Edited version of your written advice

Authorisation Number: 1013021934477

Date of advice: 24 May 2016

Ruling

Subject: Deductibility of loss on involuntary sale of shares

Question 1

Is the loss incurred by you from the sale of your shares deductible under section 8-1 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

No

This ruling applies for the following period:

1 July 2014 to 30 June 2015

The scheme commences on:

1 July 2014

Relevant facts and circumstances

You are a company director and have previously and currently directly and indirectly owned interests in a number of various businesses and investments.

You carried out a number of share transactions to purchase shares in a company using substantial funds. Prior to making the share purchases, you sought advice from experts in the industry and had specialised knowledge in the industry the company operated in. You also carried out detailed research into the company before making the share purchases.

After this time the share price started to fall and eventually you had to sell your shares for nil consideration which resulted in you making a loss.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 8-1

Income Tax Assessment Act 1997 section 995-1

Reasons for decision

Question 1

Summary

The loss incurred by you from the sale of your shares is not deductible under section 8-1 of the ITAA 1997.

Detailed reasoning

Subsection 8-1(1) of the ITAA 1997 allows a taxpayer to deduct from their assessable income any loss or outgoing that is incurred in gaining or producing assessable income.

It also allows for a deduction where the loss or outgoing was necessarily incurred in carrying on a business for the purpose of gaining, or producing assessable income.

However under subsection 8-1(2) of the ITAA 1997 a deduction cannot be claimed if the loss or outgoing is a loss or outgoing of capital or of a capital nature.

Carrying on a business

Business is defined in section 995-1 of the ITAA 1997 as 'any profession, trade, employment, vocation or calling, but does not include occupation as an employee'.

In FC of T v. Radnor Pty Ltd (1991) 22 ATR 344; 91 ATC 4689 (Radnor case), 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'.

There has been much judicial comment as to what is meant by the phrase 'carrying on a business', however the difficulties associated with the question are probably best summed up by the following comments in Martin v. FC of T (1953) 90 CLR 470 at 474; AITR 548 at 551:

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, as counsel for the taxpayer put it, the determination is eventually based on the large or general impression gained.

Whilst the existence of a business or otherwise is a question of fact, a number of factors have emerged from case law which are considered relevant in considering this question. These factors were brought together and relied upon in reaching the decision in Case X86 90 ATC 621; (1990) 21 ATR 3747 (Case 86). Block J subsequently applied them in Shields v. Deputy Federal Commissioner of Taxation [1999] AATA 4; (1999) 41 ATR 1042; 99 ATC 2037.

The question is essentially one of fact. In deciding this issue the case law has established the following factors as generally relevant considerations:

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/loss is regarded as arising from a discernible pattern of trading;

f) the volume of the taxpayer's operations and the amount of capital employed by them;

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.

Taxation Ruling TR 97/11 'Income tax: Am I carrying on a business of primary production?' (TR 97/11) summarises these indicators. Although TR 97/11 specifically refers to primary production, the same principles apply to all businesses. Paragraphs 15 and 16 of TR 97/11 state that no one indicator is decisive but they must be considered in combination and as a whole.

Specifically, paragraph 18 of TR 97/11 provides a summary of the main indicators of carrying on a business:

• a significant commercial activity;

• purpose and intention of the taxpayer in engaging in the activity;

• an intention to make a profit from the activity;

• the activity is or will be profitable;

• activity is carried on in a similar manner to that of the ordinary trade;

• activity organised and carried on in a businesslike manner and systematically - records are kept;

• size and scale of the activity;

• not a hobby, recreation or sporting activity;

• a business plan exists; and

• the taxpayer has knowledge or skill.

Main Indicators of Business

Significant Commercial Activity

The phrase significant commercial purpose is referred to by Justice Walsh in Thomas v. FC of T 72 ATC 4094 (the Thomas case). Whether there is a significant commercial activity is closely linked to the other indicators and is a generalisation drawn from the interaction of the other characters.

In the Thomas case Justice Walsh noted that any knowledge, previous experience or skill of the taxpayer in the activity, and any advice taken by the taxpayer in the conduct of the business should also be considered but is not necessarily determinative.

In the income year ended 30 June 2015, it is not considered that there was sufficient commercial activity to amount to the carrying on of a business. Although there was an intention of profit and the amount invested in the activities was substantial, the scale of the activities and the number of transactions undertaken by you did not represent a pattern of repetition and regularity to demonstrate the existence of a business.

Intention of the Taxpayer

The intention of the taxpayer in engaging in the activity is a relevant indicator (the Thomas case). However, a mere intention to carry on a business is not enough, there must be activity, Inglis v. FC of T 80 (1979) 10 ATR 493.

Relevantly paragraph 40 of TR 97/11 states:

This indicator is particularly related to:

• whether the activity is preparatory or preliminary to the ultimate activity;

• whether there is an intention to profit ...

In this case, it is not considered that there was sufficient commercial activity to amount to the carrying on of a business. Although there was an intention of profit, the scale of the activities and the number of transactions undertaken by you in the income year was relatively small compared to the level of activity that would normally be associated with carrying on a business of share trading.

Prospect of Profit

In the matter of Hope v The Council of the City of Bathurst (1980) 144 CLR 1, Justice Mason noted that usually the carrying on of a business is such that the activities are 'engaged in for the purpose of profit on a continuous and repetitive basis'.

On the facts provided, there was an intention to make a profit. You have argued that your business intent was to identify stocks that would increase in the short term and then sell them for a gain. However, the Commissioner does not consider that you conducted shares transactions on a continuous and repetitive basis. Therefore, it is considered that the profit motive related to investment activity rather than carrying on a business as a share trader.

Repetition and Regularity

Repetition is a significant characteristic of business activities. Repetition refers to the frequency of transactions, or the number of similar transactions. In the Radnor case, it was considered that the taxpayer was not carrying on a business of dealing shares, primarily because there was no pattern of buying and selling. The court held that the shares in question were not purchased for the purpose of resale and would not be viewed as trading stock of a trader in the ordinary meaning of that term. The low volume and low frequency of transactions was emphasised in finding that a business was not being carried on.

Similarly, in the case of Case X86, the AAT held that there was no pattern of buying or selling, and the taxpayer was not considered to be carrying on a business of share trading. The taxpayer had bought and sold a number of parcels of shares in 6 companies.

In this case, the number of trades entered into during the period in question is considered to be small. As there was little repetition and regularity in the transactions, the trading activity undertaken is indicative of an investor rather than a share trader. The Commissioner does not consider you to have conducted sufficiently regular activities to amount to the carrying on of a business.

Other similar activity

An activity is more likely to be a business when it is carried on in a manner similar to that in which other participants in the same industry carry on their activities (The Commissioners of Inland Revenue v. Livingston and Others (1927) 11 TC 538).

Generally, most businesses have some form of forward planning to take account of contingencies and market fluctuations, as well as setting profit targets, budgets, periodic financial reviews, record keeping systems, an appropriate office, etc. It would be reasonable to expect a share trading business to involve study of daily and longer-term trends, analysis of a company's prospectus, annual reports and the seeking of advice from experts.

In Case X86 this meant having or operating on a particular plan with the main goal of maximising profits.

Whether records of purchases and sales are kept would, in itself, lend little support to the question of whether a taxpayer is carrying on a business of share trading. For example, a taxpayer would require the same records for CGT purposes if the shares were held as an investment. However, records of research conducted such as expert advice, articles examined, etc. would be considered to be a useful indicator as to whether a business is been carried on.

In this case, while you did engage expert advice and conduct research prior to and during the period of share purchases, based on the analysis of the other factors referred to above, it is considered that this activity was similar to the actions that an investor would normally carry out prior to commencing an investment.

Size and Scale

An indicator of whether a taxpayer is carrying on a business is if there is significant commercial activity. In matters of share trading, the number of transactions and the amount of capital invested is examined under this criterion. The higher the volume of purchases and sales of shares and the larger amount of capital employed in an activity is likely to indicate that a business is carried on.

In Case X86 the taxpayer invested $100,000 and was found not to be carrying on a business. In contrast, in Case W8 89 ATC 171 the taxpayer invested $1,300 and was held to be carrying on a business.

In this case, although the amount invested in the activities was substantial, the number of trades undertaken by you in the income year ended 30 June 2015 is not regarded as a significant level for a trader and does not indicate sufficient repetition and regularity in the activities. Therefore, the Commissioner does not consider there to be significant commercial activity undertaken.

Business Plan

A business plan is an indicator of business. It is not a necessarily a prerequisite to the running of a business but the existence of a business plan indicates that it is likely that a business is in existence.

Based on the information provided, you did not have a documented business plan.

Taxpayer has Knowledge or Skill

On the facts provided, you did engage expert advice and conduct research prior to and during the period of the share purchases. Based on the information provided, it is considered that you did have knowledge and skill in undertaking the transactions.

Another Occupation

In Case X86, it was noted that an indicator that a taxpayer is engaged in share trading is whether the taxpayer is engaged in another full time occupation.

In this matter, you derived income from other sources for the income year ended 30 June 2015. Specifically, you were engaged as a director.

Summary - Carrying on a business

Based on the above facts, it is considered that you were not carrying on a business as a share trader in the 2014-15 income year. While you did carry out a significant level of research, and the amount invested in the activities was substantial, your share activities in the relevant income year were not sufficiently repetitious and regular to constitute the carrying on of a business. Based on the information provided, and taking into account all the relevant factors it is considered that your activities represented those of a share investor.

Isolated transaction

Alternatively, it is your view that the loss you made from the sale of your shares is deductible under subsection 8-1(1) of the ITAA 1997 as an isolated transaction.

In looking at Taxation Ruling 92/4 (TR 92/4) and isolated transactions, to be able to claim a deduction there has to be:

• an intention or purpose of making a profit from the transaction; and

• the transaction was entered into, and the profit (if any) was made, in the course of carrying on a business or in carrying out a business operation or commercial transaction.

In this case there was an intention to make a profit. You purchased the shares in the belief that the share price would rise and you could then sell them and make a profit from the sale.

What needs to be decided is whether the transaction, being the buying and then selling of the shares, is in the course of carrying on a business or in carrying out a business operation or commercial transaction.

As stated in paragraph 3 of TR 92/4, TR 92/4 should be read in conjunction with Taxation Ruling TR 92/3 Income tax: whether profits on isolated transactions are income (TR 92/3). In effect if the profits are assessable as ordinary income then a deduction will be allowed.

TR 92/3 was issued to set out the Commissioners view on that application of the decision of the Full Court of the High Court of Australia in FC of T v. The Myer Emporium Ltd (1987) 163 CLR 199; 87 ATC 4363; 18 ATR 693. In respect of carrying out a business operation or commercial transaction paragraph 13 of TR 92/3 provides a list of factors that that should be considered. These being:

• the nature of the entity undertaking the operation or transaction;

• the nature and scale of other activities undertaken by the taxpayer;

• the amount of money involved in the operation or transaction and the magnitude of the profit sought or obtained;

• the nature, scale and complexity of the operation or transaction;

• the manner in which the operation or transaction was entered into or carried out;

• the nature of any connection between the relevant taxpayer and any other party to the operation or transaction;

• if the transaction involves the acquisition and disposal of property, the nature of that property; and

• the timing of the transaction or the various steps in the transaction

In this case the plan was to purchase the shares and sell them for a profit. This did not eventuate and you were required sell the shares for nil consideration.

In respect of a profit-making purpose the facts of this case are similar to those outlined in example 1 in TR 92/3. This example states:

Ms Donovan, a public servant, purchased 10,000 shares in a listed public company at a price of $1 each and sold them 18 months later for $2 each. During that period, the company paid one small dividend. Donovan was not carrying on a business of trading in shares. A significant purpose of Donovan in acquiring the shares was to make a profit from an increase in the value of the shares.

The profit made on the sale of the shares is not income. The transaction was merely an investment, not a business operation or commercial transaction.

A similar example is also provided in example 2 of TR 92/4 which states:

In 1987 Mr Lyon bought 20,000 shares at $1 each in a large public company from an arm's length seller. Mr Lyon was not carrying on a business of trading in shares. He principally bought the shares to derive dividend income although a significant purpose was to benefit from an increase in the value of the shares. In 1992 Mr Lyon sold the 20,000 shares at $0.80 each.

Mr Lyon's loss is a capital loss and not deductible under subsection 51(1). If the sale of shares had returned a profit, that profit would not have been income because the transaction was merely an investment, not a business operation or commercial transaction.

In addition paragraph 11 of TR 92/4 states:

If an isolated transaction was expected to produce a capital profit, a loss incurred in that transaction is not deductible under subsection 51(1). Such a loss is expressly excluded from deduction as being a loss of capital or of a capital nature, regardless of whether the transaction also produced, or was expected to produce, income.

Although you carried out the share purchases to make a profit, the profit could only come from selling the shares at an increased value and the entire scheme was contingent on disposing of the shares for more than you acquired them for.

Although the plan involved you investing a considerable amount of money the plan itself was a simple one. The activities to be undertaken by you involved buying the shares and then selling them on a later date.

Setting aside the volume of shares involved, the mechanics of the scheme was no different to one in which someone purchases a parcel of shares with the intent of making a profit from their sale at a later date. There is a profit making purpose but once the shares are purchased the ability to make a profit is reliant on factors and actions outside of the owner's control.

In this case the whole transaction relied on you obtaining a capital gain from the transaction. There was no other way you could have made a profit from this scheme and the nature of the property purchased meant that you could not do anything to the property yourself to increase its value.

Therefore as you could not do anything to the actual property itself to increase its value it has to be seen as an investment rather than a business operation or commercial enterprise in accordance with examples 1 of TR 92/3 and 2 of TR 92/4.

Summary

The loss incurred by you is a capital loss and not deductible under section 8-1 of the ITAA 1997. This loss can only be applied against a capital gain. However it can be carried forward indefinitely and applied against a capital gain made in future years.