Edited version of your private ruling

Authorisation Number: 1012256641322

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Ruling

Subject: Am I in business as a share trader?

Question 1

For a period during the relevant income year, was your partnership carrying on a business of share trading?

Answer

No.

Question 2

For a period during the 2010 income year, are the gains or losses from the partnership's share purchases and sales treated as ordinary income under sections 6-5 and 8-1 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

No.

Question 3

For a period during the 2010 income year, do the gains or losses made from the partnership's share purchases and sales fall under the capital gains tax (CGT) provisions?

Answer

Yes.

This ruling applies for the following periods:

Year ended 30 June 2011

The scheme commenced on:

1 July 2010

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.

The partnership commenced buying and selling shares several years ago.

The partnership's tax return for the income year that the share transactions commenced was lodged on the basis that the partnership's share purchases and sales amounted to a business of share trading being carried on.

A high risk refund (HRR) review was conducted prior to the issue of a notice of assessment on the tax return for one of the partners of the partnership, in the same income year that the share transactions commenced. After requested information relating to the partnership's share trading activities was supplied to the tax office the partner's HRR review was finalised and the partner's refund was released.

The partnership then lodged its subsequent tax return on the basis that the partnership's share purchases and sales amounted to a business of share trading being carried on.

To fund the partnership's share trading personal funds of the partners a very substantial amount was used, as well as borrowed funds.

One of the partners spent approximately 30 hours per week on the partnership's share trading. All share trading was conducted using a lap top computer.

The partnership has maintained the following records in relation to the partnership's share trading activities:

· Broker purchase and sale notes

· Loan statements in relation to funding of shares

· Detailed trading manual

One of the partners also undertook training through a training entity, completing a two year course in successful personal investing. The partnership also received email subscriptions regarding share trading from various organisations, purchased the financial newspapers and magazines.

The partners of the partnership have advised that they do not have a business plan or goals which guide their activities, and believe that this would only create restrictions and limitations in regards to their share transactions. No forward planning or budgeting is carried out, beyond the fact that the partnership's overdraft facility should not be exceeded.

When buying and selling shares no stop loss limits were employed, and market fluctuations were accepted as a part of the process, believing that shares the partnership selected would rebound from any sudden downward trend in value.

Generally, the partnership invested in mining and energy shares. The majority of these shares did not pay dividends. The partnership's share trading strategy was to identify market segments that would be likely to increase in price and then use analysis to identify individual shares to invest in.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 6-5

Income Tax Assessment Act 1997 Section 8-1

Income Tax Assessment Act 1997 Part 3-1

Income Tax Assessment Act 1997 Section 104-10

Income Tax Assessment Act 1997 Section 104-25

Income Tax Assessment Act 1997 Subsection 995(1)

Reasons for decision

Question 1

Is the partnership carrying on a business of share trading?

Summary

The partnership is not carrying on a business of share trading for the 2010 income year. It is considered that the partnership was not in the business of share trading for the year 2, year 3 or year 4 income years.

Detailed reasoning

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

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

(2) Investment/Speculator - In this situation, the partnership 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 will 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 the partnership's assessable income.

To determine which of these treatments applies to the partnership's situation it is necessary to make a determination of whether or not the partnership's activity of buying and selling shares amount to the carrying on of a business.

Whether or not an entity is carrying on a business is a question of fact. The determination of whether or not a business is being carried on is generally a process of weighing up all the relevant indicators within the context of a particular situation. No one indicator determines whether or not a business is being carried on, and the weighting given to each indicator may vary from case to case.

Taxation Ruling TR 97/11 income Tax: am I carrying on a business of primary production (TR 97/11) lists the following indicators as relevant in determining if a business is being carried on:

· Whether the activity has a significant commercial purpose or character,

· Whether the taxpayer has more than an intention to engage in business,

· Whether a 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 that is 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 out in a business like manner,

· The size, scale and permanency of the activity,

· Whether the activity is better describer as a hobby, a form of recreation or a sporting activity.

Administration Appeals Tribunal (AAT) Case X86 90 ATC 621; AAT Case 6297 (1990) 21 ATR 3747 also lists the following factors as being particularly relevant 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 the partnership's case it is the Commissioner's view that the partnership was not carrying on a business as a share trader for the following reasons:

Repetition and regularity of buying and selling shares

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

In determining whether the partnership's share purchase and sale activities constitute a share trading business it would be expected that there would be a discernible pattern of trading shares, and that the pattern would exhibit a commercial level of activity.

Year 4

From the share transaction listing that has been supplied we have identified that during year 3 the partnership made less than 30 transactions in which shares were purchased, and less than 30 transactions in which shares were sold, for the six month period during year 3. Of the less than 30 share holdings purchased during this period, less than 10 were sold, less than 20 were transferred to capital account as at the end of the six month period, and one holding was partly sold, and partly transferred to capital account. Of the shares sold 70% of holdings were sold from the opening share balance. About a third of the sales were closed out transactions (bought and sold in the same period). The total of share transactions for this period was then less than 40, an average of less than two transactions per week.

Two share purchase or sale transactions per week would not be considered to be a level of activity that would be indicative that a business of share trading was being carried on.

The repetition and regularity of transactions in the partnership's share portfolio appear even less significant in view of the fact that the share portfolio is a multi million dollar portfolio as at the time share transactions ceased. It would be expected that a share trader with a portfolio of this size would be conducting multiple transactions daily.

Although the partnership's activities do exhibit some regularity in that the partnership have bought and sold shares on more than one occasion, the partnership's level of repetition and regularity falls far short of a commercial level that would be considered to constitute a business of share trading. Given the value of the partnership's share portfolio, the repetition and regularity of the partnership's transactions are much more in keeping with a wealthy investor.

Therefore, it is viewed that the repetition and regularity of the partnership's share transactions for the year 4 are not indicative that a business of share trading was being carried on.

Year 3

From the share transaction list supplied we have identified that for year 2 the partnership made less than 20 transactions in which shares were purchased, and less than 20 transactions in which shares were sold. Of the share holdings purchased during this period, approximately a third were sold, the remainder of holdings became part of the partnership's closing balance as at the end of year 2. Of the shares sold the majority of holdings were sold from the opening share balance. Only three of the partnership's sale transactions were closed out during the relevant period. The total of share transactions for this period was then less than 40, an average of less than two transactions per month, or less than one transaction per week.

This level of activity is far below what would be considered to be a commercial level, and is about half the level of repetition that was seen in the following year. Consequently, the repetition and regularity of the partnership's share transactions for year 3 are not indicative that a business of share trading was being carried on.

Year 2

From the share transaction list supplied we have identified that for year 2 the partnership made less than 40 transactions in which shares were purchased, and less than 40 transactions in which shares were sold. Of the share holdings purchased during this period, the majority were sold, and a small number of share holdings became part of the partnership's closing balance as at end of year 2. Of the shares sold a small number of holdings were sold from the opening share balance. Of the partnership's sale transactions, less than 40 were closed out within the relevant period. The total of share transactions for this period was then less than 80, an average of less than two transactions per week.

Although this level of repetition and regularity is at a greater level than in the year 3 and year 4 years, it still falls short of what would be considered to be a commercial level. Again, this is even more marked when the size of the partnership's portfolio is taken into account, with the partnership's closing stock portfolio for year 2 valued at a cost in excess of $1 million.

Therefore, the repetition and regularity of the partnership's share transactions for year 2 are not indicative that a business of share trading was being carried on.

Turnover

The larger the scale of an activity is, the more likely it is that a taxpayer is carrying on a business. However, the size or scale of an activity is not a determinative test, and a person could carry on a business as a share investor with a small amount of capital, and a share investor could have a very large amount of money invested.

Characteristics of turnover that would indicate that a business of share trading is being carried would be:

· High liquidity of portfolio

· Short holding periods

· Realisation of short term gains and short term stop loss strategies

· Commercial level of capital invested

Liquid assets are those that can be turned into cash easily and quickly without much loss in value of the product. Highly liquid investments can be viewed as short term investments, because the investor is often looking to have the option to sell at any time with few to no financial consequences. Investments with high liquidity are often indicated by a high level of buying and selling.

Short holding periods of stocks show that an investor is deriving income through the buying and selling process. Stocks are generally not held for long enough periods to generate dividend income.

Realisation of short term capital gains and short term stop loss strategies are strategies that are characteristic of being a share holder, where a gain above a certain level is accepted as a return on investment without holding on for a share to achieve a maximum price before selling. Using stop loss strategies reduces a share traders risk by minimising losses

An amount of capital invested would be considered to be commercial if it was at a level where the value of the partnership's share transactions were beyond what would be considered domestic. A domestic level may be in the range of $5,000 to $10,000 per transaction.

Year 4

For the 20XX income year the partnership made less than 30 share transactions to sell shares in the six month period from 1 July 200X to 1 December 200X. The partnership's average holding period for these shares was close to one year. A small number of the partnership's sales were made in what would be considered the short term, that is in 100 days or less. However, the remaining parcels of shares were held for periods ranging from one to three years. This would be considered to be long term holdings and would not be in keeping with a pattern of trading activity of a share trader. Holding shares for a such a lengthy period of a time when share prices are volatile means that the partnership's portfolio would be illiquid - some shares cannot be sold without crystallising a large loss. This also shows that the partnership was not realising capital gains as they arose, or monitoring share prices to sell shares before they could generate a large loss.

In regards to the partnership's capital investment you are completing share transactions at a level that uses a substantial amount of capital that would be considered to be commercial. However the partnership's portfolio was illiquid, had lengthy holding periods, and failed to realise short term gains and limit losses. These are all indicators that the partnership's activity would be considered to be that of a wealthy investor. The turnover of the partnership's portfolio and shares would not support the argument that the partnership's activities amount to a business of share trading being carried on.

Year 3

For the 200X income year the partnership sold less than 20 parcels of shares. The average holding period for these shares was over a year. The value of the partnership's share sales was substantial. It would be considered that this scenario is similar to the scenario for the year 4, and accordingly the partnership's turnover for year 3 is not indicative that the partnership is carrying on a business as a share trader.

Year 2

For year 2 the partnership sold less than 40 parcels of shares. The partnership's average holding period for these share was less than a month, and the value of the partnership's sales was very substantial. This level of trading would be considered to represent a liquid portfolio with short trading periods where short term gains were taken and losses minimised by selling shares in a loss position after a short holding period. The value of the partnership's sales was at a very substantial level that is considered to be commercial.

Overall the partnership's turnover for Year 2 is indicative of an activity that would be considered to be share trading.

Operating to a plan, setting budgets and targets, keeping records

Operating to a plan, setting budgets and targets is the usual way that a share trader would conduct their business. An example of a plan that a share trader might use in their business on a daily basis might be to maintain a 60% loan to asset ratio, invest in a speculative stocks, realise profits at 15%, to have a stop loss in place of 10%, and to look to multiple information channels to make decisions on which shares to purchase. Overall, a share trader minimises risk through realising short term gains and limiting exposure to substantial losses through very close monitoring of their share portfolio.

An investor may tend to hold on to shares in a falling market and wait for the price to rebound rather than crystallise a loss, while a share trader would sell when their stop loss limit was reached.

In this circumstance, the partnership did not use a written business plan, and haven't provided any details of an overriding strategy that the partnership have in place when the partnership are buying and selling the partnership's shares. It is evident in looking at the partnership's share activity for the year 2 that the partnership was focusing on energy and mining stocks, although not blue chip stocks, and that some sort of strategy was place as the partnership's holding periods are short and the partnership have taken both short term gains and short term losses.

However, the partnership's pattern of activity for the year 3 and year 4 show holding of stocks for longer periods. The partnership have also stated in the partnership's ruling application that some stocks were held for long periods as the partnership believed that they would recover their value in time.

This strategy is very much in keeping with a share investor in that the partnership are anticipating the growth of the partnership's share portfolio will create wealth. An increase in a shares value over time is capital growth and is a share investor's strategy.

The partnership's lack of dividends receipts in the year 4 year, even though some of the partnership's shares had been held for substantial periods indicates that some of the partnership's shares have been purchased solely for capital growth and would be considered to be speculative in nature. This is an indicator of share trading rather than share investing.

No information in regards to any budgets or targets that the partnership set when conducting the partnership's share purchases and sales has been submitted. The partnership did not have stop limits in place, and did not carry out budgeting or forward planning, apart from keeping the partnership's overdraft to a certain level.

In regards to the partnership's record keeping the partnership maintains all broker purchase and sale information in a professional manner, as well as loan statements in respect of borrowing for share transactions. The partnership also maintain a detailed trading manual.

This would be considered a reasonable amount of record keeping for both share trading, or share investing.

Overall, although the partnership have stated that the partnership does not operate with a business plan the partnership's share activity in the year 2 that there is a plan in place that is in keeping with a share trader, while the year 3 and year 4 transactions are indicative that no plan is being followed. The lack of dividends and choice of speculative shares are indicative of a share trading business, while the partnership's absence of budgeting and forward planning do not support that the partnership are a share trader.

On balance; your plans, budgeting and record keeping show some factors that indicate your activity is share trading, and others that indicate you are an investor.

Maintenance of an office

The findings in cases in the past have mentioned that the maintenance of a separate office would lend weight to an argument that a business of share trading was being carried on. Although this would still apply, the lack of a separate business premises no longer precludes that a business is being carried on.

In the partnership's case on of the partner's had a laptop computer with access to the internet. This would be considered to be sufficient to maintain a large share portfolio and to carry on a business of share trading.

Engaged in another full time profession

While not conclusive the presence of full time employment would generally be contra indicative that a business of share trading was being carried on.

In the partnership's case one of the partner's, spent 30 hours a week on activities related to the partnership's share portfolio, while working from 9.30 to 4.30 each day. This would tend to support that a business of share trading was not being carried on.

Conclusion

Year 4

Within the context of the partnership's own situation, while the value of the partnership's share transactions are at a commercial level, the repetition and regularity of the partnership's transactions fall short of what would be considered to constitute the carrying on of a business of share trading. The partnership's turnover in terms of value is at a commercial level, however the partnership's volume of purchases and sales of shares indicate that the partnership are not in business as a share trader. The partnership's plan and pattern of activity, as well as the partnership's share selections indicate that the partnership's activities are in keeping with that of a wealthy share investor, and the partnership's level of record keeping is in keeping with what would be required of a share investor with a portfolio of the partnership's size.

After weighing up all of the relevant factors it has been determined that the partnership's share purchase and sale transactions undertaken during year 4 were as a share investor, and do not amount to the carrying on of a business as a share trader.

Year 3

It is considered that the partnership's activity in relation to the partnership's share transactions is in fact similar to the partnership's activity in the 20XX income year, albeit at a reduced level. Accordingly, it is determined that the partnership's share purchase and sale transactions undertaken during year 3 as a share investor, and do not amount to the carrying on of a business as a share trader.

Year 2

The facts of the partnership's situation for the year 2 do differ from the year 3 and year 4. Although the repetition and regularity of the partnership share transactions is below the level of what would be expected of a share trader, the partnership's turnover and short holding periods are in keeping with a share trader. he partnership's activities show some evidence of planning, while conversely the partnership have stated the partnership do not operate to a plan or to a budget.

In the weighing up of all factors more weight would necessarily be given to the repetition and regularity of an activity when determining if a business is being carried on, while turnover would provide support to an argument. It is then determined that the partnership's share purchase and sale transactions undertaken during year 2 were as a share investor, and do not amount to the carrying on of a business as a share trader.

Decision not to consider share transactions in year 1

The partnership's tax return for the year 1 was lodged as a business that was eligible, and continuing in, the simplified tax system (STS). In this year, an individual that receives distributions from a partnership that carried on a business that is an STS taxpayer has a two year period of review on their tax returns. The two year period commences at the date that a notice of assessment was issued by the Commissioner.

The notice of assessments for partners of the partnership were all issued more than two years ago. The period of review on these tax returns has accordingly expired.

We have then declined to consider whether or not the partnership was carrying on a business of share trading for year 1 as there is no practical consequences in doing so as all partners are out of their review period, and could not amend this return in any case.

Note on HRR review of one partner's tax return in year 1.

In the partnership's private ruling application the HRR review that took place in relation to one of the partner's year 1 income tax return was raised. It was noted that the partner's return was released on the basis that the partnership was carrying on a business of share trading.

This review would not necessarily be determinative that a business of share trading was being conducted by the partnership at that time. A review would establish whether there was sufficient cause to amend a tax return prior to issue of a refund, however is not an in depth examination of affairs. A review would then release a refund on the basis that the return has been accepted on the basis that it had been lodged.

Question 2

Gains and losses on revenue account

Summary

The gains and losses from the partnership's share purchases and sales are not on revenue account.

Detailed reasoning

In determining whether an amount should be treated as income or capital it is the character of the receipt in the hands of the recipient which is the important factor.

As the partnership is considered to be a share investor in regards to it's share transactions during year 4, gains and losses will have the character of capital in the hands of the partnership.

Accordingly, gains and losses incurred from the partnership's share transactions would not be accounted for on revenue account.

Question 3

Tax treatment of gains and losses from share purchases and sales

Summary

The partnership must apply CGT provisions to gains and losses from the partnership's share purchases and sales.

Detailed reasoning

As the partnership was not in business as a share trader for year 4 any gains made from the sale of shares are considered to be a capital gain, and any losses are considered to be capital losses. These gains and losses then fall under the CGT provisions.

Accordingly, the partnership cannot value the partnership's shares under provisions contained in section 70-45 of the ITAA 1997, and must apply CGT provisions to each of the partnership's share holdings to work out the partnership's capital gain or the partnership's capital loss.

If the partnership have held shares for a 12 month period the partnership can apply the discount method to calculate the partnership's capital gain.