Balance Sheet and P&L Statements: Managing Trading Income as a Business

Balance sheet and P&L statements –

By declaring trading as a business income, you are required to treat it like any other enterprise and compose a balance sheet and P&L or income statement for the financial year. Depending on your turnover and profitability, an audit may have to be conducted for these financial statements. We will address this matter in more detail in the ensuing chapter.

– Turnover and Tax audit

When is an audit required?

For businesses with an income and turnover greater than Rs 5 Crores in the financial year 20-21, an audit is compulsory. Digital transactions (such as equity trading) adhere to this same limit of Rs 5 Crores. Where the turnvoer is below 5 Crores but profits are less than 6% of total earnings and surpass the minimum exemption limit, an audit will also be mandatory according to Section 44AD.

We will discuss this in detail in the next chapter.

However, let us understand what audit really means.

The dictionary meaning of audit is to check, review or inspect. There are various kinds mandated by different statutes, such as a company audit under corporate law or a cost audit under cost accounting rules. Taxpayers that meet the specified turnover thresholds are required to have their accounts audited with respect to income tax law.

An audit can be performed by having an accountant confirm whether your accounts are accurate. This verification is done to ensure that your balance sheet and P&L statement for the year are correct. It would be ideal for the IT department to conduct these audits, but since there are so many balance sheets, it is not feasible for them. Therefore, a Chartered Accountant (CA), who is authorised by the Income-tax department, should be used instead. You may choose any CA of your preference.

What role should a CA play?

A CA’s primary duty is to verify the accuracy of balance sheets and P&L statements. Still, more often than not, a CA will create these documents too and examine them as needed. We will outline how this process typically works in the following chapter.

The audit process conducted by a CA is highly essential. It assists traders/investors in being aware of their financial status, making sure earnings and deductions declared are accurate. Moreover, it helps lenders gauge credibility and works as a deterrent for any dishonest activities.

One important question is which ITR form to use. ITR3 (or ITR4 up until 2016) is the one we will discuss in greater detail later on. I have been aware of people attempting to declare both speculative and non-speculative profits as capital gains, instead of business income, so as to avoid having to fill out the ITR3 form. Unfortunately, such shortcuts could backfire badly should they be subject to an IT audit.

Business expenses when trading – Trading as a business affords the benefit of decreasing your tax burden, by showing all expenses related to it as costs. In cases where this results in net losses for the year, they can be carried forward according to what was previously mentioned.

Following are some of the expenses that can be shown as a cost when trading

• All charges when trading (STT, Brokerage, Exchange charges, and all other taxes). I hope you remember that STT can’t be shown as a cost when declaring income as capital gains, but it can be in case of business income.

• Internet/phone bills if used for trading (portion proportionate to your usage on the bill)

• Depreciation of computer/other electronics (used for trading)

• Rental expense (if the place used for trading if a room used – a portion of your rent)

• Salary paid to anyone helping you trade

• Advisory fees, cost of books, newspapers, subscriptions, and more…