Share investing versus share trading

Tax treatment

If you hold shares as an investor:

• your shares are assets and are subject to capital gains tax when you sell them
• your costs are taken into account at the time you sell your shares
• if you have a capital loss you can use it to offset capital gains but not to offset income from other sources
• income is earned from dividends and similar receipts.

If you are a share trader:

• your shares are treated like trading stock in a business
• your gains are treated as ordinary income
• your losses and costs are treated as deductible expenses in the year they are incurred.

If you change from an investor to a trader, or vice versa, the treatment of your profits or losses will also change.

Tax treatment of share investors and share traders

Cost or receipt	Share investor	Share trader
Profit from the sale of shares	Subject to capital gains tax	Assessable as ordinary income
Loss from the sale of shares	Used to offset capital gains or carried forward to offset future capital gains   Cannot be used to offset income from other sources	Deductible against income
Dividends and similar receipts	Included in assessable income	Included in assessable income
Purchase price of shares	Taken into account in calculating capital gain or loss when shares are sold	Deductible in the year incurred
Transaction costs of buying or selling shares	Taken into account in calculating capital gain or loss when shares are sold	Deductible in the year incurred
Costs (such as interest on borrowed money) incurred in earning dividend income from shares	Deductible in the year incurred	Deductible in the year incurred

How to determine if you are a share trader

Determining if you are a share trader is the same as determining whether your activities are considered to be carrying on a business for tax purposes.

Under tax law, a business includes 'any profession, trade, employment, vocation or calling, but does not include occupation as an employee'.

To determine whether you are a share trader or a business of trading shares, the following factors have been taken into account in court cases:

• the nature and purpose of your activities
• the repetition, volume and regularity of your activities
• whether your activities are organised in a business-like way
• the amount of capital invested.

Nature of activity and purpose of profit making

The intention to make a profit is not, on its own, sufficient to establish that a business is being carried on.

A share trader carries on business activities for the purpose of earning income from buying and selling shares.

Shares may be held for either investment or trading purposes, and profits on sale are earned in either case. A person who invests in shares as a shareholder (rather than a share trader) does so with the intention of earning income from dividends and receipts, but is not carrying on business activities.

You need to consider not only your intention to make a profit, but also the facts of your situation. This includes how your activities have actually been carried out, or a business plan of how your activities will be carried out.

A business plan might show, for example:

• analysis of the current market and each potential investment
• research to show when or where a profit may arise
• the basis of your decision-making on when to hold or sell shares.

Repetition, volume and regularity

Repetition is the frequency of transactions or the number of similar transactions. It is a key characteristic of business activities.

The higher the volume of your share transactions, the more likely it is that you are carrying on a business.

A business of share trading would also be expected to involve the purchase of shares on a regular basis through a regular or routine method.

Organisation in a business-like way and keeping records

A share-trading business could reasonably be expected to involve:

• study of daily and longer-term trends
• analysis of companies' prospectuses and annual reports
• seeking advice from experts.

Your qualifications, expertise, training and skills in this area would also be relevant.

Failure to keep records of share transactions would make it difficult for you to establish that a business of share trading was being carried on.

Amount of capital invested

The amount of capital you invest in shares is not a crucial factor in determining whether you are carrying on a business of share trading.

It is possible to carry on business activities with a relatively small amount of capital. On the other hand, you could invest a substantial amount of capital and not be considered a share trader.

Changing from investor to trader, or trader to investor

If you re-classify your activities, the way you treat your shareholdings will be affected.

We may ask you to provide evidence that:

• the nature of your activities has changed
• you have reported your income correctly in the past.

If we review your tax returns and find that you have incorrectly claimed losses, you may be subject to penalties.

Changing from investor to trader

If your activities change from investor to trader, your shares change from CGT assets to trading stock. When this happens, you can choose to start holding the shares as trading stock at either:

• their original cost
• their market value at the time of the change.

If you choose market value CGT event K4 occurs – CGT asset starts being trading stock. This means you make a capital gain or loss on the shares, which you must report in your tax return. You work out your capital gain or loss based on the market value of your shares at the time of the change.

Any unused capital losses from prior years (when you were an investor) remain as capital losses. You can't convert them into revenue losses. You should continue to carry forward any unused capital losses until you have a capital gain to offset them against.

Changing from trader to investor

If your activities change from trader to investor, your shares are no longer trading stock.

At the time of the change, you treat your shares as if:

1. just before they stopped being trading stock, you sold them to someone else (at arm's length and in the ordinary course of business) for their cost
2. you immediately bought the shares back for the same amount.

Work out if you are investing or trading in shares, and the difference it makes to your tax.