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NISM-Series-X-B: Investment Adviser (Level 2) · Taxation of Other Products

Taxation of Futures and Options, Crypto, PMS and AIFs

Updated 11 October 2026 · Fact-checked

Equity and commodity derivatives profits are usually business income taxed at slab rates. Exchange-traded F&O is non-speculative; intraday cash trades are speculative. Crypto (VDAs) face a flat 30% with no loss set-off. PMS gains are taxed in the client's hands. AIF taxation depends on the category.

Understand Taxation of Derivatives and Other Instruments

Start with one question: is the income a capital gain or business income? Shares held as investment give capital gains. Derivatives are different. Futures and options are rarely held for delivery, so their profit or loss is treated as business income, taxed at the person's slab rate. There is no special low rate and no ₹1.25 lakh exemption.

Business income splits into two kinds. A speculative transaction is one where a contract is settled without actual delivery, such as intraday trading in equity shares on the cash segment. Derivatives traded on a recognised exchange are specifically excluded from this label, so F&O is non-speculative. This matters for losses. A speculative loss can be set off only against speculative profit and carried forward for 4 years. A non-speculative business loss can be set off against income under other heads, except salary, and carried forward for 8 years, provided the return is filed on time.

Virtual digital assets (VDAs), such as crypto, have their own harsh regime. Gains on transfer are taxed at a flat 30%. Only the cost of acquisition is deductible. No other expense is allowed. Losses cannot be set off against any other income, and cannot be carried forward. A 1% TDS applies on transfer, subject to thresholds.

PMS is simple in principle. The portfolio manager holds securities for you in your own name, so you are the taxpayer. Each sale is taxed as per its nature: equity capital gains at capital gains rates, or business income if you are a trader. The manager only reports. AIFs depend on category. Category I and II are generally pass-through for income other than business income, so investors are taxed on the character of income. Business income is taxed at fund level. Category III funds are generally taxed at the fund level, not the investor level.

Key formulas to remember

F&O profit or loss
Taxable income = Sale proceeds − Purchase cost − Expenses (brokerage, STT, charges)
Treated as non-speculative business income at slab rates. Not a capital gain.
Turnover for F&O (audit test)
Turnover = Σ absolute profits and losses on all trades (plus premium received on options sold, as per ICAI guidance)
Used to test whether tax audit applies. Do not use the total contract value.
Speculative loss rule
Speculative loss → set off only against speculative profit; carry forward 4 years
Intraday equity cash trades are speculative.
Non-speculative business loss rule
Set off against any head except salary; carry forward 8 years against business income
Return must be filed by the due date to carry forward.
VDA tax
Tax = 30% × (Transfer value − Cost of acquisition), plus surcharge and 4% cess
No other deduction. No set-off or carry forward of VDA loss. TDS 1% on transfer, subject to thresholds.
PMS
Taxed in client's hands; nature of each security decides the head
The portfolio manager is not taxed on the client's gains.
AIF Category I and II
Pass-through for non-business income; business income taxed at fund level
Losses are not passed to investors. They are carried forward in the fund.
AIF Category III
Taxed at fund level, not pass-through
Investors are not taxed on the fund's income as it arises.

How to solve Taxation of Derivatives and Other Instruments questions

Use this order for any question on taxing derivatives and similar products.

  1. 1Identify the instrument: equity or commodity F&O, intraday cash trade, VDA, PMS or AIF.
  2. 2Decide the head of income. F&O is business income. VDA has its own section with a flat rate. PMS follows the underlying security.
  3. 3For business income, label it speculative or non-speculative. Exchange-traded derivatives are non-speculative. Intraday cash trades are speculative.
  4. 4Compute net profit or loss after allowed expenses. For VDA allow only cost of acquisition.
  5. 5Apply set-off. Speculative loss goes only against speculative profit. VDA loss goes nowhere.
  6. 6Apply carry-forward periods: 4 years for speculative loss, 8 years for non-speculative loss.
  7. 7For AIFs, identify the category first, then decide whether the investor or the fund pays tax.
  8. 8Check each option for absolute words such as 'always' or 'any loss', which are often traps.

Quickest way: Classify then apply the loss rule

When to use it: Use for MCQs where you must choose the correct tax treatment in under a minute.

  1. Match the product to one phrase: F&O = non-speculative business; intraday cash = speculative; crypto = 30% and no set-off; PMS = client taxed; AIF = check the category.
  2. For loss questions, ask which bucket the loss falls in and where it can be set off.
  3. Eliminate options that say a VDA loss can be set off or carried forward.
  4. Eliminate options that say PMS or Category III AIF investors are taxed in a way that contradicts the rules above.

Common mistakes in Taxation of Derivatives and Other Instruments

  • Treating F&O profit as capital gains

    Shares give capital gains, so students assume derivatives do too.

    Fix: Remember that F&O is business income at slab rates, with no capital gains rate.

  • Calling F&O speculative

    F&O feels like speculation in everyday language.

    Fix: The legal term excludes exchange-traded derivatives, so they are non-speculative. Intraday equity cash trading is the speculative one.

  • Setting off a speculative loss against non-speculative profit

    Both are business income, so they seem interchangeable.

    Fix: Speculative loss goes only against speculative profit. The reverse is allowed: non-speculative loss can be set off against speculative profit.

  • Allowing expenses or loss set-off on crypto

    Students apply normal business or capital gains rules.

    Fix: For VDAs only the cost of acquisition is allowed. Losses cannot be set off or carried forward.

  • Saying the PMS manager pays tax on client gains

    The manager does the trading.

    Fix: Securities are in the client's name, so the client is taxed on each sale as per its nature.

  • Treating all AIF categories the same

    Students remember only 'pass-through'.

    Fix: Pass-through applies to Category I and II for non-business income. Category III is taxed at the fund level.

Worked examples

Example 1

Meera has salary income of ₹10,00,000. In the year she has a loss of ₹2,00,000 from index options (non-speculative) and a profit of ₹50,000 from intraday trading in equity shares on the cash segment. What loss is carried forward, and for how long?

Show the solution
  1. Classify: option trading on an exchange is non-speculative business. Intraday cash trading is speculative business.
  2. Set off the non-speculative loss of ₹2,00,000 against speculative profit of ₹50,000. This is allowed.
  3. Remaining loss = ₹2,00,000 − ₹50,000 = ₹1,50,000.
  4. Set-off against other heads except salary: she has no other eligible income, and salary cannot be used.
  5. Carry forward ₹1,50,000 as a non-speculative business loss for 8 years, if the return is filed on time.

Answer: ₹1,50,000 is carried forward for 8 years, to be set off against business income.

Example 2

Arjun sells a crypto asset for ₹5,00,000. It cost him ₹3,00,000. He paid ₹5,000 in fees. On another crypto asset he made a loss of ₹1,00,000. Compute the tax on the VDA income, ignoring surcharge. Cess is 4%.

Show the solution
  1. Only the cost of acquisition is allowed. The fees of ₹5,000 are not deductible.
  2. Gain on the first asset = ₹5,00,000 − ₹3,00,000 = ₹2,00,000.
  3. The loss of ₹1,00,000 cannot be set off against this gain or any other income.
  4. Tax at 30% = ₹60,000.
  5. Cess at 4% = ₹2,400.
  6. Total tax = ₹62,400.

Answer: Tax payable is ₹62,400. The ₹1,00,000 loss and the ₹5,000 fees give no relief.

Exam tips

  • Know the 4-year versus 8-year carry-forward periods and attach them to the correct loss type.
  • Watch for the word 'any' with crypto losses. The answer is almost always that no set-off is allowed.
  • For AIF questions, find the category before reading the options.
  • If a question gives total contract value, remember that audit turnover for F&O is based on the sum of absolute profits and losses, not contract value.
  • Rates and exemptions change with each Finance Act. Answer as per the current workbook, and do not rely on old rates.

Practice questions from Taxation of Other Products

Taxation of Derivatives and Other Instruments in other exams

The same ground in other exams, if you are preparing for more than one or want another angle on it.

Taxation of Derivatives and Other Instruments: frequently asked questions

Is F&O income taxed as capital gains or business income?

It is taxed as business income at your slab rate. Exchange-traded derivatives are treated as non-speculative business. You can deduct genuine expenses such as brokerage.

What is the difference between speculative and non-speculative business income?

A speculative transaction is settled without delivery, such as intraday trading in equity shares. Exchange-traded F&O is carved out and is non-speculative. The difference matters for loss set-off and carry-forward periods.

How is PMS taxed in India?

The client is taxed, because securities are held in the client's name. Each sale is taxed as capital gains or business income as per its nature. The portfolio manager provides the reports.

How are AIFs taxed under Category I, II and III?

Category I and II are generally pass-through for non-business income, so investors are taxed on the character of the income. Business income is taxed at the fund level. Category III funds are generally taxed at the fund level.