Edited version of your written advice

Authorisation Number: 1012796277053

Date of advice: 22 June 2015

Ruling

Subject: Business of share trading

Question and answer

Are the securities you hold at the end of the 20ZZ income year trading stock for the purposes of Division 70 of the Income Tax Assessment Act 1997 (ITAA 1997)?

No.

This ruling applies for the following periods:

Year ended 30 June 20ZZ

The scheme commences on:

1 July 20YY

Relevant facts and circumstances

Your background is in the area of mortgage broking and investment finance.

You are the sole employee/director of a business.

You have Bachelor's degrees and have qualified to be a member of an association in Australia.

In 20WW, you met with a financial advisor who raised the idea of the possibility of beginning share trading activity alongside your business.

You commenced share trading at the start of the 20WW financial year.

You acquired shares for the purposes of short term holding and subsequent sale with a view to making a profit by virtue of movements in the values of the shares over this time.

You did not buy shares for the purpose of deriving an ongoing income stream or for long term capital gains.

You specifically selected securities you expected would experience significant short-term increases in value. The target when entering a transaction was to realise a profit equal to a percentage of the purchase price. You would generally sell the securities if the price dropped by % below your acquisition price. It was accepted that some losses were inevitable in carrying on a business of share trading.

You funded you share trading activities from a margin lending facility.

You devoted approximately two hours per weekday to your share trading activities. This was principally made up of conducting research into the Australian equities market with a view to identifying appropriate shares to acquire for short term trading, and also monitoring market conditions and equities prices relevant for identifying appropriate times to dispose of shares held.

You mostly used your home office to complete share transactions, which is used for your business and your share trading activities.

You completed A buy and sell transactions during the 20WW financial year.

You completed B buy and sell transactions during the 20XX financial year.

You completed C sell transactions during the 20YY financial year; your last transaction (sell) was made in the 20YY financial year.

You did not make any share transactions during the 20ZZ financial year.

You have explained that the reduction in share trading activity was the result of two major life events.

Due to a reduction in the availability of your time you reduced and subsequently ceased your share trading activity with the intention of recommencing at a later date.

You have stated that you intend to recommence share trading in the second quarter of the 2016 financial year.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 8-1

Income Tax Assessment Act 1997 Section 25-40

Income Tax Assessment Act 1997 Section 70-10

Income Tax Assessment Act 1997 Section 102-5

Income Tax Assessment Act 1997 Section 995-1

Income Tax Assessment Act 1997 Part 3-1

Reasons for decision

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

Where shares losses are from investment activity or of a speculative or one-off nature, they are generally accounted for under the capital gains tax (CGT) provisions in Part 3-1 of the ITAA 1997.

Section 25-40 of the ITAA 1997 prevents most speculative or one-off share trading losses from being deducted on revenue account.

Section 995-1 of the ITAA 1997 defines a 'business' to include any profession, trade, employment, vocation or calling but does not include occupation as an employee.

This definition, however, simply states what activities may be included in a business. It does not provide any guidance for determining whether the nature, extent and manner of undertaking those activities amount to the carrying on of a business.

For the purpose of determining whether an activity is the carrying on of a business, it is necessary to turn to the definitions and determinations established in court cases.

In the High Court of Australia case of Hope v. Bathurst City Council (1980) 144 CLR 1; (1980) 29 ALR 577; (1980) 80 ATC 4386; [1980] HCA 16 (Hope), carrying on a business was described in the following ways:

It is the words "carrying on'' which imply the repetition of acts and activities which possess something of a permanent character.

…activities engaged in for the purpose of profit on a continuous and repetitive basis.

Transactions were entered into on a continuous and repetitive basis for the purpose of making a profit…manifested the essential characteristics required of a business.

Regarding this important business indicator of repetition and regularity of activities, Taxation Ruling TR 1997/11 Income tax: am I carrying on a business of primary production considers the meaning of business of primary production in the ITAA 1997. Paragraph 56 states:

The taxpayer should undertake at least the minimum activities necessary to maintain a commercial quantity and quality of product for sale. Where there are minimum levels necessary for this activity which the taxpayer fails to maintain, it may be that for a period the taxpayer has ceased to carry on a business…

In respect of share market trading, AAT Case 6297 (1990) 21 ATR 3747; Case X86 90 ATC 621 (AAT Case 6297), listed the following indicators of carrying on a business:

(a) the nature of the activities and whether they have the purpose of profit-making

(b) the complexity and magnitude of the undertaking

(c) an intention to engage in trade regularly, routinely or systematically

(d) operating in a business-like manner and the degree of sophistication involved

(e) whether any profit or loss is regarded as arising from a discernible pattern of trading

(f) the volume of the taxpayer's operation and the amount of capital employed by him

and more particularly in respect of share traders

(a) repetition and regularity in the buying and selling of shares

(b) turnover

(c) whether the taxpayer is operating to a plan, setting budgets and targets, keeping records

(d) maintenance of an office

(e) accounting for the share transactions on a gross receipts basis

(f) whether the taxpayer is engaged in another full time occupation.

Of these indicators, TR 1997/11, states when considering whether a person is carrying on a business, all of the indicators must be weighed up. However, in doing so, equal weighting may not be given to each indicator. Whether a business is carried on depends on the general impression gained and whether it has a commercial flavour or character.

In most legal cases, the greatest weighting is given to the repetition and regularity of the activities followed by organisation in a business like manner as a supportive indicator.

For example, in AAT Case 4847 (1988) 20 ATR 3182; (1988) 89 ATC 171, a taxpayer purchased twenty parcels of shares between April 1986 and February 1987. All the shares were sold between September 1986 and April 1987. No share was held for more than five months. The Tribunal ruled there was the carrying on of a business because the shares were bought and sold repeatedly with a view to making a profit and because all shares were sold within a year of acquisition.

In Shields v. Deputy Commissioner of Taxation (Cth); Case [1999] AATA 4 (1999) 41 ATR 1042; (1999) 99 ATC 2037, during the period from 6 February 1996 to 4 March 1996, the taxpayer bought shares in Australian banks which were about to pay franked dividends for cum dividend prices and sold shares in the same banks at their ex dividend prices. Applying the factors listed in Case X86, even though the activity was for a short time only, the Tribunal decided the taxpayer was carrying on a business because of the volume of transactions and because the transactions were so carefully and systematically organised and handled.

In Damien Patch and Li-anne Grew v. Commissioner of Taxation [2005] AATA 240 (Patch & Grew), the taxpayers undertook twenty-seven buy and thirty-seven sell transactions over a period of three months. Although there was a remarkable lack of sophistication and planning about the trading, the Tribunal concluded, on balance, the taxpayers were carrying on a business. Here, the Tribunal had regard to the amount of capital involved, the repetition and regularity of the activity and the profit making purpose, coupled with the fact the taxpayers had no other real occupation.

In AAT Case 6297, one factor contributing to the decision the taxpayer was not carrying on a business was the small number of share transactions. During the relevant income year, only two lots of shares in two different companies were sold (which were part of six lots of shares bought in six companies in the previous income year, of which four lots were disposed of in that previous income year). Here, the term 'share trader' was used to describe a person who dealt in shares such that his transactions had the character of a continuing business enterprise, whereas a 'speculator' in the stock market was a person whose speculations were in the nature of individual forays in particular stocks with a view to resale. The sale of shares by the 'speculator' were deemed to be on capital account.

In the Federal Court case of Federal Commissioner of Taxation v. Radnor Pty Ltd (1991) 102 ALR 187; (1991) 22 ATR 344; (1991) 91 ATC 4689, it was decided the taxpayer did not carry on a business because there was no pattern of buying and selling of shares.

Again, in AAT Case 9183, 27 ATR 1168; Case 1/94, 94 ATC 101, whilst accepting the taxpayer's evidence that shares in one company were purchased for resale and the dominant motive was profit making by sale, the primary factor contributing to the decision the taxpayer was not carrying on a business was there was no evidence of any regular, routine or systematic trading in shares. The purchase of any of the shares appeared to have been made on a very spasmodic basis.

Regarding the matter of carrying on a business in one income year but not another, No. 2 Board of Review Case M16, 80 ATC 98, in deciding certain shares were not trading stock, said because the Commissioner treats a taxpayer as a share trader in past income years did not necessarily bear the consequence a taxpayer is to be treated as a share trader during a later income year. Here, the taxpayer claimed a deduction in his 1978 return for "losses from share trading'' incurred on the sale of shares all purchased in 1968. Although being treated as a share trader in previous years, the shares in question were not trading stock but investment assets.

Also, the existence of a period of dormancy, where trading activity ceases, often raises an issue as to whether a business is truly still in existence, though greatly reduced in scale or has actually ceased altogether.

In the High Court of Australia case of Avondale Motors (Parts) Pty. Ltd. v. Federal Commissioner of Taxation (1971) 124 CLR 97; (1971) 45 ALJR 280; (1971) 2 ATR 312; (1971) 71 ATC 4101; [1971] HCA 17 (Avondale Motors), Gibbs J held the taxpayer company did not satisfy the same business test on the basis that the business activities of the company, which comprised dealing in motor vehicle spare parts and accessories, had ceased completely. Gibbs J said:

There are cases in which it has been held that a company does not cease to carry on business notwithstanding that its activities are reduced to a minimum or indeed are almost entirely suspended. In South Behar Railway Company Limited v. IRC Lord Sumner said: "Business is not confined to being busy; in many businesses long intervals of inactivity occur." In some cases the very nature of the business is such that its conduct may require little activity, e.g. the business ... of acquiring a concession and turning it to financial benefit.

In other cases it has been held that a company continues to carry on business notwithstanding a suspension of activity due to causes beyond its control, e.g. where a steamship company had lost its only ship and was in the course of building another ... In the present case the taxpayer's activity had ceased completely. The cessation of activity was not due to the nature of the business which the taxpayer carried on, or to some temporary adversity which the taxpayer intended to endeavour to overcome; it was due to a decision to discontinue the business previously carried on because it had been unprofitable and there was no intention to resume the conduct of that business. The plain fact of the matter is that the taxpayer was not carrying on any business immediately before 15 March 1968. It follows that [the same business test is] not satisfied.'

Further, in Taxation Ruling TR 1999/9 Income tax: the operation of sections 165-13 and 165-210, paragraph 165-35(b), and section 165-126 and section 165-132 the Commissioner explains that factors relevant to whether a company has ceased business or is merely inactive will include:

n the circumstances accounting for the inactivity,

n whether the company is actively holding itself out for business though obtaining none, and

n whether there is the expectation of a resumption of active operations within a reasonable time.

In your case, we consider that you were not carrying on a business in share trading in the 20ZZ financial year because you did not make any share trades. The scale and volume of transactions that was found to be indicative of a business of share trading in Hartley v FC of T [2013] AATA 601 was not present in your case in the 201X financial year.

It is further considered that any business you were carrying on in share trading had ceased in the 20ZZ financial year because:

n the circumstances accounting for the inactivity in share trading were two major life events that reduced the availability of your time,

n your business of share trading was not actively holding itself out for business though obtaining none as share trading is highly liquid, and there was nothing to prevent you from making buy and sell transactions during the 20ZZ financial year, and

n the period of inactivity will span close to 4 years when you recommence share trading, in conjunction with the circumstances accounting for the inactivity this is not considered resumption within a reasonable time.

Our view is supported by the case of Avondale Motors because the reduction in your trading activity was not due to factors beyond your control. Rather, you made a personal choice to cease trading due to a reduction in the availability of your time.

As affirmed in Case M16, 80 ATC 98, the fact that you may have been a share trader in past years does not necessarily bear the consequence of being treated as a share trader in other years.

The absence of trading activity in A.G.C. (Advances) Ltd. V Federal Commissioner of Taxation [1975] 75 ATC 4057 and Queensland Meat Export Co Ltd v DCT [1939] QSR 240 was the result of some temporary adversity which the appellants intended to overcome. The circumstances in these cases are materially different from your own.

Therefore, the securities you held at the end of the 20ZZ financial year are not trading stock for the purposes of Division 70 of the ITAA 1997.

Additional information

If you cease carrying on a business of share trading and still hold the shares that were trading stock section 70-110 of the ITAA 1997 will apply. Under this section you are treated as if just before the item stopped being trading stock, you had sold it to someone else (at arm's length and in the ordinary course of business) for its cost and you immediately bought it back for the same amount.