Tag: Derivatives and Equity Investments

Executive Summary

This research note provides a comprehensive analysis of the taxation and regulatory framework governing investments in derivatives (futures and options) and listed equity shares in India as of August 2025. The analysis covers both resident Indian investors and non-resident investors, highlighting the distinct treatment under tax laws, securities regulations, and foreign exchange management rules. Recent legislative changes, including modifications to Securities Transaction Tax (STT) rates and capital gains tax provisions introduced in Budget 2024, have significantly altered the investment landscape. This note serves as a reference guide for understanding the comparative framework applicable to different categories of investors in the Indian securities market.

Taxation Framework for Derivatives (Futures and Options)

Classification of Income from Derivatives

1. For Resident Indian Investors

Income derived from trading in derivatives (futures and options) on recognized stock exchanges in India is classified as non-speculative business income under Section 43(5) of the Income Tax Act, 1961. Specifically, clause (d) of Section 43(5) excludes eligible transactions in derivatives referred to in Section 2(ac) of the Securities Contracts (Regulation) Act, 1956, carried out on recognized stock exchanges from being considered as speculative transactions [1] [2].

The classification of derivative transactions as non-speculative business income offers significant tax advantages:

• Losses from derivatives trading can be set off against any other income of the same year 
• Any excess loss can be carried forward for up to eight assessment years 
• Such losses can be set off against any other income (except salary) in subsequent years [1] 

This classification is particularly important when contrasted with intraday equity trading, which is considered speculative business income. Unlike intraday equity trading losses that can only be set off against other speculative income, derivative losses enjoy more flexible set-off provisions [3] [2].

2. For Non-Resident Investors

For non-resident investors, including NRIs, the income classification from derivatives follows similar principles as residents. However, there are important restrictions and considerations:

• NRIs can invest in futures and options segments only on a non-repatriation basis using funds held in India [4] 
• Such investments must be made out of Rupee funds held in India, typically through Non-Resident Ordinary (NRO) accounts [4] [5] 
• Foreign Portfolio Investors (FPIs), particularly Category I FPIs, are permitted to invest in exchange-traded derivatives approved by SEBI [6] 

For taxation purposes, non-residents’ income from derivatives is subject to the general provisions applicable to business income under the Income Tax Act, but may also benefit from reduced rates under applicable Double Taxation Avoidance Agreements (DTAAs) [7].

Tax Rates and Recent Changes

1. Securities Transaction Tax (STT)

Budget 2024 introduced significant changes to the STT rates for derivatives trading, effective from October 1, 2024 [8] [9]:

Transaction Type	Old Rate (Until Sept 30, 2024)	New Rate (From Oct 1, 2024)	Payable By
Sale of futures in securities	0.0125% of the price at which futures are traded	0.02% of the price at which futures are traded	Seller
Sale of options in securities	0.0625% of the option premium	0.1% of the option premium	Seller
Sale of options when exercised	0.125% of the settlement price	0.125% of the settlement price	Purchaser

These STT increases were aimed at curbing excessive speculation in derivatives markets and have reportedly reduced market liquidity by 30-40% [9] [10].

2. Income Tax Rates

For resident individuals, income from derivatives trading is taxed as business income at applicable slab rates [3]:

New Tax Regime (post-Budget 2024):

• Up to ₹4 lakhs: Nil 
• ₹4 lakhs to ₹8 lakhs: 5% 
• ₹8 lakhs to ₹12 lakhs: 10% 
• (and higher slabs accordingly) 

For non-resident investors, standard tax rates for business income apply, subject to the provisions of applicable Double Taxation Avoidance Agreements [7].

3. Accounting and Audit Requirements

Given that derivatives income is classified as business income, traders must:

• File ITR-3 (or ITR-4 if under presumptive taxation scheme) [1] 
• Maintain books of accounts as per Section 44AA 
• Get accounts audited if turnover exceeds ₹10 crores (for fully digital transactions) [3] 

Turnover for derivatives trading is calculated as the sum of absolute amounts of profits and losses, not just the net trading value [3].

Taxation Framework for Listed Equity Shares

Classification of Income from Equity Investments

1. For Resident Indian Investors

Income from equity investments can be classified either as:

• Capital Gains: When shares are held as investments with the primary intention of earning dividends and long-term appreciation 
• Business Income: When shares are frequently traded as part of regular business activity 

The classification depends on the investor’s intent, frequency of transactions, holding period, and other factors. However, in practice, listed equity shares held for more than 12 months are typically treated as capital assets [11].

2. For Non-Resident Investors

For non-resident investors, income from equity investments is generally classified as capital gains unless the non-resident is engaged in the business of trading securities. NRIs can invest in listed equity shares through the Portfolio Investment Scheme (PIS) on both repatriation and non-repatriation basis [12] [13].

Foreign Portfolio Investors (FPIs) registered with SEBI are specifically authorized to invest in listed shares, and their income is taxed under special provisions including Section 115AD of the Income Tax Act [14].

Tax Rates and Recent Changes

1. Securities Transaction Tax (STT)

STT rates applicable for equity transactions (unchanged in Budget 2024) [15] [16]:

Transaction Type	Rate	Payable By
Purchase of equity shares (delivery-based)	0.1% of the value	Purchaser
Sale of equity shares (delivery-based)	0.1% of the value	Seller
Sale of equity shares (intraday/non-delivery)	0.025% of the value	Seller

2. Capital Gains Tax

Budget 2024 introduced significant changes to capital gains tax rates for equity investments, effective from July 23, 2024 [17] [18]:

Type of Capital Gain	Pre-July 23, 2024	Post-July 23, 2024
Short-Term Capital Gains (held ≤ 12 months)	15%	20%
Long-Term Capital Gains (held > 12 months)	10% (above ₹1 lakh exemption)	12.5% (above ₹1.25 lakh exemption)

These rates apply to both resident and non-resident investors, including FPIs. However, non-residents may be eligible for beneficial rates under applicable Double Taxation Avoidance Agreements [19] [7].

3. Grandfathering Provisions

The grandfathering provisions introduced in Budget 2018 continue to apply. For listed shares acquired before February 1, 2018, the cost of acquisition for computing long-term capital gains is deemed to be the higher of:

• Actual cost of acquisition 
• Lower of:
  • Fair Market Value (FMV) as of January 31, 2018 
  • Actual sale consideration 

This effectively protects gains accrued up to January 31, 2018, from taxation [18] [20].

Regulatory Framework for Derivatives and Equity Investments

Regulatory Structure and Authorities

The regulatory framework for derivatives and equity investments in India involves multiple authorities:

• Securities and Exchange Board of India (SEBI): Primary regulator for securities markets, including derivatives and equity trading 
• Reserve Bank of India (RBI): Regulates foreign exchange transactions and oversees foreign investments 
• Ministry of Finance: Formulates policies related to taxation and certain aspects of foreign investment 
• Stock Exchanges: National Stock Exchange (NSE) and Bombay Stock Exchange (BSE) implement and enforce trading rules 

Regulatory Requirements for Resident Investors

Resident Indian investors face relatively fewer regulatory restrictions when investing in derivatives and equity markets:

• Must have a valid Permanent Account Number (PAN) 
• Must complete KYC procedures with registered intermediaries 
• Required to have a demat account with a depository participant 
• Must adhere to position limits set by SEBI and exchanges for derivatives trading 

For derivatives, specific position limits apply to ensure market integrity [21]:

• For index-based contracts: Disclosure required for persons holding 15% or more of open interest 
• For stock options and single stock futures: Position limited to higher of:
  • 1% of free float market capitalization (in terms of number of shares), or 
  • 5% of open interest in all derivative contracts in the same underlying stock 

Regulatory Framework for Non-Resident Investors

1. Investment Routes for Non-Residents

Non-resident investors have several routes to invest in Indian securities markets [22] [23]:

• Foreign Direct Investment (FDI): For strategic, long-term investments, typically 10% or more in unlisted companies or listed companies 
• Foreign Portfolio Investment (FPI): For financial investments in listed securities through SEBI-registered FPIs 
• Foreign Venture Capital Investment (FVCI): For investments in specific sectors with regulatory benefits 
• Non-Resident Indian (NRI) Route: Specific provisions for NRIs investing through Portfolio Investment Scheme (PIS) 

2. NRI Investments: Portfolio Investment Scheme (PIS)

NRIs investing in Indian equities and derivatives must comply with the Portfolio Investment Scheme [12] [13]:

• Must open a PIS account with an authorized dealer bank designated by RBI 
• All purchases and sales must be routed through the designated bank 
• Can invest on repatriation basis (through NRE/FCNR accounts) or non-repatriation basis (through NRO accounts) 
• Investment in derivatives is permitted only on non-repatriation basis 
• Cannot engage in intraday trading or short selling; delivery is mandatory for equity transactions [4] 

Investment limits for NRIs [13]:

• Individual NRI limit: 5% of paid-up capital of the company 
• Aggregate NRI limit: 10% of paid-up capital (can be increased to 24% by special resolution of the company) 

3. Foreign Portfolio Investors (FPIs)

FPIs are subject to the SEBI (Foreign Portfolio Investors) Regulations, 2019, with recent amendments in 2024 [24] [25]:

• Must register with SEBI through Designated Depository Participants (DDPs) 
• Categorized into two categories based on risk profile and regulatory oversight in home jurisdiction 
• Can invest in listed shares, derivatives, units of mutual funds, REITs, and other permitted securities [26] 
• Investment limit of less than 10% of the paid-up equity capital of a company (on fully diluted basis) 
• If exceeding the 10% limit, must either divest excess holdings within 5 trading days or reclassify as FDI [27] 

Recent regulatory developments for FPIs in 2024-25 include [28] [24]:

• Enhanced disclosure requirements for large FPIs 
• Framework for dealing with securities post expiry of registration 
• Procedures for reclassification of FPI investment to FDI 
• Simplified registration process for certain categories of FPIs 

FEMA Implications for Non-Resident Investors

Regulatory Framework under FEMA

The Foreign Exchange Management Act, 1999 (FEMA) and its various regulations govern all aspects of foreign exchange transactions, including investments by non-residents in Indian securities [22]:

• FEMA Non-Debt Instruments Rules, 2019: Govern equity investments by non-residents 
• FEMA Debt Instruments Regulations, 2019: Govern investments in debt instruments 
• Foreign Exchange Management (Mode of Payment and Reporting of Non-Debt Instruments) Regulations: Prescribe methods for payments and reporting requirements [29] 

A key regulatory development is the bifurcation of authority between the Central Government (for non-debt instruments) and RBI (for debt instruments) introduced by the Finance Act, 2015 and implemented through subsequent rules and regulations [30].

Banking Arrangements and Repatriation

1. For NRIs

NRIs must maintain specific bank accounts for investing in Indian securities [12] [5]:

• Non-Resident External (NRE) Account: For investments on repatriation basis; funds are freely repatriable including capital gains 
• Non-Resident Ordinary (NRO) Account: For investments on non-repatriation basis; repatriation subject to annual limits and tax clearance 
• Foreign Currency Non-Resident (FCNR) Account: Foreign currency deposits that can be used for investments on repatriation basis 

Repatriation rules [13] [4]:

• Sale proceeds of shares purchased on repatriation basis can be credited to NRE/FCNR/NRO accounts 
• Sale proceeds of non-repatriable investments can only be credited to NRO accounts 
• Investments in derivatives can only be made on non-repatriation basis using funds from NRO accounts 

2. For FPIs

FPIs operate through designated custodian banks and Special Non-Resident Rupee (SNRR) accounts [31]:

• Must appoint a SEBI-registered custodian for securities and funds 
• Investments and divestments are freely repatriable, subject to payment of applicable taxes 
• May open foreign currency accounts outside India for holding funds pending utilization or repatriation [29] 

Reporting Requirements

Non-resident investors and their authorized dealers must comply with various reporting requirements [32] [31]:

• For NRIs under PIS: Designated banks report transactions to RBI on a daily basis 
• For FPIs: Custodians report transactions through the SEBI’s reporting system 
• LRS Reporting: For resident individuals investing abroad under the Liberalized Remittance Scheme 
• Annual Return on Foreign Liabilities and Assets: Required for Indian companies with foreign investment 

Recent changes include stricter beneficial ownership disclosure requirements for FPIs and standardized procedures for reclassification from FPI to FDI [27].

Practical Compliance Considerations

Registration and Account Opening

1. For Resident Investors

• Obtain PAN and complete KYC with intermediaries 
• Open trading and demat accounts with registered broker and depository participant 
• Complete in-person verification and other onboarding requirements 

2. For Non-Resident Investors

NRIs [33] [5]:

• Open NRE/NRO accounts with an authorized dealer bank 
• Apply for PIS permission from the designated bank 
• Open NRI-specific trading and demat accounts with brokers and depository participants 
• Provide additional documentation including:
  • Valid passport and visa 
  • Overseas address proof 
  • PAN card 
  • PIS permission letter 

FPIs [24] [25]:

• Apply for registration with SEBI through a Designated Depository Participant 
• Complete KYC including ultimate beneficial owner disclosures 
• Appoint a custodian for securities and funds 
• Open special non-resident rupee accounts 

Trading Restrictions and Position Limits

1. For Resident Investors

• Subject to position limits for derivatives contracts set by SEBI and exchanges 
• No restrictions on delivery-based or intraday equity trading 

2. For Non-Resident Investors

NRIs [4] [34]:

• Cannot engage in intraday trading or short selling in equities 
• Must take delivery of shares purchased and give delivery of shares sold 
• Can trade in derivatives only on non-repatriation basis 
• Subject to the same position limits as resident clients in derivatives markets 

FPIs [26] [28]:

• Category I FPIs can invest in exchange-traded derivatives 
• Subject to investment limits and position limits prescribed by SEBI 
• Investments in a single company limited to less than 10% of paid-up equity capital 
• Aggregate FPI limit is 24% of paid-up capital (can be increased up to sectoral cap) 

Taxation and Compliance Calendar

Key compliance requirements for both resident and non-resident investors:

Compliance	Resident Investors	Non-Resident Investors
Tax Deduction at Source (TDS)	Not applicable on capital gains	Applicable at specified rates, subject to DTAA benefits
Advance Tax	Required if tax liability exceeds ₹10,000	Required if tax liability exceeds ₹10,000
Income Tax Return Filing	ITR-3 for business income (derivatives) ITR-2 for capital gains (equity)	ITR-2 for NRIs ITR-5/6 for FPIs depending on constitution
Foreign Asset Disclosure	Required in Schedule FA if applicable	Not required for non-residents

Conclusion and Key Takeaways

Comparative Framework Summary

Aspect	Resident Investors	Non-Resident Investors
Income Classification (Derivatives)	Non-speculative business income	Non-speculative business income (with restrictions)
Income Classification (Equity)	Capital gains or business income based on intent and pattern	Typically capital gains
Tax Rates (Derivatives)	Slab rates applicable to business income	Slab rates or DTAA rates, whichever is beneficial
Tax Rates (STCG – Equity)	20% (post-July 2024)	20% (subject to DTAA benefits)
Tax Rates (LTCG – Equity)	12.5% above ₹1.25 lakh exemption (post-July 2024)	12.5% above ₹1.25 lakh exemption (subject to DTAA benefits)
Trading Restrictions	No significant restrictions	No intraday trading for NRIs; derivatives only on non-repatriation basis
Repatriation	Not applicable	Permitted subject to FEMA regulations and tax compliance

Recent Developments and Future Outlook

The Indian securities market has undergone significant regulatory changes in 2024-25:

• Increase in STT rates for derivatives trading effective October 1, 2024 
• Increase in capital gains tax rates for equity investments effective July 23, 2024 
• Enhanced disclosure requirements for FPIs 
• Simplified registration process for certain categories of FPIs 
• Standardized procedures for reclassification from FPI to FDI 

These changes reflect a regulatory approach focused on:

• Curbing excessive speculation in derivatives markets 
• Enhancing transparency in foreign investments 
• Streamlining compliance requirements 
• Increasing tax revenues from financial market transactions 

As India continues to integrate with global financial markets, further regulatory refinements are expected to balance market development with prudential oversight. Investors should stay updated on regulatory changes and ensure compliance with evolving requirements.

Key Considerations for Investors

For Resident Investors:

• Maintain proper documentation to support income classification 
• Consider tax implications when choosing between derivatives and equity investments 
• Comply with position limits and reporting requirements for derivatives trading 
• Plan for increased tax outflows due to higher STT and capital gains tax rates 

For Non-Resident Investors:

• Choose appropriate investment route based on investment objectives and repatriation needs 
• Understand and comply with FEMA regulations and reporting requirements 
• Maintain proper documentation for claiming DTAA benefits 
• Be aware of restrictions on trading strategies, particularly for NRIs 
• Monitor regulatory changes that could impact investment strategies and compliance obligations 

By understanding the distinct regulatory and tax frameworks applicable to different investor categories, both resident and non-resident investors can develop effective investment strategies while ensuring compliance with Indian laws and regulations.

Sources:

Judgements

1. Pankaj Agarwal,Kanpur vs Jt.Cit Circle-1(1)(1), Kanpur on 22 April … 

Legislation

1. Circular No. 1/2024 :Circular explaining the provisions of the Finance Act, 2023​ 

Web Articles

1. Income Tax for Foreign Investors 
2. Contract Specifications, Equity Derivatives – NSE India 
3. SEBI Turnover Fees, STT and Other levies 
4. NishithDesai 
5. Foreign Portfolio Investment in India 
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15. FAQs – NRI Trading Account 
16. How different is stock market investing for NRIs? | Stock Market News 
17. Regulatory Compass Updates & Key Rulings – Securities – India 
18. NishithDesai 
19. Nishith Desai Associates The Financial Services Bulletin 
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