Edited version of private advice

Authorisation Number: 1052116711454

Date of advice: 16 May 2023

Ruling

Subject: Derivative trading - deductibility of losses

Question 1

Are the gains made from your derivative trading activities assessable income under section 6-5 or section 15-15 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

Yes.

Question 2

Are the losses made from your derivative trading activities deductible under section 8-1 or 25-40 of the ITAA 1997?

Answer

Yes.

Question 3

Are the losses made from your derivative trading activities subject to the non-commercial; loss provisions in Division 35 of the ITAA 1997?

Answer

No.

This ruling applies for the following period:

Year ended 30 June 20XX

The scheme commenced on:

XX June 20XX

Relevant facts and circumstances

You have a Bachelor of Business majoring in Finance.

You worked as a trader for X years and then worked in a management role for Y years.

You resigned from your employment and have not been employed for the past four years.

As a derivative trader you did not own the underlying assets subject to the contracts.

On DDMMYYYY you commenced trading in cryptocurrency.

To be able to trade in options you needed to have a 'covered position'. That is, it was required that you owned an underlying asset of equivalent value.

During your time trading you held cryptocurrency valued from $XXX to $XXX.

Prior to commencing the trading activities, you had no training in cryptocurrency and while you had substantial knowledge of the technical aspects of options trading, you do not have a comprehensive technical understanding of trading in cryptocurrency.

You did not have a business plan or system that you followed when trading.

You had no training and received no professional advice regarding cryptocurrency derivative trading.

You adopted a combination of both straddle and strangle option strategies when trading. These strategies allow the trader to benefit from the movement of the underlying asset price irrespective of whether the price of the asset increases or decreases in value.

You did not spend a significant amount of time engaged in trading activities. You spent approximately 20 to 30 minutes on a single occasion each month involved in the trading activities. This involved 5 to 10 minutes rebalancing your portfolio and the rest of the time was spent monitoring your portfolio.

You conducted these activities solely on a platform which you accessed remotely from your laptop from the location you were in at the time.

While you intended or hoped to make a profit from your trading activities, you did not intend to carry on a business. You did not set up business premises, engage staff or keep records of your activities.

Your trading activities but for the large decrease in the cryptocurrency market and in particular, the volatility of the market, would have been profitable. The trading strategy that you utilised was typically more favourable when the markets didn't move significantly up or down.

On DDMMYYYY you ceased trading in cryptocurrency as you were finding it difficult given the extreme volatility in the cryptocurrency market and because you did not want to continue incurring losses.

In most months you had both gains and losses on option trading. Option positions are partially offset or fully offset against the underlying assets and some months profitability was dominated by the large rallies or falls in the underlying coin.

You made gains in over XX trades (or positions) and losses in over XX trades (or positions).

All of your cryptocurrency positions were liquidated in MMYYYY.

In the year ending 30 June 20XX you made an overall loss from your trading activities.

The only other financial products you have invested in are ASX shares approximately XX years ago.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 6-5

Income Tax Assessment Act 1997 section 8-1

Income Tax Assessment Act 1997 section 15-15

Income Tax Assessment Act 1997 section 25-40

Income Tax Assessment Act 1997 Division 35

Reasons for decision

Subsection 6-1(1) of the ITAA 1997 states that assessable income consists of both ordinary income and statutory income.

Subsection 6-5(1) defines ordinary income as income according to ordinary concepts and ordinary income has generally been held to include three categories: income from rendering personal services, income from property and income from carrying on a business.

Statutory income is income that is not ordinary income, but income included as assessable income by way of a specific legislative provision. Specifically relevant to your circumstances section 15-15 of the ITAA states:

(1)  Your assessable income includes profit arising from the carrying on or carrying out of a profit-making undertaking or plan.

(2)  This section does not apply to a profit that:

(a)  is assessable as *ordinary income under section 6-5; or

(b)  arises in respect of the sale of property acquired on or after 20 September 1985.

Taxation Ruling TR 2005/15 Income tax: tax consequences of financial contracts for differences (TR 2005/15) and ATO Interpretative Decision ATOID 2010/56 Assessable income: derivation of income - spread betting (ATO ID 2010/56) consider the concepts of ordinary and statutory income in relation to financial contracts for differences and spread betting transactions.

'Contracts for differences' are defined in TR 2005/15 as a form of cash-settled derivative in that they allow investors to take risks on movements in the price of a subject matter ('the underlying') without ownership of the underlying and participants take a risk that the price of the underlying will or will not exceed a price for that underlying at some time in the future. TR 2005/15 provides that a contract for differences transaction will result in revenue gains or losses, either as a result of carrying on a business or, as a result of being part of a commercial transaction that was entered into for the purpose of profit making. Specifically, TR 2005/15 states:

Ruling

11. A gain from a financial contract for differences will be assessable income 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.

12. A loss from a financial contract for differences 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.

13. A gain from a financial contract for differences will be assessable income under section 15-15 of the ITAA 1997 where a taxpayer enters into a financial contract for differences in carrying on or carrying out a profit-making undertaking or scheme, and the gain from it is not assessable under section 6-5 of the ITAA 1997.

14. A loss from a financial contract for differences where the gain would have been assessable under section 15-15 of the ITAA 1997 is an allowable deduction pursuant to section 25-40 of the ITAA 1997.

15. A gain or loss from a financial contract for differences entered into for the purpose of recreation by gambling will not be assessable income under section 6-5 or section 15-15 of the ITAA 1997 or deductible under section 8-1 or section 25-40 of the ITAA 1997. A capital gain or capital loss from a financial contract for differences entered into for the purpose of recreation by gambling will be disregarded under paragraph 118-37(1)(c) of the ITAA 1997.

In relation to financial spread betting activities, ATO ID 2010/56 similarly concludes:

• A gain from a financial spread betting activity is assessable income under section 6-5 of the ITAA 1997 where the transaction is entered into as an ordinary incident of carrying on a business.
• Where the activities do not constitute the carrying on of a business, the gains made on each individual contract may still be assessable as ordinary income under section 6-5 of the ITAA 1997 if the profits were obtained in a business operation or commercial transaction entered into with the intention or purpose of making a profit (Federal Commissioner of Taxation v. The Myer Emporium Ltd (1987) 163 CLR 199; 18 ATR 693; 87 ATC 4363 and Income Taxation Ruling TR 92/3: 'Income tax: Whether Profits on Isolated Transactions Are Income').
• If section 6-5 of the ITAA 1997 does not apply, the gains are nevertheless assessable income under section 15-15 of the ITAA 1997 as the spread betting contracts amount to carrying on or carrying out a profit-making undertaking or plan.
• Any losses would be deductible under section 8-1 of the ITAA 1997 where, had a gain been made it would have been assessable under 6-5. Similarly, losses are deductible under section 25-40 of the ITAA 1997 where, had a gain been made on the relevant contract, it would have been assessable under section 15-15 of the ITAA 1997.

Your cryptocurrency derivatives trading activities had a profit-making intention similar to the transactions discussed in TR 2005/15 and 2010/56. You commenced the activities with the intention to make a profit. Multiple trades were made with significant money at risk and profit was made before the losses were ultimately incurred.

Carrying on a business

Income Taxation Ruling TR 97/11 Am I Carrying on a Business of Primary Production (TR 97/11) discusses the relevant indicators to consider in determining whether a taxpayer's activities amount to carrying on a primary production business and, as confirmed in ATO ID 2010/56, these indicators are equally relevant when determining whether a taxpayer is carrying on a business generally. TR 97/11 lists the following indicators as having emerged from case law as relevant:

• 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 repetition and regularity of the activity
• Whether the activity is of the same kind and carried on in a similar manner to that of the ordinary trade in that line of business
• Whether the activity is planned, organised and carried on in a businesslike manner such that it is directed at making a profit
• The size, scale and permanency of the activity
• Whether the activity is better described as a hobby, a form of recreation or a sporting activity.

TR 2005/15 confirms:

17. Whether there is a business being carried on is a question of fact and involves an inquiry into matters such as whether the transactions are entered into in a systematic, organised and 'businesslike' way; the repetition or regularity of the transactions; the scale of the transactions; whether the transactions are related to, or part of, other activities of a businesslike character; the purpose of the taxpayer; the degree of skill employed in how the taxpayer engages in the transactions.

Business operation or commercial transaction entered into with the intention or purpose of making a profit

Where the activities do not constitute the carrying on of a business, the gains made on each individual contract may still be assessable as ordinary income under section 6-5 of the ITAA 1997 if the profits were obtained in a business operation or commercial transaction entered into with the intention or purpose of making a profit.

Profit or gain arising from an isolated business or commercial transaction will generally be ordinary income if the taxpayer's purpose in entering into the transaction was to make a profit.

Income Taxation Ruling TR 92/3: Income tax: Whether Profits on Isolated Transactions Are Income (TR 92/3) confirms:

16. If a taxpayer not carrying on a business makes a profit, that profit is income if:

(a)  the intention or purpose of the taxpayer in entering into the profit-making transaction or operation was to make a profit or gain; and

(b)  the transaction or operation was entered into, and the profit was made, in carrying out a business operation or commercial transaction.

As stated above, both TR 2005/15 and ATOID 2010/56 confirm that even if your cryptocurrency derivatives trading activities do not constitute the carrying on of a business, the gains made may still be assessable as ordinary income in accordance with section 6-5 of the ITAA 1997 if the profits were obtained in a business operation or commercial transaction entered into with the intention or purpose of making a profit.

TR 2005/15 summarises:

22. Financial contracts for differences are productive of a gain or loss stemming from exposure to typically short-term financial risk. The risks assumed in financial contracts for differences, namely stock indices, individual shares, currencies, financial products, interest rates, and commodities are all the basic subject matter of the financial services industry.

23. Although this has been doubted in the past, speculation on a financial risk can be characterised as being commercial, in that it increases the efficiency of the financial markets by adding to the depth and liquidity of the markets. ...

...

26. If a financial contract for differences is entered into with a profit-making purpose in a commercial transaction, the gain or loss made on the contract will be respectively assessable income or an allowable deduction, even though not an ordinary incident of carrying on a business. The High Court held in Federal Commissioner of Taxation v. The Myer Emporium Ltd (Myer) (1987) 163 CLR 199 at 209-210; 18 ATR 693; 87 ATC 4363, that:

The authorities establish that a profit or gain so made [in an isolated transaction] will constitute income if the property generating the profit or gain was acquired in a business operation or commercial transaction for the purpose of profit-making by the means giving rise to the profit.

Purpose of profit-making

27. The intention or purpose of the taxpayer (of making a profit or gain) referred to in Myer must be discerned from an objective consideration of the facts and circumstances of the case. This is implicit from the judgment of Mason J in Myer at 163 CLR 209-210:

Generally speaking, however, it may be said that if the circumstances are such as to give rise to the inference that the taxpayer's intention or purpose in entering into the transaction was to make a profit or gain, the profit or gain will be income, notwithstanding that the transaction was extraordinary judged by reference to the ordinary course of the taxpayer's business.

28. One example of where it would be objectively concluded that there was a commercial transaction for the purpose of profit-making is where a financial contract for differences was used in an arbitrage transaction. The exploitation of a market imperfection is a commercial transaction, and its purpose is to make a profit.

29. Speculative transactions would also come within the Myer principle, if there is a profit-making purpose and the transaction is commercial.

Statutory Income - section 15-15 ITAA 1997

As discussed above, if section 6-5 of the ITAA 1997 does not apply, the gains will be assessable under section 15-15 of the ITAA 1997, as entering into the cryptocurrency derivative contracts will amount to carrying on or carrying out a profit-making undertaking or plan.

As summarised in ATOID 2010/56:

This is the case even if there are only isolated transactions entered into by the taxpayer as 'the profit arising from an isolated commercial or business transaction will constitute income if the taxpayer's purpose or intention in entering into the transaction was to make a profit' (See Antlers Pty Ltd (in liq) v. Federal Commissioner of Taxation 97 ATC 4192; 35 ATR 64). What is important is the intention or purpose, determined by a consideration of the objective facts. Spread betting contracts are the purchase of financial risk -something with a significant commercial flavour - by means of a contract productive only of a gain or loss. It is an activity undertaken for the purposes of making a profit.

Similarly, in discussing contracts for differences TR 2005/15 states:

37. What is important is the taxpayer's actual purpose, determined by a consideration of the objective facts. Part of the objective factual matrix is that the transactions are the purchase of financial risk - something with a significant commercial flavour - by means of a contract productive only of a gain or a loss. The statements of a taxpayer's subjective intention are also relevant.

For completeness we note that we do not consider that your derivatives trading activities were entered into for the purpose of recreation by gambling.

15. A gain or loss from a financial contract for differences entered into for the purpose of recreation by gambling will not be assessable income under section 6-5 or section 15-15 of the ITAA 1997 or deductible under section 8-1 or section 25-40 of the ITAA 1997. A capital gain or capital loss from a financial contract for differences entered into for the purpose of recreation by gambling will be disregarded under paragraph 118-37(1)(c) of the ITAA 1997.

Your circumstances

In the 20XX financial year you traded cryptocurrency derivatives. This was an investment activity whereby you intended to make a profit.

The underlying asset of the cryptocurrency derivatives contracts was cryptocurrency.

During the year ended 30 June 20XX you invested significantly in your trading activities and made gains in over XX trades (or positions) and losses in over XX trades (or positions). As you were required to have a 'covered position; in order to trade you held cryptocurrency valued between $XX and $XX during this time. You spent approximately 20 to 30 minutes on a single occasion each month involved in the trading activities. This involved 5 to 10 minutes rebalancing your portfolio and the rest of the time was spent monitoring your portfolio.

Your cryptocurrency derivatives trading activities have relevantly similar characteristics to the contracts for differences discussed in TR 2005/15 in which it is concluded that in the sense that there is no ownership of an underlying asset, financial contracts for differences are essentially contracts of speculation productive of a gain or loss stemming from exposure to typically short-term financial risk.

Prior to commencing the trading activities, you had no training in cryptocurrency and while you had substantial knowledge of the technical aspects of options trading, you do not have a comprehensive technical understanding of trading in cryptocurrency. You adopted a combination of straddle and strangle option strategies when trading with the intention of benefiting from the movement of the underlying asset price irrespective of whether the price of the asset increased or decreased in value.

In most months you had both gains and losses on option trading. Option positions are partially offset or fully offset against the underlying assets and some months profitability was dominated by the large rallies or falls in the underlying coin.

Your trading activities but for the large decrease in the cryptocurrency market and in particular, the volatility of the market, would have been profitable. The trading strategy that you utilised was typically more favourable when the markets didn't move significantly up or down.

Considering these factors and the speculative nature of cryptocurrency derivatives trading, you were not carrying on a business of cryptocurrency derivatives trading, your activities align with being either commercial trading activities with a profit-making purpose; and/or a profit-making undertaking. This conclusion is supported by the views taken in TR 2005/15 and ATOID 2010/56. As such, the gains made from your trading activities in the year ended 30 June 20XX are assessable as either ordinary income under section 6-5 of the ITAA 1997, or assessable under section 15-15 as a profit-making undertaking.

Question 2

Detailed reasoning

Section 8-1 of the ITAA 1997 allows a deduction for all losses and outgoings to the extent to which they are incurred in gaining or producing assessable income, except where the outgoings are of a capital, private or domestic nature, or relate to the earning of exempt income.

Losses are deductible under section 25-40 of the ITAA 1997 where, had a gain been made on the activity, it would have been assessable under section 15-15 of the ITAA 1997:

Loss from profit-making undertaking or plan

(1)  You can deduct a loss arising from the carrying on or carrying out of a profit-making undertaking or plan if any profit from that plan would have been included in your assessable income by section 15-15 (which is about profit-making undertakings and plans).

As concluded above, the gains made from your trading activities in the year ended 30 June 20XX are assessable as either ordinary income under section 6-5 of the ITAA 1997, or assessable under section 15-15 as a profit-making undertaking and as such, the losses are respectively deductible under section 8-1 or 25-40 of the ITAA 1997.

Question 3

Detailed reasoning

A non-commercial business activity is a business activity where the expenses in the year exceed income.

Division 35 of the ITAA 1997 prevents losses of individuals from non-commercial business activities being offset against other assessable income in the year that the loss is incurred. The loss is deferred.

Division 35 sets out a series of tests to determine whether a business activity is treated as being non-commercial.

The deferred losses may be offset in later years against profits from the activity, or if one of the tests is satisfied or the Commissioner exercises a discretion, against other income.

The Division only applies to losses from business activities.

As concluded in Question 1 you are not carrying on a business of trading during the year ended 30 June 20XX. As you are not carrying on a business the non-commercial loss provisions in Division 35 have no application to your circumstances.

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