclosed in CG Schedule |
| Buyback (Sec 115QA) | Capital Gains (exempt for shareholder) | Company pays 20% tax | Not turnover |
| Bonus / Rights issue | Not taxable at allotment | CG on sale | Not turnover |
Clause 44 and Related Audit Disclosures
| Clause | Relevance | F&O / Share Trader | MF / AIF / PMS Investor |
|---|---|---|---|
| Clause 8A | Nature of business | Trading / Derivatives | Investment |
| Clause 13(e) | Stock valuation method | Mark-to-market (F&O) | NA |
| Clause 14 | Investments | Yes | Yes |
| Clause 18 | Other incomes | Dividend, AIF share | Yes |
| Clause 32(a)/(b) | Losses carried forward | Business & CG separately | Yes |
| Clause 40 | Turnover and ratios | Applicable | NA |
| Clause 42 | TDS compliance (194Q/194H/194J) | Brokerage, exchange fees | NA |
| Clause 44 | Digital payment ratio | Must show >95% digital for exemption | NA |
Loss Set-off and Carry-forward Mechanics
| Income Type | Section | Set-off in Same Year | Carry-forward Period |
|---|---|---|---|
| F&O loss (non-speculative) | 72 | Any business income | 8 years |
| Speculative (intraday) loss | 73(1) | Only speculative income | 4 years |
| Short-term capital loss | 70(2) | Any capital gain | 8 years |
| Long-term capital loss | 74(1)(b) | Only LTCG | 8 years |
| AIF business loss (Cat I/II) | 115UB(3) | Pass-through to investor | 8 years |
| PMS or MF capital loss | 70/74 | Capital gains only | 8 years |
Practical Decision Matrix — Section 44AB Tax Audit
| Case | Turnover Basis | Digital % | Audit Required? |
|---|---|---|---|
| F&O trader – turnover ₹8 Cr | 98% | No | |
| F&O trader – turnover ₹8 Cr | 90% | Yes (cash >5%) | |
| Intraday trader – turnover ₹2 Cr, loss | 100% | Yes (opted out of 44AD) | |
| Delivery trader (capital) | NA | NA | No |
| PMS / MF investor | NA | NA | No |
| AIF investor (Cat I/II) | NA | NA | No |
| AIF trust (Cat III receipts ₹15 Cr) | NA | NA | Yes |
Audit Checklist for Professionals
✅ Confirm nature of income via holding pattern, frequency, and intention.
✅ Compute turnover strictly per ICAI GN.
✅ Verify digital transaction ratio (Clause 44).
✅ Separate F&O from delivery, intraday, and capital activities.
✅ Map all income heads correctly in ITR (Business, CG, Other Sources).
✅ Reconcile brokerage statements, ledger, and demat/PMS reports.
✅ Match carried-forward losses in Form 3CD with ITR schedules.
✅ Ensure AIF Form 64C/64D consistency with ITR.
Final Interpretation
The audit exemption threshold of ₹10 crore is purely turnover-based, not profit-percentage dependent, provided digital transactions exceed 95%.
Thus, F&O, intraday, and delivery-based business traders must compute turnover as per ICAI norms; capital investors in shares, MF, PMS, or AIFs remain outside tax audit unless they engage in active business trading.
