Edited version of private ruling

Authorisation Number: 1011611924407

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Ruling

Subject: Contracts for Difference

The taxpayer is a full-time salaried employee.

The taxpayer has a history of investing in the share market but has also begun to deal in CFDs with a view to making a profit. During the Global Financial Crisis the taxpayer took the view that the value of stocks would fall and therefore entered into short CFDs. The taxpayer sold CFDs with the view to a profit from falling share prices.

The short positions were opened during the period from June 2008 to July 2009 and were all closed out as at 30 March 2010. A small number of trades were made during the 2010 financial year to close out all CFD positions.

The total gains from CFD trades were exceeded by the total losses during the financial year.

What is a contract for difference ('CFD')?

According to the ASX, a CFD is an agreement between a buyer and a seller to exchange the difference in value of a particular instrument between when the contract is opened and when it is closed. The difference is determined by reference to an 'underlying' instrument such as stock, an index, a foreign exchange rate or a commodity.

CFDs can be used to take a 'short' position where a person expects the value of the underlying instrument to fall or a 'long' position where a person expects the value of the underlying instrument to increase. An investment in CFDs does not entitle a person to ownership of the underlying instruments. Gains or losses from CFDs can only be determined when the contracts are closed out.

Tax treatment of gains or losses from CFDs

Taxation Ruling TR 2005/15 sets out the Commissioner's views on the tax consequences of entering into financial contracts for difference.

A gain from a CFD will be assessable under section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997) where the transaction is entered into as an ordinary incident of carrying on a business, or where the profit was obtained in a business operation or commercial transaction for the purpose of profit making.

A gain from a CFD will be assessable under section 15-15 of the ITAA 1997 where a person enters into a CFD in carrying out a profit-making undertaking or plan and the gain is not assessable under section 6-5 of the ITAA 1997.

A loss from a CFD will be an allowable deduction under section 8-1 of the ITAA 1997 where the transaction is entered into as an ordinary incident of carrying on a business or in a business operation or commercial transaction for the purpose of profit making.

A loss from a CFD will be an allowable deduction under section 25-40 of the ITAA 1997 where the gain would have been assessable under section 15-15 of the ITAA 1997.

Carrying on a business

The question of whether a taxpayer is carrying on a business is a question of fact and degree. There are no rigid rules for determining whether activities amount to carrying on a business. However the courts have developed indicators that may be applied to a set of circumstances to help determine whether a business is being carried on. Taxation Ruling TR 97/11 summarises the relevant indicators of whether a business is being carried on:

§ whether the activity has a significant commercial purpose or character

§ whether the taxpayer has more than just an intention to engage in business

§ whether the taxpayer has a purpose of profit as well as a prospect of profit from the activity

§ whether there is regularity and repetition of the activity

§ whether the activity is of the same kind, and carried on in a similar manner, to that of ordinary trade in that line of business

§ whether the activity is planned, organised and carried on in a business-like manner such that it is directed at making a profit

§ the size, scale and permanency of the activity, and

§ whether the activity is better described as a hobby, a form of recreation or a sporting activity.

A taxpayer does not need to derive all his/her income from the activity. The taxpayer may also be employed in some other occupation or profession.

It is important to consider if a business is being carried on as it may be subject to the Non-commercial Loss rules in Division 35 of the ITAA 1997.

Non-commercial losses legislation

From 1 July 2000, legislation came into effect regarding losses from 'business' activities. Division 35 of the ITAA 1997 contains the measures, known as the non-commercial loss legislation.

If you are in business (for tax purposes) you can only offset the loss from a business activity against your income from other sources if you pass one of four tests, an exception applies to you, or the Commissioner exercises his discretion in your favour.

If not, the tax loss from the business activity is deferred to a later year when you are able to pass a test, an exception applies or you have been granted the Commissioner's discretion.

The four tests are:

i) you have assessable income from the business of at least $20,000

ii) you have made a profit from the business in least three out of the last five years

iii) you use real property worth at least $500,000 (excluding private dwellings) on a continuing basis in the business, or

iv) you actively use assets worth at least $100,000 (excluding motor vehicles) in the business.

Exceptions to passing the four tests apply for taxpayers carrying on a professional arts business or a business of primary production. Taxpayers in these categories may offset a business loss against their other income if their other income for that year is $40,000 or less.

Application to taxpayer's circumstances

Although the taxpayer's investment in CFDs shows some indicators of a business activity, the actual volume of dealings in CFDs during the financial year are not sufficient to describe the activity as a business. The activity can be better described as a profit making undertaking or plan. As the taxpayer is not carrying on a business, the provisions of Division 35 of the ITAA 1997 will not apply to the losses.

Therefore any gains made from the taxpayer's dealings with CFDs will be assessable under section 15-15 of the ITAA 1997 and any losses made will be deductible under section 25-40 of the ITAA 1997.

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