How can traders avoid income tax Notices?

Amidst the chaos of the COVID-19 pandemic, everyday people found themselves drawn to the derivatives market like never before. A report from the Securities and Exchange Board of India (SEBI) revealed a staggering 540% increase in individual traders dabbling in futures and options (F&O) from FY19 to FY22.

In FY22 alone, more than 4.5 million folks jumped into the world of equity F&O trading. As tax season rolls around, it's hitting home for these traders that they need to get their income tax returns (ITRs) filed, whether they're barely scraping by or comfortably employed.

But here's the rub: many of them are scratching their heads over the whole reporting thing. See, there's this misconception floating around that you only need to report your F&O trades if you're raking in the profits. So, naturally, some traders are thinking, "Why bother reporting if I'm not making any money?" They figure since these trades don't pop up on their Annual Information Statement (AIS), they can just let it slide under the radar when it comes time to file their ITRs.
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And here's another curveball: trading in F&O isn't just a casual hobby; it's treated as a full-on business. That means even regular Joes with day jobs who dabble in derivatives have to tackle the more complicated ITR forms like ITR-3 or ITR-4 instead of the simpler ones they're used to.
So, while the allure of the derivatives market might be strong, it's important for all these newfound traders to navigate the tax maze with care. After all, nobody wants an unexpected visit from the taxman knocking on their door.
 

What is an income tax notice?

An income tax notice is an official communication from the IT department to the taxpayer, stating that there is a problem with his/her IT return. 

Now, why might you get one of these ominous notices? Well, the reasons can vary. Maybe you forgot to file your income tax return, or perhaps there's some discrepancy in the assessment they need to clear up. It could even be a request for additional information they need from you.

Whatever the reason, it's natural to feel a surge of anxiety when that notice arrives. After all, nobody likes dealing with tax stuff, and the prospect of being scrutinized by the taxman can send shivers down anyone's spine.

These notices can crop up for all sorts of reasons. Maybe you made a mistake in your calculations, or perhaps you didn't report all your income accurately. Sometimes, it's because you made some pretty ambitious claims for losses that need a second look.
 

6 common types of income tax notices

When it comes to Income Tax Notices, there's a whole spectrum of reasons why you might find one waiting for you in your mailbox. Let's break down the six most common types and what they mean for you:

Wrong ITR form or tax underpaid (Notice under Section 139(9)): This notice usually arises from small errors in your tax returns. It could be anything from using the wrong ITR form to discrepancies in refund claims or outstanding taxes. You've got around 15 days to respond, and you can either meet your Assessing Officer or reply online. Ignoring it could lead to penalties or interest on delayed tax payments.

Notice for adjustment of refund against outstanding (Notice under Section 245): If the tax department finds that you owe previous tax dues, they might issue this notice to adjust them against your current or past refunds. You can contest the demand online or meet with the Assessing Officer to explain your situation.

Mismatch between AO’s computation and your returns (Notice under Section 143(1)): This notice pops up if there's a discrepancy between what you've declared and what the Assessing Officer has on record. It's usually sent electronically and requires a response within 30 days. Failing to address it promptly could delay your return or lead to adjustments against your dues.

Discrepancies in Form 16 or Form 26AS (Notice under Section 143(1A)): Here, the notice flags differences between your Form 16 or Form 26AS and your actual returns. It's often a technical issue, like missing tax-saving investments or unrecorded TDS deductions. Respond online within 30 days and tackle any delays in tax deposits with your employer pronto.

Some income has escaped assessment (Notice under Section 148): This notice is more serious and indicates that the tax department suspects undisclosed income. It could be triggered by irregularities in your purchases compared to your reported income. Take it seriously, as it involves meeting with the Assessing Officer and potentially facing interest and penalties.

Delay in filing returns (Notice under Section 234(F)): Missing the July 31st deadline for filing returns can result in this notice, accompanied by a fine. From this year onwards, the penalty is mandatory, starting at Rs. 5,000 if you file by December 31st and doubling to Rs. 10,000 if you file later.

So, if you ever find one of these notices staring back at you, it's best to address it head-on and follow the necessary steps outlined to ensure a smooth resolution.
 

Common scenarios when people get a tax notice

Here's a rundown of common situations where investors and traders might find themselves facing a tax notice:

Not reporting transactions mentioned in the AIS: Your Annual Information Statement (AIS) provides a snapshot of your financial activity, so it's crucial to ensure that the information in the AIS matches up with what you've reported in your Income Tax Return (ITR).

Improper classification of capital gains: Incorrectly calculating the tax liability on capital gains can lead to discrepancies. For example, mistakenly reporting short-term gains as long-term gains can raise red flags.

Incorrectly categorizing intraday and F&O trading profits: Profits from intraday and futures & options (F&O) trading should be treated as business income, not lumped into Income From Other Sources (IFOS).

Not declaring referral income or commission: Failing to disclose income earned from referrals or commissions provided by your broker may trigger a notice, as these details are often recorded in Form 26AS or the AIS.

Not reporting foreign assets: If you've invested in foreign equity shares or received ESOPs from a multinational company not listed in India, it's crucial to disclose these assets in your ITR to avoid potential penalties.

Wrongly adjusting losses under improper income heads: Properly offsetting losses based on the type of loss and income earned is essential. For instance, long-term capital losses can only be offset against long-term gains, while short-term losses can be offset against both short-term and long-term gains.

Not conducting an audit when applicable: Profits from F&O and intraday trading are treated as business income, and depending on turnover and profits, you may be required to undergo an audit to remain compliant with tax regulations.

Not filing ITR when incurring losses: Even if you've experienced losses, filing your ITR is essential for remaining tax compliant. It also allows you to carry forward and offset these losses against future gains, reducing your overall tax liability.

Staying vigilant and accurately reporting your financial activities can help mitigate the risk of receiving a tax notice and ensure smooth compliance with tax laws.
 

What to do if you receive a tax notice?

If you find yourself on the receiving end of a notice related to any of the reasons mentioned above, here's a step-by-step guide on what to do:

    Determine the reason for the notice: Carefully read through the notice to understand the specific issue or discrepancy highlighted by the tax authorities. Understanding the reason behind the notice is crucial for formulating an appropriate response.
    
    Assess the difference in your income tax return: Review your income tax return to identify any significant disparities that may have triggered the notice. Understanding where the discrepancy lies will help you address the issue effectively.
    
    Verify essential information in the notice: Double-check the notice to ensure that all essential details, such as your name, PAN Card number, contact information, etc., are accurate. This helps confirm that the notice is indeed intended for you.
    
    Respond within the allotted time frame: Time is of the essence when responding to a tax notice. Failure to reply within the stipulated time frame can result in fines and legal consequences. Therefore, it's crucial to act promptly and provide a comprehensive response addressing the concerns raised in the notice.
    
By following these steps and taking timely action, you can effectively address the issues raised in the tax notice and mitigate any potential penalties or legal repercussions.
 

Conclusion

In conclusion, it's imperative to promptly respond to income tax notices to prevent further complications and maintain compliance with tax laws. If you ever find yourself facing a tax notice and need assistance, don't hesitate to seek guidance from a qualified professional.
Whether it's clarifying the reason behind the notice or navigating the response process, consulting with experts can help ensure a smooth resolution and peace of mind.