SMITH v FC of TJudges:
G Ettinger SM
Administrative Appeals Tribunal, Sydney
MEDIA NEUTRAL CITATION:
 AATA 576
Ms G Ettinger, Senior Member
1. Mr Richard Smith, comes to this Tribunal appealing against assessments made by the Commissioner of Taxation (the Commissioner), in relation to the 2007 and 2008 tax years. Mr Smith appeals on the basis that he has been held not to be in business, and not to be a share trader during the relevant years, and appeals in relation to the consequences of those decisions.
2. Mr Smith, who is 38 years old, and from the UK, told me that he has worked exclusively in investment banking. He is a highly educated man who holds a Master of Engineering from the University of Manchester (1994), and a MPhil in Management Science from Cambridge University, with a thesis on 'share market overreaction' (1995). He has since completed a graduate diploma in finance from the Securities Institute in Sydney, which, he told me, included a subject on corporate finance.
3. Mr Smith transferred to Australia in 1996, and between 1997 and July 2005, he worked for ABN Amro in Sydney and London, focusing mainly on the financing of large infrastructure and property transactions. In August 2005 he was one of five directors employed by Babcock & Brown to develop an infrastructure team primarily focused on public/private partnerships. He was undertaking that employment at the relevant times, being 2007 and 2008.
4. Mr HollestelIe, Mr Smith's accountant who represented him at the Tribunal, filed numerous documents and various versions of his share accounts as well as four sets of Statements of Facts and Contentions over the period of preparation of this matter, including amended figures during the hearing.
5. I am satisfied from the evidence before me that Mr Smith invested reasonably large amounts of money in shares during the relevant period, and conducted various buying and selling transactions. However, I am satisfied that Mr Smith did not meet the tests in order to be held to have been conducting a business in 2007 and 2008, nor to have been a share trader in the relevant years. I am not satisfied that his shares can be treated as trading stock on revenue account. My reasons follow.
Issues before the tribunal
6. The Commissioner disallowed in full Mr Smith's objection against income tax assessments for the 2007 and 2008 years. Mr Smith has appealed, and I have to decide whether he was carrying on a business, and whether he was in the business of being a share trader rather than an investor in 2007 and/or 2008. Clearly taxation consequences flow from those decisions.
7. I also have to deal with Mr Smith's argument, in the alternative, that his shares be treated as trading stock on revenue account.
8. A number of specific questions were raised in the Statements of Facts and Contentions of the parties relating to the concepts of ordinary income (pursuant to section 6-5 of the Income Tax Assessment Act 1997 (the Act)), allowable deductions (section 8-1 of the Act), whether the Applicant commenced holding shares and securities as trading stock in either the year 2007 or 2008, and the tax consequences which follow. In the paragraphs below, I have dealt primarily with whether Mr Smith was in business, and in the business of share trading in the relevant years. The tax consequences that flow from my decision on those points make the replies to the particular questions raised in the Statements of Facts and Contentions of the parties clear. I have accordingly not restated each.
9. The relevant legislation is the Income Tax Assessment Act 1997 (the Act), in particular:
- " 6-5 Income according to ordinary concepts (ordinary income)
- (1) Your assessable income includes income according to ordinary concepts, which is called ordinary income .
Note: Some of the provisions about assessable income listed in section 10-5 may affect the treatment of ordinary income.
- (2) If you are an Australian resident, your assessable income includes the *ordinary income you *derived directly or indirectly from all sources, whether in or out of Australia, during the income year.
- 8-1 General deductions
- (1) You can deduct from your assessable income any loss or outgoing to the extent that:
- (a) it is incurred in gaining or producing your assessable income; or
- (b) it is necessarily incurred in carrying on a *business for the purpose of gaining or producing your assessable income.
Note: Division 35 prevents losses from non-commercial business activities that may contribute to a tax loss being offset against other assessable income.
- (2) However, you cannot deduct a loss or outgoing under this section to the extent that:
- (a) it is a loss or outgoing of capital, or of a capital nature; or
- (b) it is a loss or outgoing of a private or domestic nature; or
- (c) it is incurred in relation to gaining or producing your *exempt income or your *non-assessable non-exempt income; or
- (d) a provision of this Act prevents you from deducting it.
- 70-10 Meaning of trading stock
Trading stock includes:
- (a) anything produced, manufactured or acquired that is held for purposes of manufacture, sale or exchange in the ordinary course of a *business; and
- 70-30 Starting to hold as trading stock an item you already own
- (1) If you start holding as *trading stock an item you already own, but do not hold as trading stock, you are treated as if:.
- (a) just before it became trading stock, you had sold the item to someone else (at arm's length) for whichever of these amounts you elect:
- • its cost (as worked out under subsection (3) or (4));
- • its *market value just before it became trading stock; and
- (b) you had immediately bought it back for the same amount.
Note: Depending on how you elect under paragraph (1)(a), the sale may or may not give rise to a capital gain or a capital loss for the purposes of Parts 3-1 and 3-3 (about CGT). It does not if you elect to be treated as having sold the item for what would have been its cost: see subsection 118-25(2). However, it can if you elect market value.
When you must make the election
- (2) You must make the election by the time you lodge your *income tax return for the income year in which you start holding the item as *trading stock. (If you do not make the election by then because you do not realise until later that you started to hold the item as trading stock, you must make the election as soon as is reasonable after realising that.)
However, the Commissioner can allow you to make it later (in either case).
How to work out the item's cost
- (3) The item's cost is what would have been its cost for the purposes of section 70-45 (about valuing trading stock at the end of the income year) if it had been your *trading stock ever since you last acquired it. In working that out, disregard section 70-55 (about acquiring live stock by natural increase).
- 70-35 You include the value of your trading stock in working out your assessable income and deductions
- (1) If you carry on a *business, you compare:
- (a) the *value of all your *trading stock on hand at the start of the income year; and
- (b) the *value of all your *trading stock on hand at the end of the income year.
- (2) Your assessable income includes any excess of the *value at the end of the income year over the value at the start of the income year.
- (3) On the other hand, you can deduct any excess of the *value at the start of the income year over the value at the end of the income year.
- 70-40 Value of trading stock at start of income year
- (1) The value of an item of *trading stock on hand at the start of an income year is the same amount at which it was taken into account under this Division or Subdivision 328-E (about trading stock for small business entities [formerly, STS taxpayers]) at the end of the last income year.
- (2) The value of the item is a nil amount if the item was not taken into account under this Division or Subdivision 328-E (about trading stock for small business entities [formerly, STS taxpayers]) at the end of the last income year.
- 70-45 Value of trading stock at end of income year
- (1) You must elect to value each item of *trading stock on hand at the end of an income year at:
- (a) its *cost; or
- (b) its market selling value; or
- (c) its replacement value.
- 102-5 Assessable income includes net capital gain
- (1) Your assessable income includes your net capital gain (if any) for the income year. You work out your net capital gain in this way:
10. In coming to a decision regarding whether Mr Smith was carrying on a business, and whether he was in the business of share trading in 2007 and 2008, I considered the evidence before me including Mr Smith's oral and written evidence, the submissions of the parties, the legislation and the case law.
11. I have also considered what Mr Smith is claiming in the alternative, that whether his shares could be treated as trading stock on revenue account.
12. By way of general guidance, I am mindful of the frequently cited words from
Martin v Federal Commissioner of Taxation (1953) 90 CLR 470:
"The test is both subjective and objective: it is made by regarding the nature and extent of the activities under review, as well as the purpose of the individual engaging in them, and ... the determination is eventually based on the large or general impression gained."
13. I am mindful also of Hill J's words in
Federal Commissioner of Taxation v Radnor (1991) 102 ALR 187 where his Honour said:
"There is no single factor that can be isolated as determinative of the question whether a taxpayer is carrying on a business. Rather, as Jessel MR said in
Erichsen v Last (1881) 8 QBD 414 at 416: 'There are a multitude of things which together make up the carrying on of trade'.
The specific factors assist, however, in marking out activities as a business - repetition and the existence of a purpose of making a profit:
Hope v Bathurst City Council (1980) 144 CLR 1 at 8-9. The significance of these factors was pointed out in the joint judgment of Bowen CJ and Franki J in
Ferguson v FCT (1979) 26 ALR 307 at 311 where their Honours said:
'here are many elements to be considered. The nature of the activities, particularly whether they have the purpose of profit-making, may be important. However, an immediate purpose of profit-making in a particular income year does not appear to be essential. Certainly it may be held a person is carrying on business notwithstanding his profit is small or even when he is making a loss. Repetition and regularity of the activities is also important. However, every business has to begin and even isolated activities may in the circumstances be held to be the commencement of carrying on business. Again, organisation of activities in a business-like manner, the keeping of books, records and the use of system may all serve to indicate that a business is being carried on'
Ultimately, the question whether the respondent was carrying on a business of dealing in shares is a question of fact and degree, a question of impression.
14. Accordingly, the decision regarding whether Mr Smith was carrying on a business, and whether he was in the business of share trading must be assessed both objectively and subjectively, and ultimately, the question whether he was carrying on a business of dealing in shares is a question of fact and degree, a question of impression.
15. I am also mindful that many of the analyses and decisions undertaken in relation to buying and selling shares apply both to investors and share traders. Mr Smith acknowledged this when giving his evidence, stating that many of the indicia upon which he relied to classify himself as a share trader may well also have applied to investors.
16. I have noted also that Senior Member Block (as he then was), stated in
Shields v Deputy Federal Commissioner of Taxation 99 ATC 2037 (1999) 41 ATR 1042 as follows:
Case 6297 (1990) 21 ATR 3747;
Case X86 90 ATC 621, Deputy-President Todd of this tribunal, in the light of the case authority referred to in his decision, summarised the applicable tests at ATR 3755-6; ATC 629 in the following terms:
- 22. In relation to the question of whether this applicant was a share trader or a speculator it is necessary to determine whether or not he was engaged in the business of share trading. In AAT Case 5570; Case X31 at 298, the tribunal cited with approval the following passage from
Martin v FCT (1952) 90 CLR 470; 5 AITR; 10 ATD 37 at p39:
'The test is both subjective and objective: it is made by regarding the nature and extent of the activities under review, as well as the purpose of the individual engaging in them, and ... the determination is eventually based on the large or general impression gained
- The question is therefore essentially one of fact. In deciding this issue the case law has established the following factors as generally relevant considerations:
- (a) the nature of the activities and whether they have the purpose of profit-making;
- (b) the complexity and magnitude of the undertaking;
- (c) an intention to engage in trade regularly, routinely or systematically;
- (d) operating in a business-like manner and the degree of sophistication involved;
- (e) whether any profit/loss is regarded as arising from a discernible pattern of trading;
- (f) the volume of the taxpayer's operations and the amount of capital employed by him;
and more particularly in respect of share traders:
- (a) repetition and regularity in the buying and selling of shares;
- (b) turnover;
- (c) whether the taxpayer is operating to a plan, setting budgets and targets, keeping records;
- (d) maintenance of an office;
- (e) accounting for the share transactions on a gross receipts basis;
- (f) whether the taxpayer is engaged in another full-time profession."
17. I am mindful that none of the factors listed above from Martin's case which I must take into account in deciding whether Mr Smith is an investor, or in business as a share trader, can be isolated as determinative of the question whether he is carrying on a business. They should not be viewed individually. However each can be given certain weight. The determination is eventually based on the large, or general impression gained (FCT v Radnor).
18. However, one of the biggest challenges in this case was actually ascertaining what share transactions Mr Smith made, and how he accounted for them in the relevant years. Mr Hollestelle produced multiple versions of figures in his four Statements of Facts and Contentions dated 20 January 2010, 9 February 2010, 20 April 2010 and 30 April 2010, and a Schedule of Sales for 2008 (Exhibit A8).
19. Mr Smith's witness statements Exhibits (A1, A2, and A3) also had detailed Schedules appended, and many of the figures did not correspond with the figures given to the Commissioner when the objection was lodged, (Exhibit R1,T5). Even during the hearing, Mr Hollestelle provided revised figures for Exhibit A4, the Further Statement of Facts, Issues and Contentions of the Applicant, which I altered by hand. One of the problems appeared to be that Mr Smith treated the shares in Babcock & Brown related entities differently from his other investments.
20. Mr Miller who appeared for the Respondent Commissioner drew certain of these inconsistencies to my attention in his written submissions, and the material tendered at the hearing, (Exhibits R3-R7).
21. I move then to deal with the various indicia as relevant, from Martin's case in the paragraphs which follow.
Mr Smith's intentions
22. Mr Hollestelle submitted that whether a person is a dealer or trader is a matter of fact, and that purpose is relevant only where the activity has not yet commenced. In that regard he referred to
John v Federal Commissioner of Taxation (1989) 166 CLR 417 at 430 where I noted that the Court stated:
"Whether or not a person is a trader seems to us to be a question of fact, albeit that in some cases the determination of that fact may depend on questions of impression and degree. If trading has not commenced or if there is no discernible trading pattern, the question of intention or purpose may be relevant in the sense that if there is an absence of intention or purpose to engage in trade regularly, routinely or systematically then the person may well not be a trader..."
23. In regard to his intentions; I noted from Mr Smith's statement at Exhibit A1 that prior to July 2006, he acquired shares and securities using a broking account with his employer ABN AMRO, and that after joining Babcock & Brown in 2005, he used a NAB share and margin loan facility. His evidence was that between 2004 and 2006, he did little share buying and selling, and held his shares for considerable periods, but that on 7 July 2006, he undertook a new margin loan facility, and transferred his existing share portfolio to Bankers Trust, (BT), on favourable terms. Mr Smith said that from 7 July 2006, he substantially increased the level of my day-to-day activities in share dealing, including the number and value of purchases and sales of parcels of shares and securities, the equity and loan capital invested, the level of personal time commitment and the range, complexity and method of operation of share dealing activities. Mr Smith also explained that he was influenced by the entrepreneurial approach at Babcock & Brown, the strong focus at corporate level to trading assets, the regular discussions which took place regarding good buys, and so on.
24. Mr Smith said that from 7 July 2006, he changed from his conservative approach to that of actively dealing and trading in shares and securities through buying, holding and selling the shares and securities for short term profit-making by way of regular and repetitive transactions. Mr Smith gave evidence that in addition to the fulltime work he undertook, he looked after his personal share trading. He conceded that the margin lending facility into which he had entered, and the surplus capital and bonus payments also influenced him.
25. Mr Smith told me that he relied on his accountant's advice, adding that the latter did not ask him whether he was a trader or an investor. Mr Smith also said that when buying and selling shares, he did not take into account longevity of holdings, with capital gains or other tax implications in mind. Mr Hollestelle submitted that Mr Smith knew in 2007 and 2008 that he had actively dealt in shares, but did not recognise that he could classify himself as a trader. That is curious given his extensive education which I have referred to in the paragraphs above, and the fact that he worked in investment banking.
26. The evidence before me indicates that Mr Smith did not represent himself as a share trader until after he had lodged his income tax returns for 2007 and 2008. Up to then, Mr Smith had treated himself as an investor in the share market, with gains and losses from the share market returned in his income tax returns as capital gains or losses. Notwithstanding Mr Smith's late decision in regard to when he decided he was a share trader, section 70-30 of the Act provides the Commissioner with a discretion to accept an election out of time. Little was made of this at the hearing, and I accept that the discretion can be exercised as appropriate.
27. I noted from his statement that Mr Smith did not really intend to be a share trader, and am mindful that at the time when he decided that perhaps he was, he was influenced by the entrepreneurial approach at Babcock & Brown, and as he agreed, also had increased disposable income. Pursuant to the case law, whether or not a person is a trader, is a question of fact, albeit that the determination of that may also depend on questions of impression and degree. I am mindful from
Ferguson v Federal Commissioner of Taxation (1979) 26 ALR 307 that the intentions and purpose of the person are important considerations.
28. In conclusion, I have noted the motivations in regard to share purchases and sales which Mr Smith discussed in his oral evidence, and in his written Statements. He considered himself an investor and behaved accordingly, and clearly from the evidence, did not decide he was a share trader for the 2007 and 2008 years until after he had lodged his income tax returns for those years. I am satisfied that given his background and education, as discussed above, and the fact that he worked as an investment banker, he knew what he was doing in regard to his investments and his shares. I am satisfied that Mr Smith found himself with amounts of disposable income to invest which he had not previously had, and found after he transferred to the BT Margin lending facility on 7 July 2006, and after lodging his 2007 and 2008 returns, and discussions with his accountant, that perhaps he might claim to be in the business of share trading. I moved then to consider the nature of his activities and whether they had the purpose of profit making
Nature of the activities and whether they have the purpose of profit-making
29. Mr Smith's evidence was that he relied on a value based approach, and dealt in high quality shares rather than being speculative. He stated that he identified securities which were undervalued while also showing a reliable and established income stream, with the intention of selling them after a short term price appreciation, and typically within a 6-12 month period. Mr Miller, on the other hand, submitted that if Mr Smith took a value based approach to his purchases of shares, which the Respondent did not accept, it could not be said that he did so in relation to sales. Mr Miller submitted sales were motivated by other considerations such as the downturn in the share market in 2008, and in shares owned by the Applicant.
30. Mr Smith claimed that prior to 2006 he was an investor in shares, and not a trader. He said that he did not have any transactions in 2005 and 2006 which he subsequently treated as trading stock until he transferred his share portfolio to BT and the Westpac facility (WBC) on 7 July 2006.
31. Notwithstanding Mr Smith said that he did not have any transactions in 2005 and 2006, I noted that the Applicant acquired 200,000 shares in a Babcock & Brown entity (totalling $200,000) on 1 March 2006, and 46,823 shares at $1.60 each, totalling $74,917 on 18 April 2006, in another Babcock & Brown entity, both of which were before the relevant date of 7 July 2006 (Schedule 5 to Exhibit A1, Mr Smith's first witness statement).
32. Once Mr Miller drew this to the attention of the Applicant, he recognised that the dollar amount claimed by him to have been brought in as trading stock on 7 July 2006, reduced from in excess of $700,000 to approximately $520,152, a not insubstantial difference.
33. I am mindful that the figures provided indicated that Mr Smith's purchases, sales and holdings were heavily weighted towards Babcock & Brown entities. Mr Hollestelle's submissions regarding this were that the infrastructure field was the one Mr Smith knew best, and serviced at the relevant times in relation to his then employer. I noted that of the $520,152 claimed to have been treated as trading stock from 7 July 2006, shares and securities in Babcock & Brown affiliates accounted for $224,916, that is, almost half, which is a significant percentage.
34. As to the nature of Mr Smith's activities, I noted from Exhibit A4, the fourth Statement of Issues, Facts and Contentions of the Applicant, figures which recorded that in relation to the 2007 year, the Applicant purchased shares and other securities at a cost of $1,196,009. I noted that $229,123 of the total purchases were in Babcock & Brown entities. Mr Smith sold shares and other securities for a total of $365,776 in 2007. The holding of trading stock at the end of 2007, was put at $1,480,126 by the Applicant. Mr Miller submitted that of the total sales of $365,376 in 2007, $317,514 was from shares or securities on hand on 7 July 2006 when Mr Smith said he commenced holding them as trading stock. The other sales were 38 shares in NAB acquired under its Dividend Reinvestment Plan (DRP). I noted from the figures that the volume of sales for 2007 was quite small, which is not in itself determinative, rather it is the time for which they are held, the profit motive, and the repetition and regularity of the transactions which are of importance when viewed as a whole. I noted that the stocks had been held for a considerable time, mainly since before 2004. Notwithstanding this was his first year, the volumes did not point to Mr Smith being in business, or trading shares for profit.
35. In the 2008 year, which in economic and share value terms presented a serious problem, the Applicant acquired shares and securities at a cost of $1,496,764, of which $148,679 were in Babcock & Brown entities. He sold shares and securities for prices totalling $1,201,968, of which $153,647 were in Babcock & Brown entities. His holdings of what he termed trading stock at the end of the 2008 year were $1,332,183. Mr Miller pointed out that sale turnover and purchases for the 2007 and 2008 years included transactions relating to the Applicant's participation in the Telstra T3 IPO, which I noted resulted in purchases and sales for 2008 being overstated by $300,000.
36. The sales for 2008 were as noted above, and overstated by $300,000. They included sales of five securities totalling $72,458 to Queens Park Trust, the Applicant's family trust. In his oral evidence Mr Smith conceded that the sales were motivated by a wish to crystallise capital losses to offset other capital gains for 2008. I noted that 75,000 shares in a Babcock & Brown entity were sold due to a compulsory acquisition.
37. As to the purpose of profit making; I was concerned after considering the data, including Annexure A to the Respondent's written submissions and Mr Hollestelle's comments thereon, that Mr Smith held his shares and securities for longer periods than a trader would generally be expected to, as profit taking would be a primary motive for a share trader's regular buying and selling of stocks. AGL Energy for example, was held for up to 75 months, AMP up to 71 months, Aristocrat Leisure up to 37 months, BHP up to 53 months, Cochlear up to 34 months, Macquarie Airports up to 35 months, Qantas up to 39 months, Telstra up to 39 months, and Westfield Group up to 47 months.
38. Mr Miller commented on the fact that Mr Smith did not use share price charting strategies or techniques as a share trader would. He submitted that for example in relation to Telstra shares, Mr Smith would, had he used such techniques, recognised many months earlier that there was no support for Telstra shares above $4.90, and accordingly sold them far earlier. Mr Hollestelle countered this argument by stating that Mr Smith sold Telstra shares three times in 2008, at between $4.50 and $4.80 which was substantially above the acquisition price of $3.52 to $3.56 in August 2006.
39. Mr Hollestelle submitted that Mr Smith could not be compared to, say, the case of a retail corner shop trader, or a high turnover consumer goods trader. He submitted that Mr Smith made good clear decisions regarding acquisitions based on his expertise and research, and regular purchases and sales of assets with the intention of taking of short term profits in the dealing portfolio.
40. Mr Hollestelle countered the argument of the Respondent which was that because Mr Smith took part in Dividend Re-investment Plans he was not a trader. He submitted that acquiring more shares through DRPs increased exposure and profitability, and DRPs are obtained at a discount. I am mindful that many traders would not take dividends or DRPs, but that in isolation, that would not weigh heavily against Mr Smith being a share trader.
41. I noted the nature of Mr Smith's activities, and whether they indicated his purpose was profit-making. I accept that to be a share trader he may not have been expected to speculate, but I would have expected a greater volume of trading, more activity within the portfolio in order to maximise profits, and for him not to have held shares for long periods, or necessarily taken DRPs. Exhibit R7, a detailed chart prepared by the Respondent, was a strong indicator that Mr Smith frequently did not sell at optimum times to take profits as a trader would.
42. In regard to the length of time Mr Smith held stocks and shares, I am mindful, (and that weighs against Mr Smith being a trader), that he suffered restrictions in regard to trading. He was required to seek permission from management and compliance on each occasion when he wanted to buy or sell. His evidence was that this could take anything from one hour to overnight, and naturally, in the case of any Babcock & Brown related entities, there was only a window for employees at restricted times, for example, after announcement of results. Mr Hollestelle submitted that this did not disadvantage Mr Smith because he was not a day trader.
Whether Mr Smith exhibited an intention to engage in trade regularly, routinely or systematically; Repetition and regularity in the buying and selling of shares
43. As to whether Mr Smith exhibited an intention to engage in trade regularly, routinely or systematically; I was mindful of the restrictions in timing he faced which I have described in the paragraphs above, that is he had to seek permission from within Babcock & Brown to buy and sell shares, and the fact he was also restricted to particular windows in order to buy and sell Babcock & Brown related entity shares. In addition, Schedule 12 records a gap of three months with no entry for the period 27 October 2006 to 21 January 2007, and three entries for 15 November 2007, with the next entry some three weeks later on 4 December 2007. Mr Miller submitted that this was not consistent with Mr Smith's claims that he was a share trader. I was satisfied from the annotated share charts at Exhibit R7 that Mr Smith held shares for substantial periods of time, and did not take profits within a reasonable time as a share trader would.
44. Mr Smith's evidence was that he accessed his internet share broking account on the WBC platform 38 times in the 2007 year, and 103 times in the 2008 year. His records and evidence also indicated he had conducted approximately 1,005 "transactions" on the WBC platform between June 2006 and June 2008 as recorded in Schedule 12 attached to his first witness statement.
45. Mr Miller argued in regard to the 1,005 "transactions" that these were electronic transactions performed by a computer which may not each have referred to the execution of a financial transaction such as an acquisition or sale of shares. He submitted that an examination of Schedule 12 indicated that in many cases there were several separate financial transactions for one share transaction, for example, the confirmation of the financial transaction, its verification, and its execution, all being part of one transaction. I noted that Mr Smith did not disagree with Mr Miller's analysis of the electronic transactions.
46. On the evidence, then, I am satisfied that the number of electronic transactions did not represent a trade on each occasion, and that this reduced the number of 1,005 transactions substantially.
47. Mr Miller submitted that Mr Smith allowed prices to fall substantially without making sales. He did not take profits when they were available, and cut losses to protect capital. He submitted: It is obvious he was waiting for the upturn that did not come. It was like the paralysis suffered by an investor. That is what appeared to me to have occurred in the case of the Telstra shares.
48. Mr Hollestelle on the other hand, submitted that the speed of turnover of trading stock was not an imperative, and referred to
Commissioner of Taxation v St Hubert's Island Pty Limited (in liquidation) (1977) 138 CLR 210 where holdings were 10 years or more. I am mindful that St Hubert's Island concerned land purchased in bulk and held while development work was completed, and that the issues were not directly applicable to Mr Smith's situation.
49. I have already noted above that Mr Hollestelle submitted that Mr Smith's case was not that of a retail corner shop trader or a high turnover consumer goods trader, and that he made good clear decisions regarding his acquisitions which were based on his expertise and research. He submitted that Mr Smith made regular purchases and sales of assets with the intention of taking short term profits in the dealing portfolio. Mr Hollestelle submitted that the pattern of Mr Smith's trading was that when he commenced in 2007, he made more purchases than sales, whereas the increase in the amount of sales for 2008 was an indication Mr Smith was trading and not just building up a portfolio of shares.
50. Mr Miller submitted that whilst Mr Hollestelle tried to explain away the gaps in time between Mr Smith buying and selling shares by referring to the demands of his job, Mr Smith himself did not give any explanation.
51. I have also noted above from Schedule 12, long intervals between buying and selling shares which led to the impression Mr Smith was not taking profits, and acting more like an investor than a trader of shares.
52. The other issue which I am satisfied would have hampered Mr Smith in being a share trader as discussed above, was the permission he was required to seek from management and compliance on each occasion when he wanted to trade. This would have hampered his repetition and regularity in the buying and selling of shares, even if he had had the intention of trading regularly and routinely.
53. I am satisfied from the evidence and submissions that Mr Smith's activities in buying and selling shares did not demonstrate that he did so regularly, routinely or systematically. He did not demonstrate to my satisfaction that there was any plan, and that there was repetition and regularity in the buying and selling of his shares. As noted above, he held shares for longer periods than a trader would, and did not take profits as they arose. He was reliant on Babcock & Brown's processing of approval to buy and sell. During 2008, his sales appeared to be due to the substantial downturn in values of his shares which occurred due to the economic downturn. Accordingly he gave the impression that he was more of an investor than a trader.
Operating in a business-like manner and the degree of sophistication involved; whether any profit/loss is regarded as arising from a discernible pattern of trading
54. In submitting that Mr Smith was operating in a business-like manner and referring to the degree of sophistication involved, Mr Hollestelle emphasised Mr Smith's background, and his high level education in the field of finance. I noted Mr Smith's evidence which was that because of his qualifications and background, and the environment in which he worked, he could access whatever advice he needed, and did not need to rely on external advisors. Mr Hollestelle compared Mr Smith's position with that in Shields, where I noted the applicant was employed by the AMP Society, and had previously been an employee of banks.
55. Mr Miller submitted that the Applicant relied on accounting records provided by the BT Margin Loan Facility and the WBC platform, and did not produce any form of profit and loss accounting or trading statement. Mr Smith did not deny this, but emphasised that he relied upon his analysis of PE ratios, gearing and other indicators prior to making an investment or trading decision. He was satisfied that he operated in a business-like manner because he analysed and considered each trade before entering into it. He said he used a historical method of share trading, which he conceded both investors and traders use. He did not however use charting, which the Respondent submitted, and I accepted, is a sophisticated approach to trading which investors would not employ.
56. Mr Hollestelle referred to the Respondent's submissions, and stated that Mr Smith's case could be distinguished from that in
Trent Investments Pty Ltd v Federal Commissioner of Taxation (1976) 10 ALR 58 because in Trent, the taxpayer was seeking to build up a share portfolio whereas Mr Smith was trading. He submitted that
Firth v Federal Commissioner of Taxation (2001) 48 ATR 93 applied.
57. In that regard, I noted Mr Smith's evidence that he was working fulltime in a very responsible position with Babcock & Brown in the relevant years. He could not give me an indication of how long he spent each day, or in each period, on what he claimed were his share trading activities. It was difficult to conclude from the lack of evidence on that point, and the long and irregular periods Mr Smith held shares, that he had a discernible pattern of buying and selling shares.
58. It would also not be reasonable to conclude that Mr Smith was a share trader in 2007 and 2008 when Mr Hollestelle submitted that he did not know he was a share trader in that period, and that accordingly he did not raise the issue until after he had lodged his income tax returns.
59. I am mindful that in order to establish business-like behaviour, there must be a discernible pattern of trading rather than a series of discrete transactions, (John v FCT). In order to establish whether a person is in business they must be shown to be in a commercial enterprise involving activities being pursued for the purpose of profit on a continuous and repetitive basis (
Hope v Bathurst City Council (1980) 144 CLR 1).
60. I was not satisfied that Mr Smith exhibited a discernible pattern of trading rather than a series of discrete share transactions in the relevant years, 2007 and 2008. In coming to that conclusion, I rely on Exhibits R5 and R7, which demonstrate Mr Smith's buying and selling activities during the relevant periods. There is also the issue that Mr Smith had to seek approval before every sale and purchase of shares, and that he was restricted to particular windows in regard to Babcock & Brown related entities. I am also satisfied that he held shares for periods which I am satisfied were longer than those which a share trader would, (Annexure A to the Respondent's written submissions dated 3 May 2010, and Exhibit R7). The following are examples of situations where Mr Smith did not take the profit as a trader would have been expected to do, page 10 of Exhibit R7 in relation to AMP, page 20, BHP Billiton, page 30, Macquarie Communications Infrastructure Group, page 34, Paperlink, page 41, Telstra.
Whether the taxpayer is operating to a plan, setting budgets and targets, keeping records; Accounting for the share transactions on a gross receipts basis
61. Mr Smith's evidence was that (having arrived in Australia in 1997), he had commenced buying and selling in the share market before 2002. He said that he had a plan, but acknowledged that it was not in writing, nor documented anywhere. He also acknowledged he did not seek professional advice from an advisor, but relied on his own expertise and the Australian Financial Review market reports which he had to access for his normal day to day duties. Mr Smith also argued that the WBC platform provided the support which he required in order to trade.
62. Mr Miller submitted that Mr Smith relied on the accounting records provided by BT and the WBC platform, as any investor might, but did not produce any form of profit and loss account or trading statement, which Mr Smith did not deny. It was not apparent how he accounted for his transactions.
63. I was satisfied that Mr Smith relied upon his own expertise to buy and sell shares, and I did not see evidence of him acting differently from an investor in that regard. In regard to plans, budgets and record keeping, he did not demonstrate to my satisfaction that he was a share trader operating to a plan, setting budgets and targets, or buying and selling to take advantage of rising markets with a clear profit motive.
The volume of the taxpayer's operations and the amount of capital employed by him, and more particularly in respect of share traders; turnover; the complexity and magnitude of the undertaking
64. In his written submissions Mr Hollestelle indicated that Mr Smith sold 14 parcels of shares held in 10 entities in the 2007 year out of the total of 32 entities held in that year. For the 2008 year, he submitted that Mr Smith sold 21 parcels of shares in 18 entities held out of a total of 39 entities held during that year. He submitted that the value of the sales was $365,776 in 2007 and $1,201,968 in the 2008 year. He submitted that this was substantial in absolute terms, but even more so taking into account the opening tax values of $520,151 for the 2007 year and $1,480,126 for the 2008 year, and year end tax values of $1,480,126 for 2007, and $1,332,183 for 2008.
65. Mr Hollestelle submitted that the pattern of sales was that of a trader, and not one of someone building up a long term investment portfolio. Neither was Mr Smith a mere speculator, he submitted. He submitted that Mr Smith acted on industry tips, many of the stocks were infrastructure, and stocks for short term speculation, and arbitrage opportunities. Many were in companies in which the Applicant had worked, and of which he had a good understanding. He was taking a value based dealing approach, Mr Hollestelle said. Mr Smith acknowledged he made substantial profits in 2007, justifying his share dealing approach, and accepted this was reversed by substantial losses in 2008, mainly because he was exposed to infrastructure and property stocks.
66. I was mindful of the Respondent's approach to the 2008 sale of securities to the Queens Park Trust, being the Applicant's family vehicle. Mr Miller submitted that this was to realise capital losses to set off against other capital gains in that year. In his oral evidence Mr Smith did not deny that, however he also explained that there was no benefit in holding those stocks within the BT Margin Lending Facility because he could not leverage against them, and they therefore ceased being a trading asset. Mr Hollestelle also emphasised that there was no suggestion that the transfers had not been done at market value, and noted that the Trust paid for the shares it acquired.
67. Mr Hollestelle submitted that It was also not in dispute that 2008 was a difficult year financially, and that share values dropped substantially. He indicated that losses for 2008 were $402,688 in relation to the total tax losses of $443,740, or as amended to$453,741, (Exhibit A4) on the final day of hearing. Mr Hollestelle submitted that: In such an environment it would be typical to expect a normal investor would typically be either a holder or seller of stocks. The Applicant undertook 34 acquisitions and 21 sales in the 2008 year with transactions occurring every month throughout the 2008 year. This is the typical activities (sic) of a trader who seeks to use the volatility in markets (against the herd like behaviour of investors) to enhance trading returns.
68. I was mindful also from the evidence before me that Mr Smith took DRPs in at least 17 of the 45 companies in which he held shares, and that his argument was that they were a means of increasing his shareholding in trading assets, normally at a discount to market value. These acquisitions could typically be funded through the BT loan facility at no marginal cost to the Applicant. He considered this to be entirely consistent with his share trading approach. I have noted Mr Smith's argument, but prefer the Respondent's approach, which is that in more cases than not, share traders do not take dividends or DRPs.
69. It is not in dispute, as noted above, that Mr Smith sold more shares in 2008 than in 2007, and the economic situation in 2008 cannot be divorced from that. My impression however, from the many different sets of figures with which I was confronted, was that the volume of the Applicant's operations, the amount of capital employed by him, and more particularly the timing and delays in respect of his purchases and sales, was that he had an excess of funds which he wanted to invest, that he took DRPs, and that he was an investor.
Whether the taxpayer is engaged in another full-time profession; maintenance of an office
70. It is undisputed, and I accept that Mr Smith was engaged in fulltime employment with Babcock & Brown at the relevant time, and during which time he claims he was a share trader.
71. The Full Federal Court in
Ferguson v Federal Commissioner of Taxation (1979) 26 ALR 307 stated that:
"The fact that, concurrently with the activities in question, the taxpayer carries on the practice of a profession or another business, does not preclude a finding that his additional activities constitute the carrying on of a business. The volume of his operations and the amount of capital employed by him may be significant.:
72. Pursuant to the Court in Ferguson, being fully employed as an investment banker does not preclude Mr Smith also being a share trader. I am satisfied that because Mr Smith was engaged fulltime at Babcock & Brown he did not maintain a separate office for his share transactions. That is accordingly not an important factor in this case. As a matter of further interest however, he was not able to indicate to my satisfaction how much time he spent on buying and selling stocks and shares.
73. In summary, although I have discussed the number and the value of transactions Mr Smith undertook in 2007 and 2008 in the paragraphs above, and other relevant indicia, I was not satisfied that he was in business or in the business of being a share trader.
74. If Mr Smith were to be held to be in business, (Hope v Bathurst City Council), and in business as a share trader, then he would be entitled to deductions for the purchase of shares and other securities as trading stock pursuant to section 8-1 and 70-15, and for the difference between opening and closing stock pursuant to section 70-35.
75. Trading stock is defined in section 70-10, and as can be seen below, shares can be trading stock. Pursuant to
Investment and Merchant Finance Corporation Limited v Federal Commissioner of Taxation (1971) 125 CLR 249 at 270, the Court stated as follows:
There is nothing in that case, in my opinion, which is authority for the proposition that shares can never be trading stock within the meaning of the Act;....
76. The High Court in
John v Federal Commissioner of Taxation (1989) 166 CLR 417 stated as follows:
"... it is relevant to inquire whether the person who acquires an item claimed to be trading stock is a trader in the sense that he is engaged or will be engaged in trading goods of the nature of the item acquired. It is for this reason that it is pertinent to inquire whether Malindi was a share trader or, as was put in argument, was engaged in the business of a share trader."
77. In coming to a decision I have considered the evidence and the submissions of the parties which are summarised below, and taken into account the above authorities, including FCT v Radnor and Shields. I am mindful that the determination whether Mr Smith was in business, and in the business of being a share trader in the relevant years, 2007 and 2008, is based on the large or general impression gained. (FCT v Radnor), and that none of the factors in Martin, can be isolated as determinative of the question. Rather, the question of whether Mr Smith was carrying on a business of dealing in shares is a question of fact and degree.
78. I am mindful that Mr Smith says he is knowledgeable and skilled in the field of shares and securities dealing and trading. He has also worked as an investment banker for a long time. Mr Hollestelle submitted on behalf of the Applicant that he applied his endeavours to the activities of buying selling stocks and shares as a trader in a systematic, repetitive and business-like manner with the object of short-term profit-making. Mr Hollestelle submitted that the following factors should influence my decision to find that Mr Smith was a share trader in 2007 and 2008:
- • the vocation of the Applicant;
- • the intentions of the Applicant to actively trade shares and securities regularly for profit;
- • the volume, frequency and the substantial quantum of sales in relative terms to capital invested;
- • the relatively substantial number of entities in which sales were made;
- • Mr Smith's stated system organisation and expert approach.
79. Not surprisingly, Mr Miller submitted on behalf of the Commissioner that I should find Mr Smith was an investor, who at the relevant time, found himself in a position of having an increase in disposable income, and decided to expand his investment portfolio. He submitted in regard to Mr Smith:
- • he is a person who knows about tax matters;
- • that although this was played down for the purposes of the appeal, he was in fact one of five senior people in Babcock & Brown at the relevant time;
- • Mr Smith acknowledged that at the relevant time, he was eligible for a substantial bonus and salary, and found himself with excess funds, and therefore invested in shares;
- • that Mr Smith did not intend, at the relevant times, to be a share trader;
- • that he was not in the business of being a share trader in 2007 and 2008;
- • that Mr Smith's evidence fell far short of the proof required;
- • that Mr Smith failed to discharge his onus in demonstrating how his skills were applied in the sale of shares;
- • that he was limited in trading, having to obtain approval for purchases and sales, and restricted to windows in Babcock & Brown related entities;
- • that the transactions to the Queen Park Trust were made in order to obtain losses for capital gains purposes;
- • that courts and tribunals have recognised that persons who are not in business as share traders, such as investors, may make sales and purchases with an eye to factors other than the income yield.
80. I have taken into account all the factors raised by the Applicant and the Respondent, and those raised in Martin, Firth, FCT v Radnor,
AAT Case 6297 (1990) 21 ATR 3747 and others, to decide whether Mr Smith was in business and in the business of being a share trader in the years 2007 and 2008.
81. In Spriggs v Commissioner of Taxation;
Riddell v Commissioner of Taxation (2009) 239 CLR 1, the High Court said:
"The existence of a business is a matter of fact and degree. It will depend on a number of indicia, which must be considered in combination and as a whole. No one factor is necessarily determinative. Relevant factors include, but are not limited to, the existence of a profit-making purpose, the scale of activities, the commercial character of the transactions, and whether the activities are systematic and organised, often described as whether the activities are carried out in a business-like manner.
82. I am satisfied, and note Mr Smith's acknowledgment that many of the analyses and decisions (for example, PE ratios, gearing etc), undertaken in relation to buying and selling shares apply both to investors and share traders. However, whether I ultimately find that Mr Smith is in business, and in the business of being a share trader, is dependent on a number of indicia, and the overall impression the Applicant has given in relation to the buying and selling of his shares. It is, as the case law suggests, a matter of fact and degree. My summary of most of the indicia I have considered, (based on Martin), follows.
83. Mr Smith is a highly educated person and had worked in investment banking for some years before the relevant years, 2007 and 2008. I am satisfied that his intentions in 2007 and 2008 did not extend to being a share trader. I am satisfied that he found himself with an increase in disposable income, and invested in shares. Due to his employment with Babcock & Brown, and the offer of favourable terms, he changed to BT and the WBC platform, and when his accountant suggested to him he could class himself as a share trader, he attempted to do so after lodgment of his 2007 and 2008 tax returns. He gave evidence, that accordingly, he sold his shares for appropriate cost on 7 July 2006. His share holdings were substantial, and a substantial portion were, due to his employment with, and interest in infrastructure, in Babcock & Brown related entities.
84. I have examined the large amount of figures provided, the transactions in the share portfolio Mr Smith made, the restrictions in trading he encountered in share trading generally, due to his position, and further restrictions imposed on him in regard to Babcock & Brown entity related shares.
85. I have come to the conclusion that Mr Smith could not demonstrate to my satisfaction that the nature of his activities had the purpose of profit making. He held his shares for periods longer than a share trader generally would, and took DRPs and dividends. His activities did not demonstrate to my satisfaction repetition and regularity in the buying and selling of shares in order to demonstrate that he was in business (Hope v Bathurst City Council). Mr Smith did not maintain a separate office and worked fulltime in a very responsible position at Babcock & Brown, and although I do not put much weight on that, I was concerned that he was unable to indicate what kind of time he spent on buying and selling shares. He did not keep any separate accounting but relied on BT and the WBC platform.
86. The evidence points strongly to, and my overall impression is, that Mr Smith was not conducting a business either in 2007, or in 2008, that he was not in business, and not in the business of share trading. I was satisfied that he had more disposable income than previously, and invested it in shares as an investor might.
The fallback position
87. Mr Hollestelle argued on behalf of Mr Smith that if the Applicant was held not to be carrying on business as a share dealer or trader, then he was carrying on a business of dealing in revenue assets, and that the profits and losses from the realisation of sale of shares would be ordinary income under section 6-5 of the Income Tax Assessment Act 1997, or a deduction under section 8-1. He added: The range and extent of revenue assets is not limited only to cases such as London Australia Investment Company Limited v Federal Commissioner of Taxation where a reliance on dividends gives rise to the sale of shares.
88. Mr Miller noted that the Applicant's first fall back position was that if he was not a share trader in the 2007 year, then he was one in the 2008 year. He then submitted that Mr Smith was unable to establish that he conducted a business in either year, and that accordingly, the Applicant must fail on his first fallback position.
89. I have found in the paragraphs above that Mr Smith was an investor, and not in business, and not in the business of share trading in either the 2007 or 2008 years. I have preferred the submissions of the Respondent in that regard.
90. Mr Miller noted further that the Applicant's second fall back position was that the disposal of shares and other securities during the 2007 year and the 2008 year were the disposal of revenue assets. To that end, Mr Miller submitted that in
London Australia Investment Company Limited v Federal Commissioner of Taxation (1977) 138 CLR 106, Gibbs J said that the position for an individual or a trust is materially different to the considerations that may apply to a company in deciding whether a sale is made in the course of a business of profit making, and has an income character. Mr Miller submitted that in FCT v Radnor, Davies J said that the fact of incorporation adds weight, but perhaps not as much as in other countries. In an article, titled "A finding that a taxpayer carries on business: What is required, related issues and what are the tax consequences?", Justice Edmonds referred to those comments and said:
"But even where the activities of an individual or the trustee of a trust are not passive in nature but involve, for example, the buying and selling of securities, it is less likely that a finding will be made that a sale of securities was an operation in the course of carrying on a business of investing for profit than it is in the case of a company; it is more likely that the finding will be made that the sale was a mere realisation or change of an investment."
91. Mr Miller accordingly submitted that Mr Smith had failed to show that his disposals of shares and other securities were other than a mere realisation or change of investment.
92. I was mindful that in London Australia Investment Company Limited the High Court affirmed the findings of the Court below that the shares in that case were not acquired for the purpose of resale at a profit within the meaning of those words in section 26(a) of the Income Tax Assessment Act 1936. The Court then went on to ascertain whether the profit arising from the acquisition and disposal of the shares was income, being a profit arising from the carrying on of a profit making undertaking, (the second limb of section 26(a)), and whether there was income as a result of the application of section 25 and section 51. In each case the profit would only be income if it arose from the carrying on of a business undertaking, the High Court said. The identification and characterization of the business carried on by the taxpayer was the essential task. The Court said:
"It may first be stated that the activity of the taxpayer must be identified as a business activity. If, otherwise than as part of a business of so doing, a man purchases a particular item of property primarily in order to enjoy it in specie or to enjoy the income from it, but at the same time expecting and intending that he will at some time in the future, if and when an opportune occasion presents itself, sell the item of property at a profit, the profit will not be taxable under the first limb of s 26 (a). But if the dominant purpose is that of sale, then it will be."
93. The High Court continued:
"If the acquisition and disposal of property is part of a business of so doing, the position is significantly different. There must still be a purpose of resale because resale is part of the description of the relevant business, and, since business has in it the notion of profit-making rather than loss-making, there must no doubt be a purpose of resale at a profit. But the significant difference is that the purpose of resale need not be the sole purpose or the primary or dominant purpose, as is the case under the first limb of s 26 (a).
Though frequent activity of acquisition and resale does not necessarily signify a business, it is evidence from which it may be inferred that there is a business. First, the frequency of the activity may itself tend to show that it is not of a private or of a casual nature, but that rather the person is carrying on the activity as a business operation. Secondly, the frequency of the activity may enable the inference to be drawn, if the fact be in dispute, that there was a purpose or intention or expectation, at the time of acquisition, of dealing at a profit if and when a suitable occasion should arise. Nevertheless, it must be made quite clear that frequency of an activity is not synonymous with business. There may be no business despite frequency and on the other hand there may be a business where the activity is an isolated one."
94. I have concluded from the evidence of the parties and the case law, and relying on London Australia Investment Company Limited, that Mr Smith was not carrying on a business, rather that his disposals of shares and other securities were none other than a mere realisation or change of investment. His shares cannot be treated as trading stock on revenue account.
95. As I have found that Mr Smith was not in business, and not a share trader in 2007 or 2008, the questions as stated in the preamble to the Respondent's written submissions dated 3 May 2010 have been answered. I do not intend to deal with each separately.
96. The Tribunal affirms the decision under review.