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Ruling

Subject: Carrying on the Business of Share Trading

Question 1

Am I an investor/speculator or share-trader for income tax purposes?

Summary

You are an investor for income tax purposes so your profits and losses are reported on a capital basis.

Detailed reasoning

For income tax purposes, there are two possible scenarios as to how share activities can be treated. These scenarios are:

Business income this is where a person is a share trader and the shares would be regarded as trading stock and income/losses are included as assessable income/allowable deductions.

Investment/speculator this is where a person is not in business and any shares are regarded as capital assets. Any gains earned from the disposal of the shares would be assessable income as a capital gain and any losses sustained from the disposals will be a capital loss. Any dividends and other similar receipts would be included as assessable income.

Business is defined in section 995-1 of the Income Tax Assessment Act 1997 (ITAA 1997) to be any profession, trade, employment, vocation or calling, but does not include occupation as an employee.

Taxation Ruling TR 97/11 outlines some factors that indicate whether or not a business of primary production is being carried on. These factors can be applied to other types of businesses, such as share transactions. No individual factor is determinative, but should be weighed up in conjunction with the other factors.

The question of whether a person is engaged in share trading has been addressed in a number of court cases and is essentially based on the facts of the situation.

In Case W8 89 ATC 171; (1988) 20 ATR 3182 (Case W8) a trainee accountant purchased 20 parcels of shares between April 1986 and February 1987. All the shares were sold between September 1986 and April 1987, no share having been held for more than five months. A small loss made on four parcels was claimed as a deduction. The Administrative Appeals Tribunal (AAT) held that the shares were purchased as trading stock during the 1987 year. As the shares were bought and sold repeatedly with a view to making a profit and all shares were sold within a year of acquisition, the person was in the business of share dealing.

In contrast to that decision, Case X86 90 ATC 621; AAT Case 6297 (1990) 21 ATR 3747 (Case X86), disallowed a deduction for losses on two parcels of shares sold after the 1987 stock market crash. Instead, the losses were quarantined under the capital gains tax provisions. It was found that there was a lack of sophisticated share trading techniques, business plan, market research in shares invested, contingency plan in falling market or large number of transactions, such that the applicant's activities did not exhibit a system of operation of a business in share trading. The applicant had only a limited contact with the share market, which he then entered for the purpose of making quick profits by generally buying and selling speculative mining shares. The applicant was not engaged in a business of share trading but rather that he was a speculator in the share market.

The taxpayer was unable to satisfy the AAT that he had established a proper pattern of trading in shares and that the share trading was not done in a regular, routine and systematic manner. This was despite arguments that he traded in speculative shares, received regular advice from his accountant, had discussions with his stockbroker and there was a continuity of business, the aim of which was to make a profit.

These cases give a good explanation of the difference between a share trader and a speculator. A share trader was seen as one whose dealings were seen as part of a more extensive business of buying and selling shares. The transactions have the character of a continuing business enterprise. A speculator makes individual forays in particular stock with a view to resale. The difference was determined by following a two-stage test:

· Is there a discernible pattern of trading in shares?

· If not, is there an evident intention to trade regularly, routinely and systematically?

In Case X86 and in Shields v DFC of T (Cth) 99 ATC 2037; (1999) 41 ATR 1042 the following were stated as factors to be considered:

· the nature of the activities and if 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.

These factors are outlined below:

The nature of the activities and profit making intention

Shares may be held for either investment or trading purposes, and profits on sale are earned in either case.

The intention to make a profit is not, on its own, sufficient to establish that a business is being carried on. Where a business of share trading exists, there is usually a business plan of how the activities will be conducted.

A business plan might show, for example:

· an analysis of each potential investment,

· analysis of the current market value and various segments of the market,

· research to show when or where a profit may arise, and/or

· the basis of decisions as to when to hold or to sell shares.

Generally shares purchased for the purpose of making a profit on sale would be re-sold within a relatively short period of time, whereas shares held as an investment would be held over the medium to long term.

It is necessary to consider not only the subjective intention to make a profit, but also the objective facts of the case. This includes evidence of how the activity has actually been carried out, or evidence of how the activities were conducted.

In your case, you state you did not have a business plan, budget or target. Also, that you undertook trading with the aim of making some quick trades with the view of making a profit.

The complexity and magnitude of the undertaking

As can be seen from your transactions for the income year you commenced purchasing shares in March with a spike in activity in April and very little activity after that.

The repetition and regularity of the activities

Repetition is a significant characteristic of business activities. Repetition refers to the frequency of transactions or the number of similar transactions.

In FC of T v. Radnor (91 ATC 4689), Hill J considered that the taxpayer was not carrying on a business of dealing in shares, primarily because there was no pattern of buying and selling. The low volume and low frequency of transactions was emphasised in finding that a business was not being carried on.

Similarly, in Case X86, there was no pattern of buying or selling, and the taxpayer was not considered to be carrying on a business of share trading.

In your case, there is no obvious pattern or regularity to your buying and selling shares. Your shares were bought and sold repeatedly for a short period and then bought and held after that.

Organisation in a business-like manner and the use of a system

In general, most businesses have some form of forward planning to take account of contingencies and market fluctuations, as well as setting profit targets, budgets, periodic financial reviews, record keeping systems and an appropriate office. It would be reasonable to expect a share trading business to involve study of daily and longer-term trends, analysis of a company's prospectus and annual reports, and the seeking of advice from experts. As per Case X86, this means having or operating on a particular plan with the main goal of maximising profits.

You have stated that you have received no formal training in shares and that you have read many publications and consult with your partner. No other expert advice has been sought.

Profit/loss arising from discernible pattern of trading

You have bought and sold chares for a short period followed by buying and holding shares. On the figures provided you are in a loss situation with regards your transactions to date.

The volume of operations and the amount of capital employed

The higher the volume of purchases and sales of shares, the more likely it is that the taxpayer would be regarded as being in business.

The amount of capital employed in the activity is not a determinative factor and must be considered in line with other factors. An example is provided by Case X86 where the taxpayer invested $100,000 and was found not to be carrying on a business whilst in Case W8, the taxpayer invested $1,300 and was found to be carrying on a business. However, the larger the amount of capital that is invested, the more likely it is that the person is carrying on a business.

In Case W8 the taxpayer made a profit on buying and selling shares. He sold 21 parcels of shares, 17 of which generated a net profit of almost $4,500; the other four sales resulted in losses of $325.

Your total invested capital at any one time was not significant.

Turnover

The gross purchase value of your shares was large in comparison to your total at risk investment but reflects the initial trading activity followed by the investment activity.

Keeping records

If records of purchases and sales of shares were not kept, it would be more difficult for a person to demonstrate that a business of share-trading was being carried on.

You record each share transaction and have profit and loss details. You keep electronic records.

Maintenance of an office

You have a computer and internet access to carry on your share activities. This is carried out in the room that you have set aside for study purposes.
Another occupation

You and you partner engage in full time work as well as study.

Conclusion

After considering the above factors and your specific circumstances, it is considered that you are not carrying on a business as a share trader during the income year. Your share trading activities lacked significant repetition or regularity.

Although you carry out market research, it is considered that the activities do not amount to that of a business. You have not shown that you have a sophisticated share trading technique or a business contingency plan to cope with falling markets. You have not established a proper pattern of trading in shares and your share trading was not done in a systematic manner.

The fact that you bought the shares with a purpose of making a profit does not mean that a business is being carried out.

Although you spend some time each week on share activity and you keep records, your situation is not indicative of a share trading business. You are regarded more as a share speculator.

As you are not in the business of share trading:

· the cost of purchase of shares is not an allowable deduction, but is a capital cost,

· receipts from the sale of shares are not assessable income, however any net profit is subject to capital gains tax (section 102-5 of the ITAA 1997),

· a net loss from the sale of shares can not be offset against income from other sources, but may be carried forward to offset against future capital gains,

· costs incurred in buying or selling shares are not an allowable deduction in the year in which they are incurred, but are taken into account in determining the amount of any capital gain/loss,

· dividends and other similar receipts are included in assessable income, and interest on borrowed money incurred in earning dividend income is an allowable deduction at the time it is incurred