Search the net for guidance on how profits and losses on CFDs are treated for tax purposes, and what you can and can’t claim as deductions, and you’ll find plenty of “information,” not all of it useful and much of it misleading.
Discussions in stock trading forums typify the confusion that surrounds CFDs and tax, and many articles with scant information simply recommend getting professional tax advice.
Of course you should. But although the tax situation is complex, the taxation rules for the vast majority of leveraged traders can be stated in a few paragraphs.
First, to get it out of the way, you can’t claim credits for the goods and services tax (GST) on any expenses you incur in trading because you should not be registered for GST. Although you do pay GST on broker’s fees, no claim is possible for a credit on GST since you are not charging and collecting GST in your activities.
Melbourne-based accounting firm, Trentons, is a specialist in CFD taxation, and has trader clients all over Australia. Its principal, Thanh Tran, says, “CFDs, like other leveraged instruments such as warrants, e-MINIs and options, are effectively financial products that are input taxed under the legislation. You don’t charge GST and you can’t claim it.”
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Second, under the taxation rules, leveraged traders are not share traders. Professional share traders who meet the share trading criteria can treat shares purchased as trading stock, treat the proceeds of share sales as income, offset the cost of the shares acquired, and are allowed tax deductions for costs incurred in selling that stock.
But professional share traders deal in actual shares. CFDs aren’t shares, and CFD traders are either carrying on a business for the purpose of profit, or engaging in CFD trading as a hobby (effectively a form of gambling), or they are speculators who happen to have made gains.
Those who use CFDs for hedging (that is, to manage the price risk of other assets) are in a separate category for which there is no space here; but briefly if the asset being hedged is on revenue account, so are the profits and losses on the hedging instrument. Similarly, CFD gains and losses may be able to be treated as on capital account if the asset is a capital item.
“Speculators are those who trade on a one-off or semi-regular basis. They’re not traders or gamblers but they are entering into CFDs with a view to making a profit. The profit on an isolated transaction is also taxable,” says Alison Noble, account director at Deloitte Tax Services and the author of a recent paper on the tax treatment of CFDs. Available here.
“A speculator is not a trader or a gambler. If the CFDs were entered into for the purpose of making a gain, and they make a loss, then the loss is deductible,” Noble says.
Hobby traders and gamblers (the ATO doesn’t distinguish between them) will normally show losses, rather than profits, as is the case with most gambling activity. They can’t claim any tax benefit from those losses. They can keep any net gain they do make, but if it’s a large profit and they are audited by the tax office, they will be asked for evidence that it was made up of isolated windfalls and not part of a profit-making enterprise.
Third, if you’re trading CFDs as a business venture – which isn’t hard to prove if you approach trading frequently and systematically, keep careful records and have a business plan – then the tax situation is fairly simple. Trading profits are assessable as ordinary income, after deducting trading losses and expenses incurred in trading.
To qualify as a CFD trader, says Tran, “you must be trading routinely or systematically; we are not talking about a once-a-week trader. The tax office will also look at turnover, the amount of capital involved, and whether there is a home office specifically set aside for conducting trading activities.
“Once they are established as a trader, they declare profits as revenue in the business section of their personal tax return,” he says. “Claimable expenses are any expenses incurred necessary to derive that income. Many CFD traders can spend thousands on websites and subscriptions.”
If your trading shows a net loss in any year, it is deductible against any other income. Any sophisticated leveraged trader, using CFDs with a trading strategy and money management system, would fall into this category.
But care must be taken with the non-commercial loss rules, which work to prevent the claiming of losses from non-commercial ventures – such as hobby farmers from claiming deductions for business expenses for activities where there is little or no hope of achieving a profit.
In other words, you can’t set up a CFD trading business and claim losses year after year against other income. If you’re in the business to make a profit, the tax office expects to see one, otherwise it may rule that your business is non-commercial and insist that any losses be offset only against profits in future years.
“If it’s a commercial business activity you can offset losses against income from other sources, including capital gains,” says Noble.
“The question is, when do you tip over from a hobby to trading activity? There is a range of different facts and circumstances that the ATO considers,” she adds, pointing to a recent statement by the Australian Tax Office on the subject in relation to a turtle farmer. (Read it here) This document gives a checklist to help you determine whether your venture is commercial or non-commercial.
In deciding whether a business is commercial or not, Noble says, the ATO takes into account such factors as the amount of assessable income, the level of trading profits, whether the taxpayer has real property and whether they have other assets. More detailed information from the tax office is available here:
The official ATO ruling on non-commercial losses is available here.
Tran at Trentons says the income threshold for deciding whether a business is commercial is $20,000. “If gross income (not net profit) does not reach $20,000 then any loss is quarantined, brought forward to the next year and offset against future CFD profits,” he says, “assuming the activity does not satisfy the other criteria to be a commercial venture.
“Assuming you are conducting a business but you are not earning that gross $20,000 turnover, you should still declare any income you make, but any net loss cannot be claimed against other income. It is brought forward and offset against future profits. That’s the whole intention of the non-commercial losses rules.”
Finally, there is the question of deductions. Any expenses essential to making the profits returned from CFD trading are theoretically deductible, but, says Noble, “There must be a nexus with the assessable income.”
Allowable deductions would include brokerage, finance journals, advice from advisers, and essential software such as a charting package. “But be aware that software may be depreciable rather than deductible upfront,” Noble says.
“Courses are generally deductible. But there is some discussion, where you enter into a course to understand the basics of CFDs, about whether that has a capital element. The start-up expenses are the grey area, as to when you start to carry on the business.”
Tran says, “You can claim any cost incurred that’s necessary to derive the income, as long as it’s not for private or domestic use or incurred at a point too early in time for the derivation of income.” So if you use the internet predominantly for trading and also partly for private purposes, you can either claim a business percentage – say 95 per cent – or have two separate internet accounts, he suggests.
The above article is of a general nature only and is not investment advice. TheBull recommends that you seek individual advice from a tax specialist.