Tax on Commodity Trading

Most countries impose taxes on individuals for profits generated from commodity trading. The amount of tax owed by individuals is determined by various factors, including the level of trading activity and the types of trading instruments involved. First, let’s explore how commodity trading operates, followed by a review of the tax regulations that apply to residents in three regions: the United States, Canada, and India.

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What Is Commodity Trading?

Commodity markets are crucial to the global economy, as they facilitate the trade of raw materials used to produce goods for end consumers, allowing society to function effectively. I am typing this on a computer in my home office, and soon I will drive my car to get lunch. Each of those items—my car, my home, the food at the restaurant, and the coffee I drank this morning—was produced from raw materials such as gold, copper, aluminum, crude oil, lumber, wheat, coffee beans, and others. All these materials are priced and traded on the commodity markets.

Here’s what to know about commodity trading:

1. Commodity trading involves buying or selling trading instruments, e.g., futures contracts or Contracts for Difference (CFDs) that reflect the changes in the prices of commodities. It rarely involves taking physical delivery of commodities.
2. Commodities are divided into two main groups: hard commodities (including energy and metals) and soft commodities (such as agricultural products).
3. The most liquid commodities to trade are crude oil and gold.
4. Commodity trading can take place through centralized exchanges, such as the Chicago Mercantile Exchange (CME), the New York Mercantile Exchange (NYMEX), and India’s Multi Commodity Exchange (MCX). Individuals access these exchanges through their brokers, and they do not necessarily need to be in the same country as the exchanges. Some countries, such as Canada, allow CFDs, which are “over the counter” (OTC) instruments that do not trade through exchanges. However, the US and India do not allow these.
5. Energy commodities include Crude oil (e.g., West Texas Intermediate and Brent crude), ethanol, gasoline, natural gas, heating oil and coal.
6. Metals on commodity exchanges include precious metals (gold, silver, platinum, and palladium) and base metals (copper, aluminum, zinc, lead, tin, and nickel)
7. Agricultural commodities include softs (coffee, sugar, cotton, cocoa, orange juice, lumber, wool, rubber), grains (wheat, corn, soybeans, rice, and oats), oilseeds (soybean oil, soybean meal), livestock (live cattle, feeder cattle, lean hogs), and dairy (milk, cheese, butter, non-fat dry milk).

Tax on Commodity Trading in the US

Most commodity trading in the US is conducted through futures and options contracts, which are subject to the 60/40 tax rule.

The 60/40 tax rule on commodity futures and options

The 60/40 tax rule, applicable to commodity futures and options, states that 60% of the profits on futures and options are subject to capital gains, and the remaining 40% is subject to ordinary income tax.

The Federal Capital Gains Tax has three rates: 0%, 15%, and 20%, which apply to different dollar amounts that adjust annually for inflation. Federal Income taxes run from 10% to 37% across different income bands and marital categories. State capital gains and income taxes may apply depending on the taxpayer’s residency.

Taxpayers can deduct capital losses against ordinary income, up to a maximum of $3,000, in any given tax year. They can indefinitely carry forward capital losses exceeding $3,000 until they fully exhaust the amount.

Futures and options contracts allow “Mark to Market” accounting for tax purposes, where any unrealized gains or losses in open positions are counted for tax purposes at the end of the year.

Tax On Commodity ETFs

Some exchange-traded funds, or ETFs, hold futures contracts, making them eligible for the 60/40 tax rule. Other ETFs hold equity in companies that invest in commodities, making profits from these ETFs subject to ordinary income tax. (ETF issuers typically state which tax rules apply for their US clients.)

Trader Tax Status: Writing Off Business Expenses

US traders who can demonstrate to the IRS that their trading activities meet the level of a business or profession can apply for “trader tax status” (TTS), more formally known as “trader in securities for tax purposes.”

There are two primary benefits to Trader Tax Status:

1. Taxpayers can deduct business expenses related to their trading activities, such as courses, computer and office equipment, subscriptions, and data feeds.
2. TTS eliminates the $3000 carryover limit on capital losses. This feature can substantially lower future taxes after sustaining a significant loss in any given year.

The IRS’s guidance on achieving TTS conditions states that:

1. Trading activity must be substantial, regular, frequent, and continuous.
2. The trader must seek to profit from daily market fluctuations rather than longer-term positions.

The above guidance is subjective, and to help, tax experts have suggested the following to meet the Trader Tax Status conditions:

1. Traders should aim to trade at least four days per week and complete at least four transactions per day. This amounts to a minimum of 16 trades per week or 720 trades annually. Opening and closing the same trade constitutes two transactions, and scaling in and out of trades are counted as multiple transactions.
2. The average holding period must be 31 days or less.
3. Traders should spend most days and at least four hours per day monitoring or trading the markets (this can include research and actual trading).
4. The trader should have significant business equipment, such as computers and monitors, as well as access to education and business services, and a dedicated home office.
5. Individuals must have a minimum deposit of $25,000 with a broker.

Tax experts also state that traders cannot use the following to qualify for Trader Tax Status:

1. Externally developed automated trading software
2. A copy trading service or a money manager
3. Trading retirement funds in non-taxable retirement accounts.

The IRS provides more information in its “Topic 429” (available here).

Tax on Commodity Trading in Canada

For those trading in Canada, the Canada Revenue Agency will apply capital gains tax, income tax, or corporation tax to commodity trading profits, depending on the trader’s situation. Here are the key rules:

1. The CRA applies Capital Gains Tax when trading is not a primary source of income, but rather a hobby. The Capital Gains Tax rate is 50% of the income tax rate. Paying capital gains tax does not allow the taxpayer to deduct trading-related expenses.
2. The CRA applies income tax to trading profits when it views an individual’s trading as a business or job. In this case, the person can write off trading-related expenses, such as office equipment, data feeds, subscriptions, courses, etc. The CRA uses four criteria to determine whether trading is a hobby versus a profession: the frequency of trading, the duration of trades, the time spent trading, and the amount of money earned. Essentially, a combination of shorter-term trading, a higher number of trades, more time spent trading, and greater earnings will more likely lead the CRA to view someone’s trading activity as a profession rather than a hobby.
3. Some active traders establish corporations, which can result in the lowest tax rates. However, additional work is required with a corporation, such as hiring an accountant to compile financial records and file taxes.

Tax on Commodity Trading in India

India introduced a tax on non-agricultural commodity trading in 2013, which has undergone several revisions since then.

Intraday vs. Longer-term Trades

For those trading in India, the country’s tax rules divide trades into two groups for tax purposes, based on the duration of the trade. The tax authorities in India refer to the categories as “speculative” and “non-speculative”; however, the only difference between the two groups is the duration of the trades.

The rules label trades opened and closed within the same trading day (i.e., intraday trades) as “speculative trades.” Trades open for more than one trading day are considered “non-speculative trades.”

The tax rules favour longer-term, non-speculative trading over intraday speculative trading.

Non-Agricultural Commodity Tax Rules

Income tax and Commodity Trading Tax (CTT) apply to commodity trading, and certain agricultural commodities are exempt.

Let’s first look at the rules for applying income tax:

1. Standard income tax rates apply to non-agricultural commodity trades. (Income tax rates range from 0% to 30% across various income tax slabs.)
2. Non-speculative losses can offset speculative gains. For example, if I earned ₹1 lakh in speculative profits and incurred ₹1 lakh in non-speculative losses, I would pay zero income tax on my trading.
3. Losses from speculative trades cannot offset gains from non-speculative trades. Let’s say my speculative trades generated a profit of ₹1 lakh, and my non-speculative trades incurred a loss of ₹1 lakh. My net profit is zero. However, I would still pay tax on the ₹1 lakh speculative gains.
4. Taxpayers can carry forward speculative losses for four years to offset future gains only in speculative trades.
5. Taxpayers can carry forward non-speculative losses for up to eight years, allowing them to offset them against either speculative or non-speculative trading gains.

Now let’s look at the Commodity Transaction Tax (CTT):

1. Like the Securities Transaction Tax, which applies to stock trading, the CTT is a direct tax levied on each trade. It applies to futures and options contracts. CTT does not apply to agricultural commodity trading.
2. The seller of a futures contract pays 0.01% of the contract's trading price.
3. The seller of an option on a commodity derivative pays 0.05% on the option’s premium.
4. The purchaser of an option on a commodity derivative, where the option is exercised, pays 0.0001% of the settlement price.

Note that commodity derivatives also incur SEBI charges, Goods and Services Tax (GST), and stamp duty from the respective state governments where the trader resides.

Bottom Line

Most countries apply taxes to trading profits, and commodity trading is no exception. In the US and Canada, taxes can vary depending on the level of the trader’s activity and whether the respective tax-collecting authority views their trading as a profession or a hobby. In India, taxes only apply to non-agricultural commodities, subjecting them to income tax and favouring trades held for longer than a day. I always recommend that active traders work with an accountant who is experienced in dealing with traders—they will know how to help structure your trading to minimize taxes. They can also take a lot of hard work off your hands.