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Ruling

Subject: Am I a partner in a business of share trading

Question:

For the year ended 30 June 2012, were you a partner in a business of share trading?

Answer:

Yes.

This ruling applies for the following period

Year ended 30 June 2012.

The scheme commenced on

1 July 2011.

Relevant facts and circumstances

You and your spouse have been involved with the share market for a number of years. Until sometime in the first half of 20XX, you and your spouse held your shares on an investment basis and focused on the stability of the big four banks during the global financial crisis and hoped to receive capital gains on these shares.

In the early part of 20XX, you and your spouse reviewed your investment strategy and after extensive research decided to invest in a share trading plan.

Your aim from then was to derive as much income as possible via purchasing shares just prior to the cut off date of being entitled to receive dividends on these purchases.

In summary your trading plan is as follows:

· hold shares for at least 47 days so as to qualify for the 45 day rule and qualify for franking credits;

· having satisfied the requirement to receive the dividend and franking credit you immediately sell the entire holding of those shares, excepting for a small token holding which you are required to keep on hand to satisfy a requirement of your margin loan facility; and

· you then immediately execute your next buy order on a previously selected share (or shares) (you generally reinvest the whole of the proceeds of the previous sale) with the intention of repeating the previous two planning rules.

You have identified that the big four Australian banks offer important advantages for your share trading strategy. You have determined that the share prices of the big four banks generally track in unison. This is the very crux of your share trading strategy as it allows you to always purchase a similar number of shares in each particular bank each time you execute a trade sequence regardless of whether the market is up or down 5% or 10%. You plan to have your available capital fully committed at all times with an amount that you plan to increase over time as you commit more dividends to your share trading activities. Buy and sell decisions are dictated only by the respective ex dividend dates and the holding period requirement of the '45 day rule' so as to receive franking credits. The amount allocated to each trade/s is the entire net proceeds of the prior sell transaction. You check daily that the big four banks are tracking in unison. Your trading system self corrects for market fluctuations because you sell and buy at the same time and the big four bank stocks track in the same direction. You ignore the state of the market as to whether it is up or down because your shares will be tracking in unison. You have no stop loss limits as they would render your system inoperable.

In 20XX, you commenced your share trading strategy of investing your funds in mainly the big four banks with a plan to hold the investment for Y to Z days including their dividend date. Once this period was over you then invested in the next company expected to issue a dividend, again with no view of holding the shares for capital growth.

The purpose of your share trading activity is to provide a profitable income stream for you and your spouse through the receipt of dividend income. You have received a substantial amount of dividend income for the year ended 30 June 2012.

Toward the end of the year ended 30 June 2012, you and your spouse's share portfolio was valued at just over one X dollars.

The initial investment was financed through your own capital, a bank loan and a margin loan.

You and your spouse are concerned about the risk involved with a margin loan and therefore attempt to maintain a loan value ratio of about A%. In order to have approval for your margin loan you and your spouse need to always have investments in a minimum of five different stocks so that your portfolio holdings are considered diversified.

You spend certain hours per week reviewing and monitoring the market, executing share trades and performing historical data testing to ensure that you hold the shares at the right times. You also spend time training your spouse to perform your duties and the various skills required to continue the operation if you became incapacitated.

You and your spouse perform continuous research in the area including extensive testing of your system against recent historical data as well as reading articles and journals published in your area of trading.

For the year ended 30 June 2012, you had a certain number of share buy transactions and a slightly lesser amount of share sell transactions.

All of your share buying and selling transactions are completed through one broker.

For the year ended 30 June 2012, your total income from your share trading activity was in the X of dollars.

For the year ended 30 June 2012, your total share purchases including brokerage was in the X of dollars.

For the year ended 30 June 2012, you had the following expenses in relation to your share trading activities.

· Bank Low Doc Loan - interest charge

· Bank Margin Loan - interest charge

· Brokerage (including GST)

· Internet and home office upkeep

· Software data subscription

You have a designated home office where you carry out your activities, that is furnished with general office equipment. You have also invested in; and have access to various software products that you use in your operation.

You have included various documents which are to be read with and form part of the scheme for the purpose of this private binding 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 35-10,

Income Tax Assessment Act 1997 Section 35-30,

Income Tax Assessment Act 1997 Section 70-30 and

Income Tax Assessment Act 1997 Section 995-1.

Reasons for decision

Question 1

Summary

For the year ended 30 June 2012, you were a partner in a business of share trading.

Detailed reasoning

For tax purposes, a partnership is an association of people who carry on a business as partners or receive income jointly. Taxation Ruling TR 94/8 Income tax; whether business is carried on in partnership (including 'husband and wife' partnerships) (TR 94/8) provides the ATO view on whether a business is carried on in partnership.

The following factors are used in deciding whether persons are carrying on business as partners in a given year of income:

· Intention

· The mutual assent and intention of the parties

· Conduct

· Joint ownership of business assets;

· Registration of business name;

· Joint business account and the power to operate it;

· Extent to which parties are involved in the conduct of the business;

· Extent of capital contributions;

· Entitlements to a share of net profits;

· Business records; and

· Trading in joint names and public recognition of the partnership.

The weight to be given to these factors varies with the individual circumstances. The above list of factors is not exhaustive and no single factor is decisive, although the entitlement to a share of net profits is essential.

In your case, after considering the above factors a partnership exists because:

· You have the intention to act as partners, (evidenced mainly by the share trading account being held in joint names, (yours and your spouse's); and by the facts provided in your application for a private binding ruling;

· you and your spouse are both involved in the operation of the share trading business, (you spend between certain hours per week on this activity and you have been training and skilling up your spouse);

· you and your spouse have taken out a bank loan of a certain amount and a margin loan to invest in share trading;

· you and your spouse both have a 50% entitlement to a share of the net profits or losses;

· you and your spouse both made capital contributions to setting up the original share activity; and

· the share trading account is held in joint names.

Share trading

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.'

And more recently re-iterated in Smith v Federal Court of Taxation 2010 ATC 10-146; 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.  

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 when the following factors were taken into account:

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/loss is regarded as arising from a discernible pattern of trading; the volume of the taxpayer's operations and the amount of capital employed by him;

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

· turn-over;

· whether the taxpayer was operating to a plan, setting budgets and targets, keeping records;

· the maintenance of an office;

· accounting for the share transactions on a gross receipts basis;

· whether the taxpayer was engaged in another full-time profession.

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:

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

· took DRP's and dividends;

· his activities did not demonstrate to the Tribunals satisfaction repetition and regularity in the buying and selling of shares in order to demonstrate that he was in business;

· the applicant did not maintain a separate office;

· the applicant worked fulltime in a very responsible position at Babcock & Brown. He qualifying 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".

· 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 are a partner in a business of share trading for the year ended 30 June 2012 are:

· you had a profit making intention;

· you did not hold shares for long periods of time and traded shares in a regular, routine and systematic manner;

· you operated in a business like manner, that is you followed your business plan and used a degree of sophistication, your trading was not left to chance;

· there was a discernable pattern of trading;

· you injected a significant amount of capital into your trading activity, (you and your spouse contributed a certain amount from your own assets, took out a bank loan and a margin loan so that you had funds available for your share trading activity;

· there was not a high number of trades for the year ended 30 June 2012, however there was a high turnover;

· you maintained a separate home office that was set up for carrying out your share trading activities; and

· you spend certain hours a week on your share trading activities reviewing and monitoring the market, executing share trades and performing historical data testing. You also spend time teaching your spouse to perform the duties.

The overall impression gained is that you were a partner in a business of share trading for the year ended 30 June 2012.

As you are in the business of share trading 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.