Edited version of private advice

Authorisation Number: 1052042769748

Date of advice: 10 October 2022

Ruling

Subject: Income tax - assessable income - trading stock - other

Question 1

Did you begin carrying on a business of share trading in the 2022 income year?

Answer

Yes

Question 2

Do you continue to hold shares as an investor?

Answer

Yes

Question 3

Did CGT event K4 under section 104-220 of the Income Tax Assessment Act 1997 (ITAA 1997) happen to you once the parcel of shares that you previously held as an investor started to be held for share trading purposes?

Answer

Yes, if you elect under paragraph 70-30(1)(a) of the ITAA 1997 to be treated as having sold the parcel of shares for its market value.

Thisrulingappliesforthefollowingperiods: Year ended 30 June 2022

Year ending 30 June 2023

Relevant facts and circumstances

1.     You have held shares on capital account as an investor since 2005.

2.     The shares you held as an investment as at the end of the 2021 and 2022 income years were as follows:

3.     You have rarely sold shares held as an investor.

4.     Those shares were acquired and have been held for the purpose of earning money from dividends and long-term capital growth.

5.     On 1 July 2021 you decided to use 1,200 of X PTY LTD shares held to that point as an investment for the purposes of trading to make short-term profits.

6.     The market value of the 1,200 X PTY LTD shares determined to be used for the purposes of trading was $X as on 1 July 2021.

7.     You have one trading account from which you make transactions in relation to shares (whether they be held for investment purposes or otherwise).

8.     In the income year ended 30 June 2022 you completed 10 buy transactions and 2 sell transactions involving X PTY LTD shares.

9.     Between 1 July 2022 and 30 September 2022, you completed 43 further transactions involving X PTY LTD shares.

10.   You attempted other transactions involving X PTY LTD shares during these periods of time, however many of your orders were unsuccessful.

11.   You retain records of your share trading activity.

12.   You estimate that your net trading position for the year ended 30 June 2022 was a $X profit.

13.   The number of days the X PTY LTD shares that were sold since June 2022 were held ranged from 1 to 40 days.

14.   You hold a bachelor's degree in economics.

15.   You hold a post graduate qualification in accounting.

16.   You have over 20 years' experience in the share market.

17.   You are a member of a program for active traders as a result of your frequent trading.

18.   You receive newsletters as a trader from Stockpedia.

19.   You conduct research relating to the stock market through the relevant program for active traders, Motely Fool and other internet resources.

20.   You resubmitted your historic ABN registration due to the frequency of your trading.

21.   You limit your risk by trading in only one type of share (X PTY LTD), which you have analysed as being at an acceptable risk level due to how large X PTY LTD is. You have considered what a fair target price for X PTY LTD shares is and when there is room to gain from trading.

22.   Your budget per trade is $X on average.

23.   Your version of forward planning is to trade in only X PTY LTD shares.

24.   You spend at least one hour a day on your share trading activities.

25.   You retired from your work teaching economics and accounting approximately 3 years ago.

26.   You undertake seasonal accounting work.

27.   You utilise an office space, a computer, desk, chairs, 2 printers, 2 laptops and an ipad to undertake your share trading activities.

28.   You expect your share trading activity to grow in the future.

Relevant legislative provisions

IncomeTaxAssessmentAct1997section 6-5

IncomeTaxAssessmentAct1997section 8-1

IncomeTaxAssessmentAct1997subsection 70-30(1)

IncomeTaxAssessmentAct1997paragraph 7030(1)(a)

IncomeTaxAssessmentAct1997section 102-5

IncomeTaxAssessmentAct1997section 102-10

IncomeTaxAssessmentAct1997section 104-220

IncomeTaxAssessmentAct1997subsection 118-25(2)

Reasons for decision Question 1

Did you begin carrying on a business of share trading in the 2022 income year?

Summary

Yes, you began carrying on a business as a share trader in June 2022.

Detailed reasoning

In order to be classified as a share trader, your share trading activities must constitute the carrying on of a business. The question of whether a business is being carried on is a question of fact and degree. If your activities do not amount to the carrying on of a business in one income year, that will not prevent them doing so in a later income year. Similarly, when the extent of an activity falls below what is required for that activity to be commercially viable, the activity may no longer constitute the carrying on of a business.

If you are considered a share trader, your shares are treated as trading stock and any profit from the sale of your shares is assessable as ordinary income under section 6-5 of the ITAA 1997 while any loss from the sale of your shares, as well as any costs associated with your share trading activities, are deductible expenses under section 8-1 of the ITAA 1997.

Taxation Ruling TR 97/11 IncomeTax:amI carrying on a business of primary production? provides a guide to the indicators that the courts have held to be relevant as to whether or not a person is carrying on a business. It should be noted that the principles in this ruling apply equally to all businesses.

There is also a comprehensive body of case law in respect to share trading activities. This case law has established the following factors as relevant considerations in such cases:

(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; and

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

Further factors considered include:

(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; and

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

No single factor is necessarily determinative (see Federal Commissioner of Taxation v Radnor Pty Ltd (1991) 102 ALR 187 at 202 per Hill J). However, one of the key factors to consider when analysing whether a business of share trading is being carried on is the repetition and regularity of share trading activities. The higher the volume of trades, the more likely it is that a business of share trading is being carried on. Additionally, it would be expected that a business of share trading would involve the purchase of shares on a regular basis through a regular or routine method.

Applicationtoyourcircumstance

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

The Commissioner accepts that you have a profit-making purpose with regard to the share trading activities you conduct, but this alone is not indicative that you are carrying on a business of share trading. As Senior Member Lazanas said in Devi and Commissioner of Taxation [2016] AATA 67 at [24], a profit making intention is consistent with being a share trader and being a share investor.

As you continue to hold a number of shares as an investor, your method of making profit from the X PTY LTD shares you trade can be differentiated from your method of making profit from the shares held as an investment. Your intention from your share trading activities is to create a short-term profit via active trading (rather than through the receipt of dividends). This is indicative that a business of share trading is being carried on.

(b)           the complexity and magnitude of the undertaking

Your method of buying and selling shares is not overly complex, however it follows a strategy that you have established. You utilise a risk minimisation strategy of only trading in X PTY LTD shares. You provided the reasoning that as the X PTY LTD is one of the largest companies in Australia, it is safer to trade in than other options. Through research you have tracked that volatility and decided you could buy and sell X PTY LTD shares frequently for gain. You have not purchased any shares that are volatile or in the high-risk sectors in an attempt to realise short-term gains.

The number of transactions you undertook and the general magnitude of your trading activities significantly increased in June 2022 and has since continued to increase (for e.g. you conducted 43 transactions between 1 July 2022 and 30 September 2022). In addition to your recorded transactions, you have attempted numerous transactions that were not successful and eventually lapsed. You dedicate approximately one hour per day (sometimes more) to share trading activities.

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

The Commissioner accepts that you have an intention to engage in share trading regularly. You have provided an explanation of your trading strategy, explaining your system for buying and selling only X PTY LTD shares (as described above).

This said, paragraph 39 of TR 97/11 states that 'a mere intention to carry on a business is not enough. There must be activity'. Brennan J in Inglis v. FC of T 80 ATC 4001 at 4004-4005; (1979) 10 ATR 493 at 496-497 said that:

The carrying on of a business is not a matter merely of intention. It is a matter of activity.... At the end of the day, the extent of activity determines whether the business is being carried on. That is a question of fact and degree.

Although you may have had the intention to carry on a business of share trading from 1 July 2021 (when you first decided to use 1,200 X PTY LTD shares previously held as an investment for trading purposes), there was no significant share trading activity until months later (with transactions being conducted regularly from June 2022). It would only be from this point, where both intention and activity exist, that you can be said to have started to carry on a business of share trading. Activities conducted before this time, such as research or the making of a decision to begin to hold shares for a changed purpose, may be considered preparatory in nature.

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

You hold a bachelor's degree in economics, a post graduate qualification in accounting and you have over 20 years' experience in the share market. You have come up with a trading strategy that involves trading only in X PTY LTD shares (as described above). It is indicative of operating in a business-like manner that you have a trading strategy, limits and records of your transactions.

You utilise an office space, a computer, desk, chairs, two printers, two laptops and an ipad to undertake your share trading activities. The use of an office space and equipment is indicative of operating in a business-like manner.

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

You estimate that your net position for the income year ended 30 June 2022 is a $X profit. This profit can be regarded as arising from a discernible pattern of trading in June 2022. Specifically, you made several transactions in X PTY LTD shares in order to create a profit, in line with your business plan, and have continued to do so up to the date of this ruling.

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

You hold a number of shares as investments, on capital account. You have repurposed 1,200 X PTY LTD shares to trade to create a short-term profit. The value of these shares as of 1 July 2021 was $X.

Although the volume of transactions that you carry on in relation to the relevant parcel of X PTY LTD shares may not be as large as others carrying on a similar business of share trading, this does not preclude a finding that a business is being carried on if other facts and circumstances indicate that it is.

Repetitionandregularityin the buying and selling of shares

Repetition and regularity are key factors when considering if a business of share trading is being carried on. You have been conducting successful transactions regularly from June 2022. Although this is a small window to establish regularity and repetition, we must consider that repetition and regularity can often be harder to establish in the beginning stages of a business. In their joint judgement in the Full Federal Court decision of Ferguson at FLR 314; ATC 4264-4265 Bowen CJ and Frankie J explain that:

Certainly, it may be held a person is carrying on a business notwithstanding his profit is small or even where he is making a loss. Repetition and regularity of the activities is also important. However, every business has to begin, and even isolated activities may in the circumstances be held to be the commencement of carrying on a business.

Furthermore, it is your intention to continue to actively trade in X PTY LTD shares for short term profit in the future, and to continue to grow your activities. Your level of activity from June 2022 onwards demonstrates repetition and regularity of the buying and selling of shares, and it is your intention that this will continue. This is indicative that you are carrying on a business as a share trader.

Otherfactors

Other factors that indicate that you are carrying on a business as a share trader include:

•                    you have set a budget for each transaction and follow a business plan;

•                    you have no other full-time occupation; and

•                    you hold relevant qualifications (i.e. in economics and accounting).

Conclusion

In considering the totality of the facts and circumstances, the Commissioner accepts that you began to carry on a business as a share trader from June 2022.

Question 2

Do you continue to hold shares as an investor?

Summary

Yes, you continue to be classified as an investor in relation to those shares you hold as an investment.

Detailed reasoning

Whether you are classified as an investor or a trader (or both) will be determined by the totality of the facts and circumstances around your share trading activities and whether they indicate that you are investing or carrying on a business of share trading.

If you hold your shares for the purpose of earning income from dividends and capital growth, you will be regarded as a share investor. In this scenario, your shares would be treated as CGT assets with any gains realised or losses sustained from the disposal of the shares included in the calculation of your net capital gain or net capital loss for the year (sections 102-5 and 102-10 of the ITAA 1997).

It is possible to operate both a share investment and trading portfolio simultaneously and each will be treated differently.

To operate as a share trader and also as an investor you should ensure the two activities are kept separated and you keep sufficient records to identify how you treat each activity.

Applicationtoyourcircumstances

You hold shares as long-term investments and rarely sell them. You hold them for the purpose of earning income from dividends and receipts. As such, you are considered a share investor in relation to those shares.

From June 2022, the Commissioner considers that you are both carrying on a business of share trading with regard to the parcel of X PTY LTD shares you regularly trade and holding shares as an investor, on capital account.

Any shares bought and held for the purpose of long-term investment must be accounted for under capital gains tax and excluded from your share trading activity in your income tax return for the relevant income year.

Question 3

Did CGT event K4 under section 104-220 of the ITAA 1997 happen to you once shares that you previously held as an investor started to be held for share trading purposes?

Summary

CGT event K4 will happen if you elect under paragraph 70-30(1)(a) of the ITAA 1997 to be treated as having sold the parcel of shares for its market value.

Detailed reasoning

If you start holding as trading stock an item you already own, but do not hold as trading stock, subsection 70-30(1) of the ITAA 1997 treats you as if:

(a)           you had sold the item just before it became trading stock for either its cost or its market value at that time, as elected; and

(b)           you had immediately bought the item back for the same amount.

CGT event K4 under section 104-220 of the ITAA 1997 happens if a taxpayer starts holding as trading stock a CGT asset already owned by the taxpayer but not held as trading stock and the taxpayer elects under paragraph 70-30(1)(a) of the ITAA 1997 to be treated as having sold the asset for its market value.

The time of CGT event K4 is when the taxpayer starts holding the asset as trading stock.

A taxpayer makes a capital gain from CGT event K4 if the market value of the asset just before it becomes trading stock is more than its cost base. If the market value of the asset is less than its reduced cost base, a capital loss is made.

If, in the alternative, the taxpayer elects under paragraph 70-30(1)(a) of the ITAA 1997 to be treated as having sold the asset for its cost, CGT event K4 does not apply and any capital gain or capital loss is disregarded (see subsection 118-25(2) of the ITAA 1997).

The election under paragraph 70-30(1)(a) of the ITAA 1997 must be made by the time you lodge your income tax return for the income year in which you start holding the item as trading stock. However, if you do not make the election by then because you do not realise until later that you started to hold the item as trading stock, you must make the election as soon as is reasonable after realising that.

Applicationtoyourcircumstances:

As discussed in response to Question 1 of this ruling, your activities from June 2022 amount to a carrying on a business of share trading. At this point those shares that you used to hold as an investor and then started to hold for the purpose of trading as part of your share trading business became trading stock. As such, CGT event K4 will be triggered if you make an election under paragraph 70-30(1)(a) of the ITAA 1997 to be treated as having sold the parcel of shares for its market value.

If you elect under paragraph 70-30(1)(a) of the ITAA 1997 to be treated as having sold the parcel of shares for its cost, then CGT event K4 will not happen and any capital gain or loss will be disregarded pursuant to subsection 118-25(2) of the ITAA 1997.