Foreign exchange, or forex, is a network of buyers and sellers who exchange currency at a predetermined price. Individuals, businesses, and central banks use it to turn one currency into another. And you can be a trader — it is open 24 hours a day since there is no central location — trading in forward and futures markets, cash, options, and swaps. And being well-informed on the taxation laws and rules before investing will help you avoid any legal issues later.
Tax treatment
While the goal of traders in the foreign exchange market is to make profitable trades and hence typically have a short-term view, it is important to think about the tax consequences of buying and selling forex.
There are two types of taxes when it comes to Forex Trading. The first is an indirect tax that is not tied to the income or profit from Forex trading but tied to the notional value of the forex amount. This could be GST or STT and stamp duty. The second is direct or income tax, tied to the profit one makes on the forex transaction itself.
You must identify the tax category under which forex trading transactions are recorded. In case of losses in speculative business, it can be set off only against other speculative income. Whereas in the case of losses from non-speculative businesses, such losses can be set off against any other heads of income including income from the speculative business but excluding income under the head “salaries” of that year.
If the person is in the business of forex trading, such income shall be taxable under the head “Business Income.” In other cases, it may be covered under the head “Income from other sources.” The tax rate applicable to individuals is charged on such income.
The taxable value associated with foreign exchange trading is classified and divided into three separate slabs for accurate processing, which apply to various foreign exchange processes, currency conversion, and other operations that are part of forex trading.
The three slabs are as follows:
Slab I - Transactions of less than ₹1 lakh
- Taxable value: 1 per cent of the transaction amount, subject to a minimum of ₹250
- Tax amount: 18 per cent of the taxable value
- The maximum GST, however, is ₹180
Slab II -Transactions greater than ₹1 lakh and less than or equal to ₹10 lakh
- Taxable value: 1,000 + 0.5 per cent of the amount above 1 lakh
- Tax amount: 18 per cent of the taxable value
- The GST amount ranges from ₹180 to ₹990
Slab III- Transactions greater than ₹10 lakh
- Taxable value: 5,500 + 0.1 per cent of the transaction amount
- Tax amount: 18 per cent of the computed taxable value
- The GST amount ranges from ₹990 to ₹60,000
Indirect taxes on the other hand are paid to the Government and are as follows:
Other aspects
Graphics by Visveswaran V
Besides taxes, there are also various charges when trading in Currency Derivatives in India. For example, you must pay all intermediaries such as the brokers, NSE a brokerage fee. This could be a percentage of the notional value or a fixed fee per contract.
In the futures category, apart from brokerage fees, one also has to pay ₹1.10 per lakh as transaction charges to the exchange (NSE) and ₹0.25 per lakh as clearing member charges.
In the options category, apart from brokerage fees, one also has to pay ₹40 per lakh on the premium value (not notional amount) as transaction charges and ₹7.5 per lakh as clearing member charges.
The central authorities in charge of overseeing forex trading are the Reserve Bank of India (RBI) and the Securities Exchange Board of India (SEBI). You are legally safe if you use the Indian Rupee as your base currency. Forex trades are permitted in currency pairs of the Indian currency with the US dollar, the British pound, and the Euro.
Make sure you are aware of the maximum amount that can be traded varies for cash and derivatives. Cash trades are restricted to $3,000. Exchanges over this limit require a forex card, which lets you exchange up to $2,50,000 in one or in a series of cash transactions. For currency Derivatives, RBI has allowed without having to establish the existence of underlying exposure, up to a single limit of $100 million equivalent across all currency pairs involving INR, put together, and combined across all exchanges.
You must ensure that you invest through an authorised broker, who has SEBI approval. Without SEBI authorisation, the said trading platform functions illegally.
Forex is a global business — You should be up-to-date on global economics in order to make money from Forex trades. In the same vein, understanding forex taxation laws and spending enough time comparing brokers will help avoid losing money or even being charged with unethical activities.
(The writer is a Chartered Financial Analyst (CFA) with over 15 years of experience in the asset management industry. He currently runs his own advisory firm based out of Chennai.)