In a recent case, Smith v FCT (2010) AATA 576, the decision of the Administrative Appeals Tribunal (the Tribunal) has once again highlighted the importance of whether an investor is considered to be carrying on a share trading business or merely to be holding shares as a passive investor for long term growth.
This distinction is important as it will give rise to different tax treatments and the Australian Taxation Office (ATO) has signalled that it will actively look at share disposals as part of its ongoing compliance program. In this regard the ATO has previously issued an Taxpayer Alert (TA 2009/12) in which it warns against re-characterising losses on disposal of shares as revenue losses rather than as capital losses.
Tax distinction between a “share trader” and a “share investor”
In order for a taxpayer to be considered a “share trader”, a person must establish that the share trading activities constitute the carrying on of a business. Where such evidence exists (see commentary below) the share portfolio is taken to be trading stock and any profit or loss generated in an income year is assessed on revenue account for tax purposes.
In contrast, a taxpayer who acquires shares for the purpose of long term investment, albeit with annual dividend returns, is considered to be a passive investor and any gains or losses on disposal of shares are assessed under the capital gains tax regime. Importantly, any increase or decrease in the value of the share portfolio from year to year is ignored for tax purposes.
Notwithstanding the above distinction, a person may have separate share portfolios to distinguish between shares held for long term growth to those held on share trading account.
Indicators of a share trading business
The ATO has issued a number of interpretative decisions (based on past court cases) which provide guidelines on some of the factors which should be considered in determining whether a share trading business exists. These factors generally include the following:
Ø the nature of the activities and whether they have the purpose of profit-making;
Ø the complexity and magnitude of the undertaking;
Ø the intention to engage in trade regularly, routinely or systematically;
Ø operating in a business-like manner and the degree of sophistication involved;
Ø whether any profit or loss is regarded as arising from a discernible pattern of trading;
Ø the volume of the taxpayer’s operation and the amount of capital employed;
and more particularly in respect of share trades:
Ø repetition and regularity in the buying and selling of shares;
Ø whether the taxpayer is operating to plan, setting budgets and targets and keeping records;
Ø maintenance of an office;
Ø accounting for the share transactions on a gross receipts basis; and
Ø whether the taxpayer is engaged in another full time occupation.
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In the Smith case, the Tribunal considered various factors, including the indicators detailed above and also the evidence presented by the taxpayer. The Tribunal noted from the taxpayer’s evidence that he did not “really intend” to be a share trader.
Rather, in the Tribunal’s view, the evidence suggested that the taxpayer did not represent himself as a share trader until after he lodged his tax returns. It found that this decision was perhaps influenced by the “entrepreneurial approach” at his workplace and the increase in his disposable income.
The Tribunal also noted that the taxpayer held his shares for periods longer than a share trader generally would, participated in dividend reinvestment plans and received dividends. It also examined the number of transactions in the taxpayer’s share portfolio, which it noted was “heavily weighted” towards entities of his employer.
Furthermore, the Tribunal noted the taxpayer’s employer imposed restrictions on the taxpayer’s share trading activities. Therefore, the Tribunal was satisfied that the taxpayer’s activities did not have the repetition and regularity of a business and that the activities did not have a profit motive.
While the Tribunal found that the taxpayer did not maintain a separate office and worked full-time, it did not place much reliance on these factors in coming to its decision, rather it focussed more on the fact that the taxpayer was unable to indicate the amount of time he devoted to his share trading activities.
Considering the overall indicators of what constitutes a business activity, the Tribunal concluded that the taxpayer was not in the business of share trading.
Although you may not fall into a similar fact scenario that Mr Smith found himself in, it is important that before embarking on a share trading business you take appropriate measures to ensure that you fall into the category of a business and not merely that of a share investor.
Craig Wilford is with Nexia Court and Co.