Edited version of your private ruling

Authorisation Number: 1012450094901

Ruling

Subject: Self managed superannuation fund (SMSF) - Am I in business

Question 1: For the year ended 30 June 2012, were you carrying on a business of share trading contracts for difference (CFD's)?

Answer 1:

Yes.

Question 2: For the year ended 30 June 2012, will the losses from your business of CFD trading be deductible on revenue account?

Answer 2:

Yes.

This ruling applies for the following period

Year ended 30 June 2012.

The scheme commences on

Early 2011.

Relevant facts and circumstances

In late 2009 the self managed superannuation fund (SMSF) commenced.

In early 2011, you became aware of the Australian Taxation Office (ATO) views contained in:

· ATO Interpretative Decision ATO ID 2007/56 Superannuation Self Managed Superannuation Funds: contracts for differences (CFDs) - no fund assets deposited with CFD provider (ATO ID 2007/56); and

· ATO Interpretative Decision ATO ID 2007/57 Superannuation Self Managed Superannuation funds: contracts for differences (CFDs) - fund assets deposited with CFD provider - charge over fund assets (ATO ID 2007/57)

You invested in CFD contracts during most of the 2012 financial year through a single CFD provider.

You traded regularly.

You made gains from profitable trades of over one hundred thousand dollars.

You made losses from losing trades of more than two hundred thousand dollars.

CFD funding interest paid was a certain amount.

CFD funding interest received was a certain amount.

Commissions paid were a certain amount.

Dividends paid were a certain amount.

Dividends received were a certain amount.

Exchange fees paid were a certain amount.

Foreign exchange interest paid was a certain amount.

The business plan and investment strategy for the SMSF has been merged into one document.

In regard to your CFD trading you have a sophisticated business plan and you seek to follow it.

Your trading in CFD's is done within the context of the SMSF asset allocation strategy. Currently, the trustees' asset allocation strategy is to allocate one third of the SMSF's assets to each of the three following asset classes:

· ASX listed shares, mostly high dividend yielders;

· CFD's, mostly Australian and International equity indices and commodities; and

· Cash deposits.

Your trading in CFD's is a leveraged activity. Only a small percentage of the total CFD investment is held as margin in the CFD account. The SMSF does not leverage its investments, so the total value of open positions does not exceed one third of the SMSF's total assets. The amount invested in CFD trading over and above the amount in the margin account is kept as a cash deposit in a bank savings account.

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

· Excel spreadsheet titled 'P&L Statement for 2012FY.xls';

· Excel spreadsheet titled 'Transaction History for 2012FY.xls';

· Excel spreadsheet titled 'Questionnaire 2c.xls';

· Document titled 'Investment Strategy.doc'; and

· Share trading questionnaire signed and dated by the trustee for the SMSF.

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 and Question 2

Summary

For the year ended 30 June 2012, you were carrying on a business of share trading contracts for difference (CFD's). The losses from your business of CFD trading will be deductible on revenue account.

Detailed reasoning

Contracts for difference

CFD's are a form of cash-settled derivative in that they allow investors to take risks on movements in the price of a subject matter (the 'underlying') without ownership of the underlying. Financial CFD's include those relating to share prices, share price indices, financial product prices, commodity prices, interest rates and currencies.

Unlike share trading, the non-margin amount of a CFD position is merely a deposit. When a transaction is made, the deposit is not included in the calculation of gross receipts.

The Commissioner's view about the tax consequences of CFD trading is found in Taxation Ruling TR 2005/15 Income Tax: tax consequences of financial contracts for differences (TR 2005/15). Where CFD trading is part of the carrying on of a business, the gains from the CFD transactions will be accounted for under section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997) and the losses under section 8-1 of the ITAA 1997.

Otherwise, the CFD trading will be regarded as part of the carrying out of a profit making undertaking and the gains from the CFD transactions will be accounted for under section 15-15 of the ITAA 1997 and the losses under section 25-40 of the ITAA 1997.

Either way, the gains and losses from CFD trading are accounted for on revenue account. 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 provisions.

However, a gain or loss from CFD trading 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 nor be deductible under section 8-1 of the ITAA 1997 or section 25-40 of the ITAA 1997. Further, a capital gain or capital loss from a financial CFD entered into for the purpose of recreation by gambling will be disregarded under paragraph 118-37(1)(c) of the ITAA 1997.

In your case, your CFD trading allowed you to take risks on movements in the price of a subject matter (the 'underlying') without ownership of the underlying.

Regarding the matter of whether you were carrying on a business of CFD trading in the year ended 30 June 2012, 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 a supportive indicator.

In your case, in the year ended 30 June 2012, the factors that gave the overall impression that you were in business are:

· You traded regularly, you opened and closed many CFD positions. Some positions remained open at 30 June 2012; and

· Turnover was high; you made gains from profitable trades of over one hundred thousand and made losses from losing trades of over two hundred thousand.

· You operate in a business like manner and your trading has a degree of sophistication.

Consequently for the year ended 30 June 2012, the losses from your business of CFD trading will be deductible on revenue account.

SELF MANAGED SUPERANNUATION FUNDS (SMSF'S)

This guidance is general in nature and is not binding on the Commissioner

Investment strategy

Given the importance of the investment process, the Superannuation Industry (Supervision) Act 1993 (SISA) legislation imposes a specific duty on all trustees to formulate, document and give effect to an investment strategy that has regard to the whole circumstances of the fund as well as specific considerations. The duty is in the form of a covenant, or binding undertaking, by the trustees, which, if it does not already appear in a fund's governing rules, is implied into the governing rules under paragraph 52(2)(f) of the SISA. By that covenant in paragraph 52(2)(f), trustees undertake to formulate and give effect to an investment strategy that has regard to the whole of the circumstances of the fund including, but not limited to, the following:

(i) the risk involved in making, holding and realising, and the likely return from, the fund's investments having regard to its objectives and its expected cash flow requirements;

(ii) the composition of the fund's investments as a whole including the extent to which the investments are diverse or involve the fund in being exposed to risks from inadequate diversification;

(iii) the liquidity of the fund's investments having regard to its expected cash flow requirements;

(iv) the ability of the fund to discharge its existing and prospective liabilities.

This is a positive duty from which trustees cannot escape, on pain of contravening the SISA and exposing their fund to loss of complying status, and exposing themselves to suit for breach of trust or duty. However, subsection 52(4) of the SISA allows for the possibility that in formulating and carrying out an investment strategy the trustee may be subject to the direction of one or more beneficiaries. Broadly, this can happen where the trustee of a fund gives the beneficiaries a choice between two or more investment strategies in the circumstances set out in regulation 4.02 of the Superannuation Industry Supervision Regulations 1994 (SISR) legislation.

The covenant to formulate an investment strategy set out above leaves the trustee with a good deal of flexibility in the actual formulation. Investment strategies have always been greatly different as among the various kinds and sizes of funds, and the SISA allows for this. But in doing so, the SISA also imposes a prudent man test, that is, an overriding duty to exercise the same degree of care, skill and diligence as an ordinary prudent person would exercise in dealing with the property of another for whom the person felt morally bound to provide as stated in paragraph 52(2)(b).

Minimum requirements for investment strategy

The law provides little guidance on the exact requirements for an investment strategy. The regulators cannot instruct a fund as to what investments it makes, only that they comply with the requirements of the law and the investment strategy. However, when reviewing a fund's investment strategy, the regulator will expect to see, at a minimum, that it:

· is in writing

· complies with the legal requirements and trust deed provisions

· has been implemented accordingly and documented in meeting minutes

· is reviewed regularly; and

· any changes are documented in meeting minutes

The sole purpose test and investments

The sole purpose test is a principle-based regulatory measure which focuses on the overriding purpose for which an investment is made and maintained. That is, it does not attempt to categorically prescribe every type of investment or activity that could involve a breach of the test.

Whether an investment or activity involves a breach of the sole purpose test must ultimately be determined in the light of the overall circumstances of the particular superannuation fund. At the most basic level, trustees should always asked themselves whether the overriding purpose of an investment or activity is consistent with the government's policy objectives, i.e. the provision of member benefits in retirement. In situations where the answer is not clear-cut, trustees need to turn their mind to whether the circumstances and documentation will be acceptable when viewed by their approved auditor and/or the regulator against this fundamental principle.

The Australian Taxation Office (ATO) considers that a strict standard of compliance is required under the sole purpose test. According to the ATO, the test requires exclusivity of purpose, which is a higher standard than the maintenance of the self managed superannuation fund (SMSF) for a dominant or principal purpose as stated in Self Managed Superannuation Funds Ruling SMSFR 2008/2 Self Managed Superannuation Funds: the application of the sole purpose test in section 62 of the Superannuation Industry (Supervision) Act 1993 to the provision of benefits other than retirement, employment termination or death benefits

However, the Commissioner accepts that the provision of incidental, remote or insignificant benefits that fall outside the scope of those specified in section 62 of the SISA may occur in certain circumstances, particularly as an inherent or unavoidable consequence of otherwise legitimate activities of the SMSF. Nevertheless, the provision of benefits other than those specified in section 62 of SISA that are incidental, remote or insignificant does not of itself displace an assessment that the trustee has not contravened the sole purpose test. Rather, the Ruling says that determining whether benefits are incidental, remote or insignificant requires the circumstances surrounding the SMSF's maintenance to be viewed holistically and objectively.

For example, the Commissioner says a SMSF may provide benefits that fall outside the scope of those that are specified in section 62 of the SISA as an incident of activities carried on by it that meet the requirements of the sole purpose test. In contrast, the provision of benefits (other than those specified in section 62 of the SISA), that is not an inherent or unavoidable consequence of otherwise legitimate activities of the SMSF may result in a contravention of the sole purpose test, particularly if the benefits are relatively significant in nature.

The ATO notes that the sole purpose test is particularly concerned with how a SMSF came to make an investment or undertake an activity. The Commissioner also advises trustees to ensure they do not provide a purposeful benefit to the members when undertaking SMSF activities, even if there is no net cost to the SMSF in providing the benefit. Although the impact of an arrangement on the SMSF's resources is a relevant consideration, it is ultimately the objective purpose of providing the benefit rather than the net financial impact of the arrangement on the SMSF's resources that determines whether the sole purpose test is contravened as per SMSFR 2008/2.

Carrying on a business

According to the ATO, a possible indication that the sole purpose test has been contravened is where a fund is running a business as part of its investment strategy. The ATO generally considers that if a superannuation fund is carrying on a business, it is not administered for the sole purpose of providing retirement benefits for the members and beneficiaries of the fund. However, the fact that activities undertaken by a SMSF trustee are considered business activities for income tax purposes does not necessarily mean that the trustee contravenes the SISR legislation.

As a preliminary issue, a SMSF may not be permitted by trust law to carry on a business if its trust deed does not expressly empower it to do so. This is because a superannuation fund is a trust and is bound by the ordinary principles of trust law. It is a well established principle of trust law that a trustee cannot carry on a business unless expressly authorised to do so by the trust instrument or by statute as per Kirkman v. Booth (1848) 50 ER 821 at 824; Hagan v. Waterhouse (1991) 34 NSWLR 308 at 339.

Whether a SMSF is carrying on a business (in breach of the sole purpose test) is a question of fact and degree to be determined by the specific circumstances. When determining compliance with the SISR provisions, the ATO examines the activities of the trustee rather than whether a business is being carried on by the SMSF. Cases that may attract the attention of the Tax Office include those where:

· the trustee employs a family member. The Tax Office will look at the stated rationale for employing the family member and the level of salary or wages paid;

· the trustee carries on a business that relates to an activity that is commonly carried out as a hobby or pastime;

· the business carried on by the fund has links to associated trading entities;

· there are indications that assets of the SMSF are available for the private use and benefit of the trustee or related parties.

The ATO Document, 'Carrying on a business in a self-managed superannuation fund' (dated 25 May 2010) available on the ATO website www.ato.gov.au gives guidance to the trustee of a SMSF.

In Taxation Ruling TR 93/17 Income tax: income tax deductions available to superannuation funds, the Commissioner considered that superannuation funds are generally prohibited from carrying on an active business. However, the Commissioner provides the following guidance on the operation of the sole purpose test in respect of the activities of a superannuation fund:

As noted above a superannuation fund has as its sole purpose the provision of benefits to members on retirement or attainment of a certain age, or the provision of benefits to dependants on the death of a member. Therefore superannuation funds are generally prohibited from undertaking speculative activities or carrying on an active business such as operating a retail shop, motel or primary production business. However, the activities of a superannuation fund in holding shares and other investments and from time to time realising them may, in some cases, amount to the carrying on of a business: FCT v. Radnor Pty Ltd (1991) 22 ATR 344.

There is no single factor that can be isolated as determinative of the question whether a superannuation fund is carrying on an investment business or a business of buying and selling shares. A significant (though not conclusive) factor is that its activities are undertaken by a trustee with an obligation of prudence as stated in the Radnor case. This obligation puts trustees in a different position to trading companies as per London Australia Investment Co Ltd v. FCT (1977) 7 ATR 757 at 763. In many cases, therefore, the activities of a superannuation fund in dealing with shares and investments will not amount to carrying on a business but will simply be the performance of a fiduciary duty to preserve the assets of the fund for the benefit of members, as in Charles v. FCT (1954) 90 CLR 598 at 612; 6 AITR 85 at 92.

However, other factors may indicate that the fund is in fact carrying on a business; for instance:

· the volume, frequency and scale of activities (bearing in mind the size of the portfolio);

· a systematic course of buying and selling for the purpose of producing profits; and

· the intention of the trustee. Ultimately, the question is one of fact and degree, a question of impression: Radnor case (1991) 22 ATR 344 at 359.

In the Taxpayer and FCT [2011] AATA 545 an individual taxpayer was held to be carrying on a business of a share trading for an income year despite a lack of sales due to the global financial crisis. The Administrative Appeals Tribunal (AAT) accepted that the taxpayer was a share trader on the balance of evidence as he intended to make a profit out of his activities, the activities were occurring on a relatively large scale (at least in value), he behaved as if he was following a systematic strategy (albeit not detailed, scientific or formal) and he made purchase decisions according to a consistent general criteria.

However, a superannuation fund would not necessarily breach the sole purpose test where it was considered to be carrying on a business of share trading pursuant to an investment strategy with the sole purpose of maximising retirement benefits.

Investments in Contracts for Difference (CFDs)

No provision of the SISA or the Superannuation Industry (Supervision) Regulations 1994 (SISR) specifically prohibits trustees of SMSFs from investing in CFDs.

Prohibition on charge over fund assets

A trustee of an SMSF is prohibited from placing a charge over, or in relation to, an asset of a fund as per regulation 13.14 of the SISA. However, limited exceptions apply for charges in relation to certain derivatives contracts that meet the conditions in regulation 13.15A of the SISA and other charges permitted, expressly or by necessary implication, by the SISA legislation.

A charge includes a mortgage, lien or other encumbrance: as stated in regulation 13.11 of the SISA. Self Managed Superannuation Funds Ruling SMSFR 2009/2 Self Managed Superannuation Funds: the meaning of 'borrow money' or 'maintain an existing borrowing of money' for the purposes of section 67 of the Superannuation Industry (Supervision) Act 1993 states that:

Subject to exceptions in relation to certain derivatives contracts, an SMSF trustee cannot recognise or in any way sanction an assignment of a superannuation interest or a charge over or in relation to a member's benefits or an SMSF asset - regulations 13.12, 13.13 and 13.14 of the SISR.

Investments in CFDs do not breach the investment rules, provided the fund does not deposit assets with the CFD provider as security in relation to the fund's obligations to pay margins.

Example contracts for difference

As part of the SMSF's investment strategy, the trustees invest in contracts for difference. The investment requires that the trustees make additional payments if a loss arises from movements in the prices of the asset or indices underlying the investment.

The requirement to pay a deposit and meet margin calls does not represent borrowing. No money has been temporarily transferred to the SMSF trustees under the arrangement. The payments made by the SMSF are pursuant to contractual liabilities that do not involve repayments. Accordingly, the SMSF trustees have not contravened paragraph 67(1)(a) of the SISA.

Therefore no contravention occurs in relation to a CFD investment where the trustee does not deposit fund assets with the CFD provider as per ATO Interpretative Decision ATO ID 2007/56 Superannuation Self Managed Superannuation Funds: contracts for differences (CFDs) - no fund assets deposited with CFD provider.

However a trustee who deposits fund assets with the CFD provider in relation to the fund's obligations to pay margins may breach the prohibition in regulation 13.14 of the SISR as stated in ATO Interpretative Decision ATO ID 2007/57 Superannuation Self Managed Superannuation Funds: contracts for differences (CFDs) - no fund assets deposited with CFD provider.