• The impact of this case on ATO policy is discussed in Decision Impact Statement: Taxpayer and Commissioner of Taxation (Published 1 November 2011).

CASE 10/2011

Members:
BJ McCabe SM

Tribunal:
Administrative Appeals Tribunal, Brisbane

MEDIA NEUTRAL CITATION: [2011] AATA 545

Decision date: 5 August 2011

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Senior Member Bernard J McCabe

Reasons For Decision

1. The taxpayer bought and sold a number of shares in the year of income ending 30 June 2008. He claims he was carrying on the business of share trading. He says he was not just a passive investor who acquired shares with a view to holding them. The distinction is important. If he can establish he was "carrying on a business" of share trading, any losses or outgoings he incurred in the process may be deductible under s 8-1 of the Income Tax Assessment Act 1997 (the Act), and the shares might be treated as trading stock for the purposes of s 70-35.

2. The Commissioner says the taxpayer was not conducting a share trading business in the relevant period. The taxpayer has asked the Tribunal to revisit the question. I am satisfied the taxpayer is right. I have therefore decided to set aside the decision under review. I decide in substitution that the taxpayer was carrying on a business of share trading. I explain my reasons below.

3. The facts are not really in dispute. Nor is the law. That law contemplates a characterisation process: one must look at what has occurred and ask whether, in all the circumstances, the taxpayer was conducting a business of share trading. The existence of such a business is a question of fact that will be established (or not) by evidence. The cases offer some general guidance as to what one might expect to see in the evidence if one is to find that a share trading business exists, but the process is notoriously difficult and might involve fine distinctions and questions of degree. And so it is in this case.

The Facts

4. The taxpayer is a successful businessman. He is the chief executive of a profitable services business conducted by a subsidiary of a holding company that he controls. He says day-to-day management of the services company has been delegated to competent executives, which leaves him free to pursue a range of investment interests. He controls two other companies that invest in the property and share markets. He also has investments in shares and property in his own name. This case is concerned with the investments in the share market in his own name.

5. In his oral evidence, the taxpayer explained he decided to become more active in the share market about six or seven years ago. To that end, he registered with Commsec and arranged a margin loan facility in late 2004. He acquired some shares in 2005 but he says he was building up cash reserves during this period. He says he was not especially active on the market and did little throughout most of 2006. One of the investment companies he controlled was more active in the market during 2005-2006, but that is irrelevant for present purposes.

6. Things changed in October 2006 when the taxpayer became involved with a stock-picking and research service called Stockval. He purchased a licence from Stockval and became entitled to receive the firm's regular research and advice on share market opportunities. The licence runs until 2012. According to the taxpayer, Stockval would provide daily circulars talking about particular companies it suggested were undervalued. I was provided with a copy of one of the reports which included company and share market data that financial experts refer to as "fundamental analysis". The circular included a list of stocks on a watch list. The taxpayer said he consulted the research on a daily basis and checked the progress of his shares and made strategic decisions constantly. In his earlier submissions to the Commissioner for the purposes of the ruling, he suggested he spent two hours each day on these transactions.

7. The taxpayer was not engaged in an academic or recreational pursuit. He said he used the data from Stockval to identify companies he thought were undervalued by the market. He said he would then research the companies in question by examining data on the ASX website, amongst others, to determine whether the company in question was trading at a lower value on the market than one would expect. He also conducted research on the Financial Review website, although he was unsure whether he subscribed to the site at the relevant time. He now has access to a number of financial information applications on his iPhone, but they are recent acquisitions. During the year of income in question, the taxpayer gleaned much of his information about particular stocks from his online searches on the Commsec website and elsewhere, and from talking to people in the market like his brokers. He said his investment strategy was formed after reading books by well-known businessmen like Warren Buffett and George Soros.

8. He was particularly interested in stocks that were out of favour notwithstanding his assessment of their underlying value. One of his stockbrokers, Mr Murdoch, suggested in his evidence that the taxpayer loved stocks that others hated: he would buy the shares at a low or falling price and wait for the price to rebound when the shares could be sold and a profit realised. The taxpayer was effectively betting against the market. The strategy is inherently risky. The taxpayer had purchased tranches of shares in a number of companies that had a falling stock price; if the share price continued to fall, the taxpayer sometimes continued to buy further shares - a process he called "averaging down". The taxpayer explained "averaging down" allowed him to lower the average price of the growing number of shares in a company that he had bought. That would mean greater profits if the price rebounded as he expected. The taxpayer and Mr Murdoch suggested the strategy had yielded mixed results: he had made some large gains over the years when stocks rebounded against the expectations of the market, but he had also lost a large amount of money on at least one occasion when the market price did not turn.

9. While the taxpayer referred approvingly to Warren Buffett, he insisted his own business strategy was ultimately quite different. The taxpayer acknowledged Mr Buffett was famous for identifying sound but undervalued companies, but the distinction appeared to be that Mr Buffett was a long term investor. The taxpayer expressly denied that he saw himself in that way. He said he wanted to sell the shares he bought on each occasion as soon as the price rebounded. He did not want to warehouse stocks, derive dividends or build up a portfolio. His broker, Mr Murdoch, said the taxpayer's aim was to recycle capital quickly. He was not interested in acquiring shares that contained his risk. To the contrary, he sought it out - because risk created opportunities for gains.

10. The taxpayer pointed out he would have adopted different financing arrangements if he planned to be a long term investor. He said his margin lending facility with Commsec (he later moved to a similar facility on slightly more favourable terms with the National Australia Bank) was a relatively expensive way of funding a passive investment. If he wanted to hold shares over a longer term, he said he would arrange for some other property assets to be used as security and organise a better financing arrangement at lower interest. He denied he was interested in holding the shares to secure dividends; he said the interest on the margin lending facility made that a less profitable undertaking than trading.

11. The taxpayer's trading strategy, such as it was, did not seem very scientific. The Commissioner correctly pointed out there was no formal business plan which specified points or events that would cause the taxpayer to sell the shares he acquired. The taxpayer said he sold when the price rebounded to the point where the market value of the shares more closely approximated his assessment of the underlying value of the company. That involved questions of judgement. He admitted he had held off selling some shares after prices had rebounded because he formed a judgement that the price was likely to rise even further. In essence the taxpayer's strategy was to buy and sell shares relying on his gut, which was influenced by informed speculation gathered from trusted sources, general business experience, a healthy appetite for risk, reasonable cash reserves and some basic financial analysis.

12. The Commissioner pointed out the taxpayer did not actually sell many shares during the period under review. A table prepared by the Commissioner which is attached to his statement of facts, issues and contentions noted the taxpayer purchased 20 tranches of stock in various companies during the financial year ending 30 June 2008 worth nearly $1.5 million but sold only two tranches of one company's stock worth less than $300,000. The Commissioner says the taxpayer was not turning over the shares he acquired. His portfolio was growing; whatever the taxpayer might say, his pattern of trading activity suggested he was an investor who held shares rather than a trader who bought and sold the shares.

13. The taxpayer had several explanations for this behaviour. The most important of these was the "global financial crisis" (the GFC). The GFC first took hold in 2007 but the problems deepened during 2008. The taxpayer said the GFC meant there were many companies with tumbling share prices. That suited his strategy of buying falling shares. He insisted in his evidence that he anticipated turning those shares over as soon as the rebound occurred - but the rebound took longer to eventuate than he anticipated. He pointed out no one knew how deep the GFC would be or how long it would last. He said that, having purchased the shares (and having "averaged down" his purchases when some of them continued falling), he decided during the year of income that he could and should wait for the price to improve before selling. On his account, he effectively revised his strategy after acquiring the shares so that he held onto the shares rather than crystallise a loss by selling them within the timeframe he originally envisaged. He said he saw himself like a retailer who was stuck with stock in the face of a downturn. He had the choice of selling the stock at fire-sale prices, or hanging onto the stock for longer than anticipated in the hope that things would turn around soon. He pointed out in his evidence that he was in a financial position to wait for the rebound, although he acknowledged he took steps to refinance when it became clear his holding costs under the margin loan facility would become onerous in circumstances where the GFC was likely to be deeper and more persistent than expected.

14. There is a further explanation that emerged for the failure to sell some of the shares. I have already noted the taxpayer preferred volatile stocks but he did own some blue chip stocks as well, like Qantas and Telstra. He appeared to be inclined to hang onto those shares in particular. Telstra is well known for delivering reliable dividends but the taxpayer dismissed the potential dividend stream as an attraction. He explained Commsec regarded some shares as being especially desirable when it assessed the risk of a client who had access to a margin loan facility. The taxpayer said holding Qantas and Telstra shares tended to keep Commsec happy, which meant he had an easier time with finance.

15. The taxpayer's financial commitment was relatively large. In the year ending 30 June 2008, the Commissioner estimated the taxpayer's investment in shares was worth in the order of $1.3 million. I understand there is no dispute over that figure. I note it has grown substantially since that point. The taxpayer was able to access around $2.75 million under his margin loan facility during the latter part of the period. There was a considerable amount of money at stake.

16. The taxpayer managed his share trades on his own. He used a broker and Commsec trading account and was able to record the transactions and account for them using the software available on that website. He did not have to keep books as such. He did not maintain a separate office. He operated from the offices of his services business where he oversaw his other business activities, and he maintained a study at home. Increasingly, though, his activities were conducted from his laptop and (more recently) his iPhone. Although the taxpayer is not a young man, he has taken to mobile technology with gusto. His place of business moves with him.

The Law

17. The parties have asked me to decide whether the taxpayer was engaged in a business of share trading. The question is really comprised of two related issues: whether the taxpayer is engaged in a business, and whether that business is a share trading business (as opposed to a business in which the taxpayer acquires assets that he intends to hold, presumably with a view to obtaining a dividend stream and perhaps to enjoy capital appreciation over time).

18. There have been many cases in which the courts have considered whether the taxpayer was conducting a business of any description. In
Martin v Federal Commissioner of Taxation [1953] HCA 100, for example, the question was whether a person engaged in a speculative activity like wagering on horseraces was conducting a business (so that he was entitled to deduct his betting losses) or merely indulging his taste for gambling. The Court examined the taxpayer's conduct, including the amounts he wagered, the number of days he visited the track and the extent to which he used other people to assist him and concluded he was not in the business of gambling on horses at the race-track. The court expressly set aside a suspicion that the taxpayer was talking up his betting activities to account for the proceeds of sales of sly grog from his hotel. It turns out the taxpayer was just an avid punter.

19. Whether or not someone is engaged in a business is a question of fact, but it is not always a question that admits of an easy answer. The answer in a given case depends on the impression the decision-maker forms having regard to all of the circumstances. That is the message from decisions like Martin. No single feature is necessarily determinative: see
Federal Commissioner of Taxation v Radnor 91 ATC 4689; (1991) 102 ALR 187 at 202 per Hill J. The decision of the Full Court in Radnor suggests the existence of repetition and a profit-making objective are likely to be particularly important factors to consider, but other things may be relevant as well. The Tribunal suggested in
Shields v Deputy Federal Commissioner of Taxation [1999] AATA 4 (and, more recently, in
Smith and Commissioner of Taxation [2010] AATA 576) that relevant matters might include:

• "(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."

20. I will say at once that I am satisfied the taxpayer intended to make a profit out of his activities during the year of income, and he initially intended to make that profit in the short term. He gave clear evidence to that effect at the hearing. I have also pointed out I am satisfied he was not engaged in an academic pursuit or a hobby. I am satisfied his subjective intention and the objective intention of the activity both suggest the motive was profit. The activities were not necessarily especially complex, although they did involve signing up for the Stockval service and other websites as well as contracting with Commsec and brokers. The activities were occurring on a relatively large scale, at least in value. The taxpayer had several million dollars at stake. He purchased a large number of shares in a relatively wide range of companies. He certainly regarded it as a serious business. He also intended that he would be making regular trades during the course of the year of income, even though many of them turned out to be acquisitions rather than sales (although the precise pattern of trading activity is more relevant to the question of what sort of business it was, rather than to the bare question of whether or not it was a business). The taxpayer certainly behaved as if he were following a systematic strategy, albeit I have observed it was not detailed, scientific or formal. He did not appear to have a budget as such, or formal targets; he was in the happy position of having enough cash at his disposal that he could afford to undertake transactions when they suited him. I am satisfied he was not investing on a whim. He had a clear modus operandi that was recognisable to his broker, and he made purchase decisions according to consistent general criteria (shares that were falling in price with an underlying value that was higher than the market value suggested). He was not so much a speculator as an opportunist.

21. The question of whether or not the taxpayer operated in a "business-like manner" is a curious one, if only because the concept is becoming increasingly fluid. One must be careful of stereotypes in cases like this - especially given the advances in information technology that have changed concepts like "place of business" and "office". I have already noted the taxpayer was a thoroughly modern business-man who relied on his lap-top and internet connection (and increasingly his mobile phone, complete with apps) to do business from where he was located at any given time. Research and transactions were conducted over the phone or online. Even his record-keeping occurred online. He had entered into arrangements with a broker and Commsec, including a margin-lending facility. That implied a degree of sophistication and a business purpose. He was ultimately a sole trader. Although he controlled a number of businesses with staff and had access to professional advisers, his activities on the share market were essentially carried on without the benefit (he would say burden) of a formal organisation.

22. I have noted the taxpayer had other businesses. He gave evidence to the effect that his service business did not require his close attention. He spent a good deal of time on the management of his other companies and investments, which included the purchase and sale of shares using the same approach he applied towards his own shares. His submissions to the Commissioner indicated he spent around two hours each day on his personal investments. I doubt that he worked like that in light of his evidence. He struck me as a man who was constantly on the look-out for opportunities. Some of the opportunities were taken up through his companies, and he took advantage of some in his personal capacity. He said the allocation of opportunities depended on which entity had resources available at the time.

23. On balance, I formed the impression that the taxpayer was engaged in a business. But what sort of business? That is potentially a more difficult question, however it must be answered if the taxpayer is to be entitled to treat his shares as trading stock. Was he in the business of being a passive investor, or was he in the business of trading?

24. The fact the taxpayer made a large number of acquisitions and few sales during the year of income tends to suggest he was a passive investor acquiring a portfolio of capital assets that would yield capital gains when sold. The taxpayer insisted in his evidence that he did not intend to operate in that way. He says he bought with a view to turning over the shares quickly, but events intervened and he decided to hang onto the shares rather than make a loss in the short term. The GFC meant that he bought more and sold less than he anticipated. He may not have looked like a trader, but he insists that is what he intended to be.

25. I am satisfied the taxpayer was a witness of truth. He told his story in a candid fashion. The Commissioner's counsel questioned him carefully but he told a consistent and credible story. I am inclined to accept his evidence as an accurate account of his intentions and behaviour.

26. The weight which one accords to the taxpayer's subjective intentions in a case like this is a vexed question. As it happens, I am satisfied the taxpayer's perception of himself as a trader (as opposed to a passive investor in capital assets) is accurate having regard to the objective facts. I was particularly impressed by the taxpayer's submission that the financing arrangements he chose to put in place favoured short term trading rather than long term positions. I accept his argument that it would make more sense for him (that is, it would be cheaper) to secure a bank loan if he intended to buy and hold shares. I accept that may not be true of every investor, but the taxpayer had other assets in the form of real estate and interests in other ventures that could have been used to secure a lower rate of interest from a bank. The fact he was seeking out a number of volatile shares also told against him being characterised as a "buy and hold" investor. I acknowledge his portfolio included a number of well-known stocks, some of which might be considered blue chips. But many of them were not. As Mr Murdoch explained, the taxpayer was not looking for (nor was he behaving like someone who was interested in) a balanced portfolio.

27. I am satisfied the taxpayer was in the business of trading shares during the year ended 30 June 2008. The fact he did not end up selling many of the shares during that period was an accident of history that can be explained in particular by the impact of the GFC. He was an opportunist who bought and sold when opportunities arose. As it happened, the unexpected events of 2007-2008 meant there were more opportunities to buy than there were to sell.

Conclusion

28. The objection decision is set aside. I decide in substitution that the taxpayer was engaged in the business of share trading during the financial year ending 30 June 2008.