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Ruling

Subject: Capital gains tax - am I in business

Question 1

Did the share trading activities which you carried on in partnership with your spouse, constitute a business?

Answer

Yes.

Question 2

Will you be eligible to claim a deduction under section 8-1 of the Income Tax Assessment Act 1997 (ITAA 1997) for the losses made on your CFD activities?

Answer

Yes.

This ruling applies for the following periods:

Year ended 30 June 2012

The scheme commences on:

1 July 2011

Relevant facts and circumstances

Partnership with spouse

You and your spouse had a joint bank account from which you purchased shares and deposited the proceeds of the sale of shares.

You and your spouse jointly contributed the capital required to fund the acquisition of the shares.

The partnership's used one share broker.

There were a number separate trades during the financial year.

The partnership kept accurate records of all its trades.

The partnership held the shares that it bought for short periods of time, usually only a few weeks.

The partnership consulted stock market information and closely monitored the prices of its shares.

You liaised with the broker and carried out the analysis for the partnership as you have more stock market expertise than your spouse.

Sole trader

You had a separate account, in your name only, with another financial institution.

There were a number of share trades in this account during the financial year.

You also carried out CFD trading.

There were a number of trades during the financial year, generating a loss.

You kept accurate records of all your trades.

You held the securities that you bought for short periods of time, usually only a few weeks.

You consulted stock market information and closely monitored the prices of the relevant securities.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 6-5,

Income Tax Assessment Act 1997 Section 8-1 and

Income Tax Assessment Act 1997 Section 995-1.

Reasons for decision

Question 1

Summary

You will be eligible to claim deductions under Section 8-1 of the ITAA 1997 for losses made in relation to your share activities during the 2011-12 income year.

Detailed reasoning

The difference between a share holder (investor) and share trader (business)

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, 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.'

This was re-iterated more recently 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;

· 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;

· 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; and

· Whether the taxpayer is engaged in another full time occupation.  

Applying the criteria to your circumstances

We have considered the relevant factors, as outlined above, when determining whether you were carrying on a business as a share trader during the 2011-12 income year.

Both your partnership and sole trader activities were carried out on a scale and in a manner such that they constituted business activities in accordance with criteria set out in Taxation Ruling TR 97/11 (copy enclosed). Therefore, your income from the activities is assessable under section 6-5 of the ITAA 1997 and the outgoings are generally deductible under Section 8-1 of the same Act.

Question 2

Summary

You will you be eligible to claim a deduction under section 8-1 of the Income Tax Assessment Act 1997 (ITAA 1997) for the losses made on your CFD activities.

Detailed reasoning

Losses from CFDs

CFDs are a form of cash-settled derivative in that they allow investors to take risks on movements in the price for a subject matter (the underlying) without ownership of the underlying.

Participants in CFDs take a risk that the price of the underlying will or will not exceed a price for that underlying at some time in the future.

CFDs include those relating to share prices, share price indices, financial product prices, commodity prices, interest rates and currencies.

Section 8-1 of the Income Tax Assessment Act 1997 (ITAA 1997) allows a deduction for all losses and outgoings to the extent that they are incurred in gaining or producing assessable income or are necessarily incurred in carrying on a business for the purpose of gaining or producing assessable income, except where the outgoings are of a capital, private or domestic nature.

A loss from CFDs 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 in a business operation or commercial transaction for the purpose of profit making.

A loss from CFDs where the gain would have been assessable under section 15-15 of the ITAA 1997 is an allowable deduction pursuant to section 25-40 of the ITAA 1997.

Non-commercial losses legislation

From 1 July 2000, legislation came into effect regarding losses from 'business' activities. Division 35 of the ITAA 1997 contains the measures, known as the non-commercial losses (NCL) legislation.

This Division prevents losses of individuals from NCL being offset against other assessable income in the year the loss is incurred when the individual is not able to pass a test, an exception applies or the individual has been granted the Commissioner's discretion.

If the individual does not pass the test, the tax loss from the business activity is deferred to a later year when the individual is able to pass a test, an exception applies or you have been granted the Commissioner's discretion.

For the 2009-10 income years and future income years, you must first meet the income requirements before you can apply the NCL tests. You meet the income requirement if your income for NCL purposes is less than $250,000.

Income for NCL purposes is the sum of the following:

1. Your taxable income (ignoring any business loss);

2. Your total reportable fringe benefits;

3. Your reportable super contributions; and

4. Your total net investment losses (such as rental properties and financial investments).

As outlined above, when the income requirement has been met, taxpayers must pass one of the four following tests:

· You have assessable income from the business of at least $20,000;

· You have made a profit from the business in least three out of the last five years;

· You use real property worth at least $500,000 (excluding private dwellings) on a continuing basis in the business; or

· You actively use assets worth at least $100,000 (excluding motor vehicles) in the business.

Exceptions to passing the four tests apply for taxpayers carrying on a professional arts business or a business of primary production. Taxpayers in these categories may offset a business loss against their other income if their other income for that year is $40,000 or less.

Applying the criteria to your circumstances

Your sole trader activities were carried out on a scale and in a manner such that they constituted business activities. As a result your income form the activities is assessable under section 6-5 of the ITAA 1997 and the outgoings are generally deductible under Section 8-1.

As it has been determined that you are carrying on a business in CFD trading, the non-commercial loss legislation must be considered in relation to your circumstances.

In your case, your assessable income from your CFD activities is greater than $20,000. Therefore, you are able to meet one of the four NCL tests listed above for eligibility for the NCL. However, as outlined above, you must first meet the income requirements of having received income of less than $250,000 in the 2011-12 income year.

If you meet the income requirements test, Division 35 of the ITAA 1997 will not apply to defer your losses to a future income year and you will be able to include the loss in your 2010 -11 income tax return.

If you do meet the income requirements, the loss you made on your CFD activities will be deferred to a future income year when you meet the income requirements