Edited version of private ruling

Authorisation Number: 1011472956332

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Ruling

Subject: Trading losses

Question

Can you claim a deduction under section 8-1 of the Income Tax Assessment Act 1997 (ITAA 1997) for the losses incurred on share, option and contracts for difference (CFD) trading?

Answer

Yes.

This ruling applies for the following period

Year ended 30 June 2009

The scheme commenced on

1 July 2008

Relevant facts and circumstances

This ruling is based on the facts stated in the description of the scheme that is set out below. If your circumstances are materially different from these facts, this ruling has no effect and you cannot rely on it. The fact sheet has more information about relying on your private ruling.

You are a stockbroker by profession.

You have set aside a room in your house which contains a computer with access to the internet and other resources needed for share trading activities.

You lease office space where you operate your stockbroking business. In addition to providing investment advice and trading shares for clients, you also trade on your own account.

You spend between 50 and 60 hours per week on your trading activities.

Your activities are financed with your own funds. These facilities include cash and a margin lending facility to the value of $100,000 and a CFD facility with the potential purchasing power of between $250,000 and $500,000.

You commenced your trading activities several years ago.

You conduct daily analysis and assessments of developments in a number of financial markets, including equity markets, foreign exchange and commodity markets.

You use a variety of resources to research the markets.

Your objective is to identify shares and derivatives (options and CFDs) that will increase in value within a short time frame.

Strategies that you use to gain on increases include short selling, purchasing put options and writing call options on existing shares that you hold.

Your buy and sell transactions depend on the financial product that you purchase. You have provided the following analysis of your transactions for the period 1 July 2008 to June 30 2009:

You conducted 139 trades in the year ended 30 June 2009.

For the year ended 30 June 2009 your gross proceeds from your share sales exceeded $500,000 and your 'winning' trades from all products exceeded $20,000.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 6-5.

Income Tax Assessment Act 1997 Section 995-1.

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 Section 35-30.

Reasons for decision

These reasons for decision accompany the Notice of private ruling.

While these reasons are not part of the private ruling, we provide them to help you to understand how we reached our decision.

Summary

After applying the indicators of a business to your circumstances, it is concluded that you were carrying on a business of trading shares, options and CFDs. As your assessable income from this activity exceeded $20,000 in the year ended 30 June 2009, the non-commercial loss provisions do not operate to quarantine your business loss for that year. That is, you can claim a deduction for your business loss against your other assessable income.

Tax treatment of CFD trading including foreign exchange

Taxation Ruling TR 2005/15 provides that contracts for differences are a cash settled derivative that allow investors to take risks on movements in the price of a subject matter (the 'underlying') without ownership of the underlying. CFDs include those relating to share prices, share price indices, financial product prices, commodity prices, interest rates and currencies.

TR 2005/15 states where CFD trading is part of the carrying on of a business, the gains and losses from the CFD transactions will be accounted for under sections 6-5 and 8-1 of the ITAA 1997. Otherwise, CFD trading will be regarded as part of the carrying out of a profit making undertaking and a net gain or a net loss from CFD trading will be accounted for under either section 15-15 or 25-40 of the ITAA 1997.

Either way, the gains and losses from CFD trading are accounted for on revenue rather than capital account.

TR 2005/15 states the anti-overlap provisions in section 118-20 of the ITAA 1997 prevent gains and losses from CFD trading to be accounted for under the capital gains tax (CGT) provisions.

Tax treatment of futures trading

A futures contract is an agreement to buy or sell a specified quantity of something at a specified price on a specified future delivery date.

Such a futures contract may be bought or sold as part of a hedging strategy to protect a physical shareholding or to speculate in the movements of the share market or particular market sectors.

An index futures contract is cash settled. Further, a futures contract is not trading stock.

TR 2005/15 states speculating on the financial market via a CFD is very similar to speculating in cash-settled futures. It states speculating in the futures market can be taxable on revenue account even if those activities are insufficient to constitute the carrying on of a business.

Taxation Ruling IT 2228 states profits derived by taxpayers who are bona fide traders in futures contracts are to be treated as assessable income and losses allowable as deductions. It states most activity in futures contracts, including speculative and isolated transactions of a non-business nature, will be of an income (revenue) nature rather than of a capital nature.

Tax treatment of share trading

The tax treatment of share trading is different to that for CFD and cash settled futures trading.

Where trading in shares is part of the carrying on of a business, the gains and losses will be accounted for under sections 6-5 and 8-1 of the ITAA 1997. Otherwise, the gains and losses are accounted for under the CGT provisions in Part 3-1 of the ITAA 1997.

Unlike CFDs and cash settled futures, the CGT provisions in Part 3-1 of the ITAA 1997 apply to speculative and isolated share transactions. Shares are regarded as property and sections 15-15 and 25-40 of the ITAA, in general, cannot be applied to the sale of property.

CFDs and cash settled futures, on the other hand, are derivatives without ownership of the underlying. It follows CFDs and cash settled futures are not property.

Trader vs investor

The distinction between a trader and an investor will only apply to shares transactions or other assets such as options, that is, where there is ownership of the underlying.

An entity trading CFDs and futures who is not carrying on a business cannot be an investor because they do not own the underlying. Instead, that entity will carry on a profit making undertaking.

In respect to share trading, the distinction between a share market investor and the carrying on a business of share trading has been established in the body of law through many court cases.

In Case X86 90 ATC 621; AAT Case 6297 (1990) 21 ATR 3747, the following were stated as indicators of carrying on a business:

the nature of the activities and whether they have the purpose of profit-making;

the complexity and magnitude of the undertaking;

an intention to engage in trade regularly, routinely or systematically;

operating in a business-like manner and the degree of sophistication involved;

whether any profit or loss is regarded as arising from a discernible pattern of trading;

the volume of the taxpayer's operation and the amount of capital employed by him;

and more particularly in respect of share traders:

repetition and regularity in the buying and selling of shares;

turnover;

whether the taxpayer is operating to a plan, setting budgets and targets, keeping records;

maintenance of an office;

accounting for the share transactions on a gross receipts basis;

whether the taxpayer is engaged in another full time occupation.

In AAT Case 4847 (1988) 20 ATR 3182; (1988) 89 ATC 171, a taxpayer purchased twenty parcels of shares between April 1986 and February 1987. All the shares were sold between September 1986 and April 1987. No share was held for more than five months. The Tribunal ruled the shares were purchased as trading stock in the carrying on of a business because the shares were bought and sold repeatedly with a view to making a profit and because all shares were sold within a year of acquisition.

In Shields v. Deputy Commissioner of Taxation (Cth); Case [1999] AATA 4 (1999) 41 ATR 1042; (1999) 99 ATC 2037, during the period from 6 February 1996 to 4 March 1996, the taxpayer bought shares in Australian banks which were about to pay franked dividends for cum dividend prices and sold shares in the same banks at their ex dividend prices. Applying the factors listed in Case X86, even though the activity was for a short time only, the Tribunal decided the taxpayer was carrying on a business because of the volume of transactions and because the transactions were so carefully and systematically organised and handled.

In contrast is the Federal Court case of Federal Commissioner of Taxation v. Radnor Pty Ltd (1991) 102 ALR 187; (1991) 22 ATR 344; (1991) 91 ATC 4689. Here, the taxpayer was held not to be carrying on a business of share trading because there was no pattern of buying and selling and a low volume and frequency of transactions. Here, the taxpayer, for the most part, held their shares for extended periods of time of more than twelve months and often for many years.

Application to your circumstances

In your case, you have a substantial amount of capital invested in the activity. You trade for short term gains with the intention of making a profit. Your buying and selling strategy relies on the daily monitoring of the market. Strategies that you utilise include short selling CFDs, purchasing put options and writing call options on existing shares. You maintain records of your trading transactions. You spend 50 to 60 hours per week on the activity. You show repetition and regularity in buying and selling and a high volume.

After weighing up the above factors, it is considered that you are carrying on a business of trading in shares, options and CFDs. Therefore, the income from the activity is assessable under section 6-5 of the ITAA 1997 and the losses related to the activity are allowable as deductions under section 8-1 of the ITAA 1997.

Non-commercial losses

Division 35 of the ITAA 1997 prevents losses of individuals from non-commercial business activities being offset against other assessable income in the year the loss is incurred. The loss is deferred. It 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. They may also be offset against other income if one of the other tests are satisfied, or if the Commissioner exercises a discretion.

It should be noted that the non-commercial loss provisions only apply where the taxpayer is carrying on a business. For example, where a taxpayer enters into transactions involving CFDs and futures but the transactions do not amount to the carrying on of a business, any losses that are deductible under section 25-40 of the ITAA 1997 are not subject to the non-commercial loss provisions. That is, the losses do not have to be deferred and can be deducted against the taxpayer's other assessable income.

It is only if the futures/CFD trading amounts to the carrying on of a business will the non-commercial loss provisions apply and consequently the losses may have to be deferred if none of the non-commercial loss tests are met and the Commissioner's discretion is not exercised.

In your circumstances, we have determined that you are carrying on a business, therefore the non-commercial loss provisions apply.

$20,000 assessable income test

The assessable income test is performed on gross sales or turnover. For the trading of shares, it will be performed on the sales proceeds of those shares. The sale or disposal of shares will always receive proceeds, even if those proceeds are nil. The sale of shares cannot result in a debt.

For CFDs, however, the assessable income test is performed by adding up all profitable trades while ignoring all losing trades. This is because, unlike shares, no proceeds are received for a losing CFD trade. Only a debt is incurred. A CFD contract is a margin or deposit. The value of the shares 'borrowed' that form the underlying are not included in the calculation of assessable income.

Your gross proceeds from your share trades were approximately $500,000. Therefore you meet the $20,000 assessable income test in relation to your business of trading in shares, options and CFDs (in any case your profitable trades from all products exceeded $20,000). Consequently your business loss can be deducted from your other assessable income.