Edited version of your private ruling

Authorisation Number: 1012047019192

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Ruling

Subject: Am I in business as a share trader

Question 1: For the year ended 30 June 2010 and 30 June 2011, were you carrying on a business of trading in shares?

Answer 1: Yes.

Question 2: For the year ended 30 June 2010 and 30 June 2011, will the losses from your business of share trading be deductible under section 8-1 of the Income Tax Assessment Act 1997 (ITAA 1997) and your gains be assessable income under section 6-5 of the ITAA 1997?

Answer 2: Yes.

This ruling applies for the following period

Year ended 30 June 2010.

Year ended 30 June 2011.

The scheme commenced on

1 January 2000.

Relevant facts

You commenced buying and selling shares in the year 2000, the majority of the shares purchased at that time were blue chip shares.

You studied Economics as a major subject whilst at University.

Your research prior to setting up your share activity was of the macro economy, world politics, financial events and their influence on the share market. You researched share market sectors, e.g. the commodities, (mainly copper, oil, gas, gold, nickel, coal, iron ore, potash, phosphate etc and their share price trend.

You have read many articles over the internet. You spend two to three hours every day reading the world news and financial news.

Everyday you discuss and exchange information with your spouse, who researches specific stocks. Every weekday morning they browse Australian Stock Exchange announcements and announcements regarding their own share portfolio. Your spouse also reads the financial articles in the Australian and Sydney Morning Herald newspapers.

You have stated your business plan as:

'To make profit, by identifying and investing the most promising speculative stocks that have the most potential to become blue chips.'

You currently have a significant amount of capital invested in your share activities. The source of this capital was money borrowed by mortgaging your house.

You can access additional capital if necessary through the use of a margin loan. However because the share market is so fluctuating you think it is not a good time to arrange a margin loan.

As stated previously, in the early years of your share activity you purchased mainly blue chip shares, however from the year ended 30 June 2010 and onwards the majority of the shares purchased were and are speculative mining shares. You and your spouse try and identify and purchase the most promising candidate stocks that have the potential to become blue chip stocks.

From the year ended 30 June 2010 and onwards you do not purchase shares for the purpose of earning dividends.

You have stated the following in regard to how you make decisions on whether to buy, hold or sell shares and on the amount you invest each time.

'We do a large amount of researches to identify the shares that we think they are at the right sector, at the right time and have the right assets (or most promising assets). We research their peer companies, compare their assets qualities and their market capitals and the market trend to decide their valuations. If we find out they are undervalued everything is on track and as planned we will buy and hold. But once they are off track or progress not as planned or the market trend has changed (for example uranium sector after the Japan earthquake) we will sell out.'

'As for the amount we invest each time depends on many elements: the valuation of the stock, its market capital vs. its assets or potential assets vs. its peer companies, the probabilities it can succeed and if succeed the space it can increase in its share price, the risk it involves etc.'

You have a stop loss strategy, however you rely on specific stock announcements rather than market fluctuations.

You have made the following buy and sell transactions.

You use both CommSec and E*Trade as your broker. You use CommSec almost every day.

In the financial year ended 30 June 2010, you subscribed by paying a fee to the following financial advice:

o Under the Southern Cross;

o Diggers and drillers;

o Australian small cap investigator;

You also signed up for the following free financial websites:

o Hotcopper;

o The daily wealth;

o Wealth daily;

o Smart investing daily;

o Business spectator;

o The bull;

o Proactive investors; and

o Share café

You have a home office and a computer that you use to conduct your share activities.

On average you have spend a considerable amount of hours per week on your share activities.

In relation to your answer to question 9 of the share trading questionnaire signed and dated by you on 11 November 2011, you no longer hold the shares that were held as long term investments, they have been disposed of.

For the year ended 30 June 2010 and 30 June 2011, you meet the income requirement, that is the total of the following amounts is less than $250,000:

· Taxable income (ignoring business losses);

· Total reportable fringe benefits;

· Reportable superannuation contributions;

· Total net investment losses - including financial investment losses and rental property losses; and

· you pass the assessable income test.

The following documents are to be read with and form part of the scheme for the purposes of the private binding ruling:

· You private binding ruling that we received;

· Answers to the share trading questionnaire signed and dated by you;

· E*Trade Australia trading history statements in your name, of a certain account number for the period 1 July 2006 to 30 June 2009;

· CommSec Account in your name, of a certain account number for the period 25 June 2008 to 20 August 2008;

· CommSec Account in your name and your spouse's name, of a certain account number for the period 18 November 2008 to 4 November 2011;

· CommSec Account in your name and your spouse's name, of a certain account number for the period 20 October 2009 to 2 September 2011;

· CommSec Account in your name only, of a certain account number for the period 23 February 2010 to 19 October 2010; and

· E*Trade Australia trading history statement in your name, of a certain account number for the period 1 July 2009 to 30 June 2010.

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 35-10,

Income Tax Assessment Act 1997, Section 35-30,

Income Tax Assessment Act 1997, Section 995-1,

Taxation Administration Act 1953, Section 359-35

Reasons for decision

Question 1:

There are two possible scenarios as to how share purchases and sales can be treated for income tax purposes. These scenarios, and their consequences, are as follows:

(1) Business Income In this scenario, you would be a share trader, the shares would be regarded as trading stock and any income/losses would be included in your assessable income. 

(2) Investment/Speculator In this situation, you would be regarded as a share investor or speculator. The shares will be capital gains tax (CGT) assets, any gains earned from the disposal of the shares would be 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 in your assessable income.

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

Whether a share trading activity is carried on as a business is a question of fact. Case law has determined certain factors as being relevant in making this decision and concluded that no one factor is determinative, it is the overall impression gained. The following case law supports the concept of impression gained about the distinction between a share market investor/speculator and someone who is carrying on a business of share trading.

In Federal Commissioner of Taxation v. Radnor Pty Ltd (1991) 22 ATR 344; 91 ATC 4689, (Radnor) Hill J stated 'Ultimately, the question of whether the respondent was carrying on a business of dealing in shares is a question of fact and degree, a question of impression.'

And more recently re-iterated in Smith v Federal Court of Taxation 2010 ATC 10-146; [2010] AATA 576 (Smith) Ettinger J stated at paragraph 12 ' by way of general guidance, I am mindful of the frequently cited words from Martin v Federal Commissioner of Taxation (1953) 90 CLR 470:

"The test is both subjective and objective: it is made by regarding the nature and extent of the activities under review, as well as the purpose of the individual engaging in them, and … the determination is eventually based on the large or general impression gained."

The factors that are considered relevant in determining whether an activity is carried on as a business have been addressed in a number of court cases.

In Case X86 90 ATC 621; AAT Case 6297 (1990) 21 ATR 3747 (Case X86), and more recently in Shields v DFC of T (Cth) 99 ATC 2037; (1999) 41 ATR 1042 (Shields v DFC of T (Cth)) and Smith the following were stated as factors to be considered;  

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

o the complexity and magnitude of the undertaking;

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

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

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

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

o and more particularly in respect of share traders,

o repetition and regularity in the buying and selling of shares;

o turnover;

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

o maintenance of an office;

o accounting for the share transactions on a gross receipts basis; and

o whether the taxpayer is engaged in another full time occupation.  

Three cases provide examples of the application of these factors by the Administrative Appeals Tribunal (AAT). 

In Case W8 89 ATC 171; (1988) 20 ATR 3182 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 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 trading. 

In contrast to that decision, Case X86, disallowed losses on two parcels of shares sold after the 1987 stock market crash. Instead, the losses were quarantined under the capital gains provisions of the Act. 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. 

In a recent decision handed down by the AAT on 5 August 2010, Smith, it was found that Mr Smith was not in the business of share trader during the year ended 30 June 2007 or 30 June 2008. The Tribunal found that the applicant could not demonstrate to its satisfaction that the nature of his activities had the purpose of profit making because:

o he held his shares for periods longer than a share trader generally would;

o took DRP's and dividends;

o his activities did not demonstrate, to the Tribunal's satisfaction, repetition and regularity in the buying and selling of shares in order to demonstrate that he was in business;

o the applicant did not maintain a separate office;

o the applicant worked fulltime in a very responsible position at Babcock & Brown. The AAT Member qualified this by stating "although I do not put much weight on that, I was concerned that he was unable to indicate what kind of time he spent on buying and selling shares".

o he did not keep any separate accounting but relied on third party systems (BT and the WBC platform).

The tribunal concluded that "The evidence points strongly to, and my overall impression is, that Mr Smith was not conducting a business either in 2007, or in 2008, that he was not in business, and not in the business of share trading. I was satisfied that he had more disposable income than previously, and invested it in shares as an investor might. I have preferred the submissions of the Respondent in that regard".

To summarize, it was found that Mr Smith invested in shares and other securities, albeit at increased amount of capital investment because he had the funds available; and that all the transactions were on capital account.

Conclusion - Applying the criteria to your circumstances

The factors or indicators that give the overall impression that you were carrying on a business of trading in shares for the year ended 30 June 2010 and 30 June 2011 were:

You had a profit making intention, whilst you have made a loss of a certain amount before expenses in the year ended 30 June 2010, you have made a profit of a certain amount before expenses in the year ended 30 June 2011.

o in the year ended 30 June 2010, you did not hold shares for long periods of time, shares were often turned over quickly, eg. in many instances shares were bought and then sold the following day, held for a few days or a few weeks before being disposed of.

o unlike previous years, your dividend income for the year ended 30 June 2010 was miniscule, this is also an indicator that shares were not held for periods of longer than 6 months.

o you traded shares in a regular, routine and systematic manner;

o there was high number of trades and a high turnover, in the year ended 30 June 2010 you had over 200 share buying and selling transactions, for the year ended 30 June 2011 you state that the number of buy and sell transactions was greater than 600;

o there was a discernable pattern of trading;

o you operated in a business like manner, that is you followed your business plan and used a degree of sophistication; your trading depicts both taking profits as they arise through trade and also minimising any losses (stop losses) through trade, your trading was not left to chance. Complementing this, you subscribed yearly to Under the Southern Cross, Diggers and drillers, Australian small cap investigator; and signed up to the following free financial websites: Hotcopper, The dailywealth, Wealth daily, Smart investing daily, Business spectator, The bull , Proactive investors and Share cafe;

o you injected large amounts of capital into your share trading. The amount of capital is significant. You also have access to further additional capital if necessary, via a margin loan;

o you maintained a home office and a computer for carrying out your share trading activities; and

o on average for the year ended 30 June 2010 and year ended 30 June 2011 you spent 25 hours per week on your share trading activity.

The overall impression gained is that you were in the business of trading in shares for the year ended 30 June 2010 and 30 June 2011.

Question 2:

As you are in the business of trading in shares for the year ended 30 June 2010 and 30 June 2011, any gains will be assessable income under section 6-5 of the ITAA 1997 and any losses will be deductible under section 8-1 of the ITAA 1997, because the non commercial loss rules are satisfied.

Year ended 30 June 2010 - Business loss

You will be able to claim the business loss from your share trading in the current year, (the year ended 30 June 2010) against your income from other sources, such as wages because you are carrying on a business and you pass the non commercial loss rules by;

· firstly meeting the income requirement, that is the total of the following amounts is less than $250,000:

· Taxable income (ignoring business losses);

· Total reportable fringe benefits;

· Reportable superannuation contributions;

· Total net investment losses - including financial investment losses and rental property losses; and

· then secondly passing the assessable income test.

Year ended 30 June 2011 - Business profit

For the year ended 30 June 2011, you have made a profit of a certain amount before expenses from your share trading. The overall gain (share trading profit less those expenses that are allowable deductions) will be assessable income under section 6-5 of the ITAA 1997.

Notes

Year ended 30 June 2007, 30 June 2008 and 30 June 2009

From the information provided your share buying and selling in the years ended 30 June 2007, 30 June 2008 and 30 June 2009 has been correctly returned on capital account as a share investor.

Contract verse settlement date - which financial year does the share transaction belong to

The earnings method (sometimes called the accruals method) is, in most cases, appropriate to determine when business income is derived from a trading business. (Trading income is income from the sale of trading stock). Under this method the income is derived when it is earned. The point of derivation occurs when a recoverable debt is created. The term recoverable debt is used to describe the point of time at which a taxpayer is legally entitled to an ascertainable amount as the result of having performed an agreed task. For you the contract date for the sale of shares is the date that you would use to determine which financial year the transaction belongs to, rather than the settlement date.

Share investor or share trader

As stated previously the tax treatment of a taxpayer's share buying and selling activities can be classified in one of two ways, either as a share investor or a share trader. This status can change from one income year to another depending on the facts and circumstances of how the activity is carried out in each year. Enclosed are some fact sheets on this topic for your reference.

It is also possible for a taxpayer to be both a share investor and a share trader in the one financial year, however there would have to be a clear distinction regarding the separate portfolios and how each activity is carried out. Generally, at a minimum a separate strategy, accounting and record keeping for the different share activities would be needed and there would need to be a real difference in the two portfolios; that is, the activities are not artificial or contrived for a tax benefit only, (i.e. to achieve the 50% discount on gains made from shares held for more than 12 months and/or to claim any losses as revenue losses against other income, rather than as capital losses).