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Ruling

Subject: Contracts for difference - loss - recreational gambling

Question 1: Will the loss made in relation to your contracts for difference transactions be included as allowable deductions under section 8-1 of the Income Tax Assessment Act 1997 in the 2009-10 income year?

Answer: Yes

Question 2: Will the loss made in relation to your contracts for difference transactions be disregarded under section 118-37(1)(c) of the Income Tax Assessment Act 1997 in the 2009-10 income year?

Answer: No.

This ruling applies for the following periods:

Income year ended 30 June 2010

The scheme commences on:

1 July 2009

Relevant facts and circumstances

You were involved in a car accident a number of years ago from which you sustained a brain injury. You retired from your employment after a period of time and commenced receiving an invalid pension.

You and your former spouse purchased a dwelling, Dwelling A, with you owning a majority of the ownership interest and your former spouse owning the remaining ownership interest in the dwelling.

Due to your former spouse's employment, you moved interstate for a number of years, during which Dwelling A was rented out.

You moved to another state due to your former spouse's employment and you resided in a dwelling purchased by your former spouse, Dwelling B, and continue living there until the present time.

After a period of time, your former spouse moved location to commence new employment, and then moved interstate for further employment opportunities while you stayed in Dwelling B.

You would have moved back to Dwelling A at this time, but felt that you could not interrupt your child's schooling, and decided to stay at Dwelling B.

Your former spouse wanted to purchase a dwelling in the state he was employed and you took out a further bank loan to acquired their ownership interest in Dwelling A, on top of the already existing mortgage on the dwelling.

Due to your personal circumstances, you disposed of Dwelling A a number of years later and used the proceeds to pay out some of the mortgages, and the capital gains tax incurred in relation to the disposal of Dwelling B, leaving you with some of the proceeds.

You invested part of the remaining proceeds in a company, Company A, through a superannuation fund and a family trust, but Company A collapsed after a period of time.

Upon the collapse of Company A, you thought that you had little prospect of ever being able to buy back into the area where Dwelling A had been located, and at that time you had the notion that you might be able to use the contracts for difference trading platform to get back into the property market in the desired area, with your initial idea to risk a set percentage of the remaining proceeds.

You opened an account with a broker and commenced your contracts for difference activities during the 2006-07 income year, using the internet from your home computer.

You do not have any financial knowledge or training and was not required to show that you possessed any in order to open the CFD account.

You kept no records or books in relation to your contracts for difference activities, apart from the account printouts provided by the brokers and an annual tax return.

You did not have an investment system or plan other than the trends that you discerned from graphs and history available on the broker's website, and from common knowledge.

You were speculating and were not taking these bets as a "hedge" against any physical investment position.

The contracts you entered into were not derivatives that were physically deliverable or exchange traded.

During the period you undertook your contracts for difference activities, you acquired more computer screens and left them turned on with the computer running at all times. You kept the computers in a room in Dwelling B where the screens could be seen from various areas of the dwelling.

You claimed deductions in your 2006-07 income tax return for net losses made in relation to your contracts for difference transactions during that income year.

You claimed deductions in your 2007-08 income tax return for net losses made in relation to your contracts for difference transactions during that income year.

You included an assessable income amount of $1,990,495 arising in relation to your contracts for difference transactions in your 2008-09 income tax return.

Your tax agent has calculated that you made a loss in relation to your CFD transactions in the 2009-10 income year.

You provided copies of a number of documents with your private ruling, which should be read in conjunction with and form part of the scheme of this private ruling.

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 Section 118-20

Income Tax Assessment Act 1997 Paragraph 118-37(1)(a)

Income Tax Assessment Act 1997 Paragraph 118-37(1)(c)

Reasons for decision

Contracts for difference (CFDs)

CFDs allow investors to take risks on movements in the price of a "subject matter" without ownership of that subject matter. The subject matter may be a share, a share price index, the price of a financial product or commodity, an interest rate or a currency exchange rate or any other asset or index for which a market price is readily available.

Investors in such contracts make gains (losses) if they enter into contracts to (notionally) buy the subject matter and later close out the contracts by entering into contracts to sell at a higher (lower) price quoted by the provider. Conversely, investors make losses (gains) if they enter into contracts to (notionally) sell the subject matter and later close out the contracts by entering into contracts to buy at a higher (lower) price quoted by the provider.

The taxation treatment of CFD trades will depend on the nature in which the transaction is carried out. The different categories are: 

· Carrying on a business of CFD trading;

· That individual CFD trades are a business operation or commercial transaction for the purpose of profit making; or

· Recreational of a gambling nature, involving chance.

The Commissioner's view about the tax consequences of CFDs is found in Taxation Ruling TR 2005/15 (TR 2005/15). TR 2005/15 provides that a gain made from CFD transactions will be assessable income under section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997), and a loss 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 where the profit was obtained in a business operation or commercial transaction for the purpose of profit making.

Paragraph 13 of TR 2005/15 outlines that a gain made from CFDs where the taxpayer enters into a CFD transaction while 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 will be assessable under 15-15 of the ITAA 1997.

Paragraph 14 of TR 2005/15 provides that a loss from a financial CFD where the gain would have been assessable under section 15-15 of the ITAA 1997 is an allowable deduction under section 25-40 of the ITAA 1997.

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.

Paragraph 33 of TR 2005/15 states in Australia, the only decisions on the taxation of speculative futures contracts are three tribunal decisions, Case Q77 83 ATC 388, Case X47 90 ATC 382; (1990) 21 ATR 3416 (Case Q77) and Case X85 90 ATC 615; (1990) 21 ATR 3728 (Case X85). These decisions support the view that speculating on futures contracts may be taxable even though the investor does not carry on a business of speculating in these contracts. However they do not conclusively determine whether cash-settled contracts, which are gaming and wagering contracts and hence gambling transactions, are taxable without a business being carried on.

In Case Q77, the Tribunal took the view speculation on a small number and value of transactions in metal futures was undertaken for the dominant purpose of profit, profit being the difference between the cost of the various contracts and the net proceeds received by the taxpayer on their sale.

In Case X47 90 ATC 382 (Case X47), the taxpayer was a medical practitioner who also derived income from various investments. In the 1986 income year he invested $8,000, which included an $800 account establishment fee, with a futures broker for the purpose of trading in United States Treasury Bonds futures contracts. The transactions were only concerned with the yields on Treasury Bonds and the taxpayer was never exposed to any risk of having to accept or supply bonds. Within a short time, however, the taxpayer had lost the whole of his investment. The Administrative Appeals Tribunal (AAT) ruled the loss was not a loss of capital or of a capital nature and was therefore an allowable deduction within the terms of sec. 51(1) to the extent of $7,200, being the amount of the original investment less the establishment fee which was not deductible.

In Case X85, however, the Tribunal did take the view that a single cash-settled derivative transaction was within the tax base, and on revenue account as an allowable deduction, and did so on the basis of the transaction's essential commerciality.

Carrying on a business of CFD trading

 The Commissioner's view about carrying on a business is found in Taxation Ruling TR 97/11 (TR 97/11). Whilst TR 97/11 is about carrying on a business of primary production, the indicators in TR 97/11, which have been developed by the courts of law, are used for all cases about the carrying on of a business.

These indicators include:  

· The nature of the activities, particularly whether they have the purpose of profit making;

· The repetition and regularity of the activities

· Organisation in a business like manner, including 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 there is the keeping of books or records; and the use of a system;

· The volume of the operations; and

· The amount of capital employed.

Regarding the matter of carrying on a business, relevant court cases such as AAT Case 6297 (1990) 21 ATR 3747 and Federal Commissioner of Taxation v. Radnor Pty Ltd (1991) 102 ALR 187; (1991) 91 ATC 4689; (1991) 22 ATR 344 have held regularity in the buying and selling of shares and sales turnover to be the salient indicators of whether a taxpayer is carrying on a business of share trading. Operating in a business-like manner and the degree of sophistication involved is also an important indicator.

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, an appropriate office and so forth. It would be reasonable to expect a CFD trading business to involve study of daily and longer-term trends, analysis of a company's prospectus and annual reports, and seeking of advice from experts. This means having or operating on a particular plan with the main goal of maximising profits.

 In carrying on a business of CFD trading, the greatest weighting is given to the repetition and regularity of the activities and organisation in a business like manner.

CFD trades as a business operation or commercial transaction for the purpose of profit making

Paragraph 26 of the TR 2005/15 outlines that if a CFD 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 in carrying on a business.

It was held in the Myer case at 209-10' 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.

TR 2005/15 provides at paragraph 27 that the intention or purpose of the taxpayer of making a profit or gain referred to in the Myer case must be discerned from an objective consideration of the facts and circumstances of the case, as inferred from the following judgment in the Myer case:

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, not withstanding that the transaction was extraordinary judged by reference to the ordinary course of the taxpayer's business.

Speculative transactions would be included within the Myer principles if there is a profit-making purposes and the transaction is commercial, as stated at paragraph 29 of TR 2005/15.

Recreational CFD trading of a gambling nature

Capital gains or capital losses from CGT events relating directly to gambling, a game or a competition with prizes are disregarded under paragraph 118-37(1)(c) of the ITAA 1997. The exemption will also apply in relation to gains or losses arising from a CFD if the contract was entered into for the purpose of recreation by gambling:

Whilst gains or losses from CFD trading are often taxed on revenue account because of their business or profit making purpose, in some cases the facts will establish that the person did not clearly carry out the activity in a profit making way. In such a case, the gain or loss will not be on revenue account. The question then arises whether the gain or loss will be a capital gain or loss.

Paragraph 15 of Taxation Ruling TR 2005/15 states the Commissioners view in this regard:

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.

Paragraph 45 of TR 2005/15 states the terms of the financial CFDs are such as to tend to stamp it as an act of commerce. However, a taxpayer who enters into a financial CFDs only once, or very occasionally, who has no expertise in the price of the underlying by which the gain or loss of the financial CFDs will be calculated, does not engage in any income-producing activities of a character bearing some association or connection with the financial CFDs or its underlying, and, in particular, who gambles in the ordinary recreational way and who has entered into the financial CFDs in circumstances such that the financial CFDs may be seen to be part of that recreation may establish that the gain or loss is the product of gambling (and not the result of a profit-making endeavour.)

Conclusion

You commenced your CFD activities during the 2006-07 income year and undertook CFD trading in an endeavour to recoup money you had lost when Company A collapsed, to enable you to re-enter the housing market in the area you wanted to live This indicates that you had a profit making intention when you commenced trading your CFDs.

You made losses on your CFD activities during the 2006-07 and 2007-08 income years and a gain during the 2008-09 income year.

Your tax agent has estimated that you have made a loss during the 2009-10 income year in relation to your CFD activities.

The number of transactions you completed during the 2009-10 income year shows that you have undertaken an activity of some magnitude, which supports that you traded on a regular basis. The volume of your transactions does not support that you were undertaking your activities as recreational gambling given the scale of your activities. You did not undertake your activities only once, or very occasionally, but had conducted your activities on a regular and repetitive basis.

You do not have any financial knowledge or training, but have undertaken your CFD activities over a number of years and have concentrated your CFD activities on foreign currencies. This would suggest that you had some experience and expertise in relation to CFD transactions during the 2009-10 income year, which would also indicate that you were not undertaking your CFD activities as recreational gambling as outlined in paragraph 45 of TR 2005/15.

You do not have an investment system or plan, and rely on trends that you discern from historical data, graphs, and common knowledge.

You use your home computer to conduct your CFD activities and have acquired more computer screens during the period you have undertaken your CFD activities to enable you to see the screen from various areas of your Glen Waverley dwelling. Your overall objective was to increase your investment.

You kept no records or books in relation to your CFD activities, apart from the IG Market account printouts and an annual tax return.

As the Commissioner indicates in TR 2005/15, the terms of the financial CFD are such as to tend to stamp it as an act of commerce and the facts of your situation establish that you entered into the CFDs for the purpose of profiting from the expected movement in the financial market. They establish the existence of a profit making intention and that the transactions were entered into in the course of carrying out a business operation or commercial transaction.

As a result, any gain made on your CFD activities during the 2009-10 income year would be assessable under section 6-5 of the ITAA 1997. Therefore, the loss you made in relation to your CFDs activities will be included as an allowable deduction under section 8-1 of the ITAA in your 2009-10 income tax return.

Note: While we acknowledge and appreciate your situation, the Commissioner can only make a decision on a private ruling by applying taxation legislation and ATO views to the taxpayer's facts.