Tax Definition of a Trader

its quite distinct....share trader....versus an investor....when an investor who has held shares for over 12 months...makes a profit...they are entitled to the capital gain discount.....its the capital account (and the word capital) ....you need to distinguish...from a trading account....

capital gains discount is an incentive for investors to hold an asset on their capital account for longer than a year....it applies to most assets....as investments...includes investment property, works of art, stamp collections etc and of course shares or stocks

I am pretty certain I saw a case argued by an individual as an investor and also a trader....they had a portfolio of stocks on their capital account that were not activley traded......and they received the CGT discount on the sale and profit

they also had another account where they activley traded stocks, and were considered a trader for tax purposes.....they did not mix their stocks, nor did they attempt to change or swap certain stocks to gain the tax advantage...

but how much trouble is that worth, having to deal with the ATO, and be subject to so much scrutiny....

if they are seriously making good money, they are better off with another entity and keep the assets separate....in this case a company for the trading account...where cgt discounts are not applicable....and the capital /investment account in their own name..or the superfund if applicable....

trading status is determined if its run like a business....in that example of 60 trades a year...that to me is at the bottom of what one would expect to be called a business...its on the bottom ....the edge....with an average one trade a week..
I know of investors who average 50 transactions a year....but they do not consider themselves traders....its all about maximising their investments and the returns....oh and the cgt discount on the profits works well for them

Great explanations, thanks guys!

Krusty the Klown said:

If you want to claim the 50% CGT discount on holdings over 12 months, we live in a self reporting tax structure, so it is up to you what you claim. The 50% CGT discount is not available to companies however, only individuals, trusts and super funds. Why would the CGT discount not be available to an individual trader who holds shares for longer than 12 months?

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Self reporting doesn't mean that your claim will be accepted, if audited, and that you won't be fined and pay interest and penalties.

The CGT discount is NOT available to a trader (whether individual, company, trust or super fund). It is one of the trade-offs. You get to write off loses against other income, but you do not get the CGT discount, because (as the previous poster stated) they are not capital gains, but income from the business of trading.

The section from an ATO document explains it better that I can:

http://www.ato.gov.au/businesses/content.asp?doc=/content/21749.htm&page=6&H6

One issue that the previous poster raised is whether one can be a share trader and share investor (share holder) at the same time. In 2000, I checked with the ATO and was informed then (on 2 separate occasions) that you could not. Just one or the other. If you wanted to do both, the suggestion was to set up a separate legal entity (e.g. company) to do one of the activities. This is what I did. I trade under my company account and hold shares for investments under my own name. Recently there was an article in the Australian that stated the one legal entity could be both a trader and share holder, so I again called the ATO and was told that, yes, you could be both..... BUT you need to ensure that you define what purchases are to be trades and what are to be investments when buying them and don't try to switch mid-stream to get a tax advantage.

My suggestion would be, if you don't want to set up a separate legal entity, to have 2 accounts with your broker, one for each activity. Then if audited, it should be clear to the ATO what was meant to be what. If you mix them together, you may end up in strife if the ATO thinks you are switching after the event.

kincella said:

I know of investors who average 50 transactions a year....but they do not consider themselves traders....its all about maximising their investments and the returns....oh and the cgt discount on the profits works well for them

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One question I forgot to ask the ATO when I called them recently that perhaps someone here might know. I'm pretty OK with what one must do to be seen as a share trader by the ATO, but what I am not sure of is whether the ATO could classify you as a trader even if you don't want that to be the case.

Say for instance that I have a big portfolio of shares that I hold for investments, but also from time to time do some trading when I think that might be the most profitable way to handle specific stocks. If my trading activities would qualify a person for being a trader in the eyes of the ATO, can I still treat all my activities as investments?

The reason I might want to do that is that I don't want the administrative overhead of having 2 different ways of reporting my share activities for tax purposes and am happy to have everything under the CGT system.

the answer is no...the ATO will not classify you as a trader... well I have never heard anything like that....
unless of course you were doing hundreds of trades and turning over some really big money...that might catch their eye...and at the same time applying the CGT discount when it suited....
of course the ATO sometimes wakes up and changes its opinion about something....years ago they would not have contemplated one could be trading and investing...but all the online broking sites and individuals who entered the stock market have changed things...

each trade detail is required for the Capital Gains Tax Worksheet, including the date purchased, cost price, date sold and sell price

There have been some serious questions raised here in this thread.

To put it simply, if your trading activities are significant enough for these issues to arise then you should seek proffesional advice. As informative as this forum is, different circumstances require different solutions. I would recommend a taxation specialist, preferably a tax lawyer.

If you're trading with a small position then something as simple as a partnership with income splitting could be all you need.

I am no expert so please seek your own advice but remember if you pay peanuts you can get monkeys.

Cheers

bellenuit said:

Self reporting doesn't mean that your claim will be accepted, if audited, and that you won't be fined and pay interest and penalties.

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If the net tax paid is sufficient for the ATO, regardless of how it is determined, if you can demonstrate due diligence or reasonable care (under common law) you will not incur a fine or a penalty. If you do then you can object to the assessment and take it to court.

The CGT discount is NOT available to a trader (whether individual, company, trust or super fund). It is one of the trade-offs. You get to write off loses against other income, but you do not get the CGT discount, because (as the previous poster stated) they are not capital gains, but income from the business of trading.

The section from an ATO document explains it better that I can:

http://www.ato.gov.au/businesses/content.asp?doc=/content/21749.htm&page=6&H6

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No, that doesn't mention the CGT discount at all.

To be recognised as a share trader or that a business is in the business of share trading is subject to private ruling by the ATO.

One issue that the previous poster raised is whether one can be a share trader and share investor (share holder) at the same time. In 2000, I checked with the ATO and was informed then (on 2 separate occasions) that you could not. Just one or the other. If you wanted to do both, the suggestion was to set up a separate legal entity (e.g. company) to do one of the activities. This is what I did. I trade under my company account and hold shares for investments under my own name. Recently there was an article in the Australian that stated the one legal entity could be both a trader and share holder, so I again called the ATO and was told that, yes, you could be both..... BUT you need to ensure that you define what purchases are to be trades and what are to be investments when buying them and don't try to switch mid-stream to get a tax advantage.

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If you are subject to a private ruling that you are designated as carrying on the business of share trading, then the terms of that private ruling apply to you and you alone. The treatment of a private ruling by the ATO is for the applicant only. Otherwise it would be called a "general ruling". If you cannot claim the CGT discount then it is for you only.

If you get verbal advice from the ATO and not in writing, it is not enforcable, and I guarantee you the ATO's lawyer's would tell you this.

One issue that the previous poster raised is whether one can be a share trader and share investor (share holder) at the same time.

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Of course you can.

In 2000, I checked with the ATO and was informed then (on 2 separate occasions) that you could not. Just one or the other. If you wanted to do both, the suggestion was to set up a separate legal entity (e.g. company) to do one of the activities.

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This does not make sense.

If you can supply some evidence of this I would be grateful to see it.

Krusty the Klown said:

If the net tax paid is sufficient for the ATO, regardless of how it is determined, if you can demonstrate due diligence or reasonable care (under common law) you will not incur a fine or a penalty. If you do then you can object to the assessment and take it to court.

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My response was in relation to a trader claiming the CGT discount, so it would be fair to assume that the net tax paid was less than what should have been paid, although there will be cases where this does not apply, such as when total taxable income is under the tax threshold. I think it may be difficult to demonstrate due diligence, when there is no basis for claiming the CGT discount when you classify yourself as a trader for tax purposes.

Krusty the Klown said:

No, that doesn't mention the CGT discount at all.

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No, but it is obvious from the text. For example:

For a Share Trader:

- receipts from the sale of shares constitute income
- costs incurred in buying or selling shares are an allowable deduction in the year in which they are incurred

For a Share Holder:

- receipts from the sale of shares are not assessable income – however, any net profit is subject to capital gains tax

For a trader, receipts from sales are added to income, costs related to the sales are a deduction. The net effect is that these two components (income and deductions) go to different parts of your tax return. For a share holder, you actually calculate the profit on each sale and the net profit is what is taxed and it is taxed according to the rules of the CGT. So, if held for 1 year +, then the CGT discount applies.

It is because of the way they are handled as described above that when a trader makes a NET loss from share trading, that loss will be applied against other income in the current tax year (i.e. the deductions are not applied just against share trading income, but against all income), but when a share holder makes a NET loss, because it is under the CGT system, that loss doesn't get deducted from other income, but is carried forward to future years.

Krusty the Klown said:

To be recognised as a share trader or that a business is in the business of share trading is subject to private ruling by the ATO.

If you are subject to a private ruling that you are designated as carrying on the business of share trading, then the terms of that private ruling apply to you and you alone. The treatment of a private ruling by the ATO is for the applicant only. Otherwise it would be called a "general ruling". If you cannot claim the CGT discount then it is for you only.

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You don't need a private ruling to be recognised as a share trader, though you could request one if you think your activities are borderline and want confirmation. Whether you get a private ruling or not, if you are classified as a share trader (either by your own decision, or by the ATO), you cannot claim the CGT discount.

Krusty the Klown said:

Of course you can.

This does not make sense.

If you can supply some evidence of this I would be grateful to see it.

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As from my post, when I initially contacted the ATO in 2000, I was informed that you could not be a trader and investor at the same time. I read an article a few weeks ago that said you could and when I called the ATO after reading the article, I was told you could be. What I didn't mention above was that when I called the ATO the first person I spoke to agreed with me and said that you couldn't be both, but said that he was not an expert in that area and passed me on to another person who said you could.

It is quite clear that people have not been given consistent answers from the ATO in relation to that question. Just check some of the messages on this and other message boards in relation to this.

You could ask for a private ruling on whether you could be both a trader and share holder and when I initially asked in 2000, I was told that was an option open to me. I decided not to request a private ruling as I also wanted to trade through a US broker and decided that it might be best to set up a company to do it in any case. But even if you do get a private ruling that you can be both, as mentioned above, you cannot claim the CGT discount on shares you designate as part of your trading stock.

The status for me at the moment is that I have now received verbal confirmation that I can do both, but because I already have a company, I will just continue to use it for trading. But it does impose additional costs.

And no I can't supply evidence of what I was told by the ATO on these occasions, but why do you think I would want to deliberately misstate what I was told?

However, the CGT discount issue is not a question of my interpretation. That is the way it is for share trading.

bellenuit said:

And no I can't supply evidence of what I was told by the ATO on these occasions, but why do you think I would want to deliberately misstate what I was told?

However, the CGT discount issue is not a question of my interpretation. That is the way it is for share trading.

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We're roughly on the same page here.

I have no doubt that you are not misstating what you have been told and are acting in all best faith. I'll try and clarify what I'm saying, as I think you may be dis-advantaging yourself.

What I am saying is that you, as an individual, trust, or superfund taxpayer, can be an share holder and a share trader at the same time and claim the CGT discount. But you have to be able to prove it to the ATO. As you said you are already doing it but you are separating your activities via a separate legal entity, but you don't have to.

The key is to the scenario is this:

Assessable income = "ordinary" income + "statutory" income.

"Ordinary" income is regular, repetitive, similar income such as wages, salary or daily business income.

"Statutory" income is extra-ordinary income that is only deemed assessable by legislation. Capital Gains is an example, ie. a one off profit on the sale of a long term asset held by a business such as a factory.

If you have share trading activity and you choose to report the income or loss as "ordinary" income, then you are correct that you can use any loss as a deduction against other ordinary income, such as wages. As the income is not captured by the capital gains provisions, the CGT discount cannot apply

The same with capital gains income, it can only be offset against other capital gains income. You cannot mix the two, offset losses or deduct expenses from ordinary income.

However, if you take reasonable care and show due diligence as an individual taxpayer, by keeping your trading activities and long term investment activities separate there is no reason that the CGT discount would not apply to your capital gains income. They can be both reported on the same tax return. You would need to have different trading accounts, a different HIN would help, a separate business plan, trading statements and profit and loss statements to justify your claim if audited.

What would get you in to trouble, as kincella, pointed out earlier, is that you should not pollute the waters by transferring assets between the two portfolios. If you had a holding in your long term portfolio which was underperforming, and had no other realised capital gains for that tax year, if you transferred it into your trading portfolio and sold it in June and deducted the loss against your ordinary income, then that would indicate intent to avoid tax and would be captured under the Part IVA anti-avoidance provisions. That is what the ATO is looking for.

Bear in mind that ATO employees are not qualified as tax advisers/agents, so even if they act faithfully and honestly by passing on information, they may not know how to use the information to its fullest extent.

If you choose not to claim the CGT discount on your long term portfolio, then that's fine. You don't get fined for overpaying tax. You are interpreting the information you have been supplied with. But that does not mean what you do applies to everyone else. Everybody's financial circumstances are different.

This is probably the right thread and the right time for my question, hope some of our experts here can have the answer:

I have been trading quite actively in the US share market (both long and short, about 400+ trades in total), and bought some long dated call options on distressed US companies (Visa and BP for example) intended for investment purpose.
So my question is that how should I calculate my "Ordinary"/business income, given they are earned in foreign currency? And wrt the options I bought, which were bought in the same brokerage account, should/can they be treated as CGT item? If so, how can I prove to the ATO that they are indeed for investment purpose?

Great thread, was just thinking about these issues.
So I have an ABN (sole trader). Does my personal trading count towards my ABN or to me personally? I know it doesn't make a different in the end, it is still personal income, but how do I classify it?

This is definitely 'trading' and not 'investing' as the trades are made 30mins to 1-hour apart.

What I want to do is to write off trading losses against other assessable income (such as a salary), plus the fact that trading expenses like brokerage and computers/internet can be claimed as a tax deduction.

The fact that you may be a salary or wage earner, investor or someone carrying on business as a plumber, accountant, dentist etc, does not alter the fact that you may be treated as carrying on a trading business...the classification is merely for the purposes of determining how your gains and losses will be taxed.

I was reading in the Smart Money section of today's Financial Review that SMSFs that make frequent short term trades can no longer categorise themselves as "share traders" and will be taxed under the CGT system. Thus trading losses can no longer be written off against current year's income, but must be calculated according to the CGT regime and can only be written off against current or future capital gains. This is a new measure from last week's budget.

All share transactions, irrespective of their frequency and the period length held, will be treated as investments and come under the CGT system.

The rationale is that SMSFs are meant to be long term investment vehicles.

As I don't have a SMSF, I will not be investigating this change further, but those who do should.

Have found the ATO joke to deal with, with regards to CGT and all other taxes for that matter. I just get my accountant to deal with everything directly.

bellenuit said:

I was reading in the Smart Money section of today's Financial Review that SMSFs that make frequent short term trades can no longer categorise themselves as "share traders" and will be taxed under the CGT system. Thus trading losses can no longer be written off against current year's income, but must be calculated according to the CGT regime and can only be written off against current or future capital gains. This is a new measure from last week's budget.

All share transactions, irrespective of their frequency and the period length held, will be treated as investments and come under the CGT system.

The rationale is that SMSFs are meant to be long term investment vehicles.

As I don't have a SMSF, I will not be investigating this change further, but those who do should.

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If capital losses were taken to book at the nadir of the Global Financial Crisis, I suspect a few SMSF would still be offsetting their subsequent capital gains against the accrued capital losses.