It’s tax time and this means working out how much money you’ve made or lost on the stockmarket this financial year and how much tax you’re up for.
With the help of Tax for Australians for Dummies, written by tax specialist Jimmy B. Prince (2009 Wiley Publishing Australia) – we’ve highlighted some of the essential points for share traders.
First up, do you run a share trading business or do you simply invest in shares?
The reason we ask is that share traders are taxed differently to share holders. Indeed, there are perks for those classified by the Tax Office as share traders, including the ability to write off share losses against other assessable income (such as a salary), plus the fact that share-trading expenses like brokerage can be claimed as a tax deduction. Share holders don’t enjoy such perks.
We spoke to Prince personally, who reiterated this point. “If you can demonstrate you are carrying on a share trading business, all share profits are liable to tax, and any losses you incur can be offset against your salary and wages, investment income and any other business profits you derive,” he says.
“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 share trading business…the classification is merely for the purposes of determining how your gains and losses will be taxed.
“You will generally find taxpayers will try to argue that they are carrying on a share trading business only when they make substantial losses! This is because if they succeed they can claim the losses immediately! If they can’t prove that they are carrying on a share trading business, the losses are ‘quarantined’ and can only be offset against a current or future capital gain (which may never happen).”
The ATO website offers an example to help you determine the category that sums up your situation.
The ATO profiles Molly, an electrical engineer, who decides to take up share trading after watching a television program. Molly sets herself up in a room in her house with a computer and internet access. She has available $100,000 of her own money and an extra $50,000 investment loan to buy shares.
Molly conducts daily analysis on the equity market using information gleaned from financial newspapers, magazines and stock reports. She buys and sells shares online using an online broker.
Over the course of the financial year Molly purchases shares 35 times and sells shares 25 times – for a total of 60 transactions. Her average buying price is $1,000 and her average selling price is $1,800. She holds the shares for an average of 12 weeks.
All up, Molly loses $5,000 after expenses.
The ATO says: “Molly’s activities show all the factors that would be expected from a person carrying on a business. Her share trading operation demonstrates a profit making intention even though a loss has resulted. Molly’s activities are regular and repetitive, and they are organised in a business-like manner. The volume of shares turned over is high and Molly has injected a large amount of capital into the operation.”
So there you have it. If this sounds like you then what are the perks?
The advantages of being a share trader
• Share traders can offset any trading losses incurred over the financial year against other assessable income.
• Costs incurred in buying or selling shares are an allowable deduction in the year in which they are incurred.
The bad news is that you can’t take advantage of the 50% capital gains discount on shares held for more than 12 months. But as a share trader, you probably wouldn’t hold shares for this long anyway.
The best way of looking at it is that share traders buy and sell shares to profit, whereas share holders buy shares as an investment. In the same vein as other businesses, any profits made by the share trader are regarded as assessable income, and all costs incurred in running the business are deductible.
Tax for share holders
The ATO uses George, an accountant, as an example of a share holder. George purchased 200,000 shares in twenty blue chip companies over several years. His total portfolio cost $1.5 million. George bought the shares because they paid consistently high dividends. He does not intend to sell the shares unless their price appreciates markedly. By the end of the financial year, George sold 20,000 shares for a gain of $50,000.
The ATO says: “Although George has made a large gain on the sale of shares, he would not be considered to be carrying on a business of share trading. He has purchased his shares for the purpose of gaining dividend income rather than making a profit from buying and selling shares.”
Share holders cannot offset share losses against other assessable income, such as income from a wage or salary. Instead, any losses must be carried forward and offset against future capital gains made from the sale of shares or other investments such as property (except collectables). Furthermore, any costs incurred in buying and selling shares cannot be claimed as a tax deduction but are instead taken into account when calculating any capital gain made.
For share holders profits made on shares are not classed as assessable income, but as a capital gain and are subject to capital gains tax. If the shares have been held for more than 12 months then they are eligible to receive the 50% capital gains discount. That means you only pay tax on half of the capital gain made. This is a major tax perk for the share holder.
Tax For Australians for Dummies offers a handy checklist to help determine your classification as either a share trader or share holder:
• Do you intend to make a profit?
• Are you running your activities in a business-like manner?
• How much capital have you invested?
• Do you trade on a regular basis (for example, 10 trades a week)?
• What volume of trades do you make each year (for instance, 100 trades a year)?
• Do you keep proper records (for example, buy and sell contract notes)?
Prince says that share traders don’t have to set themselves up as a sole trader with an ABN, nor quote this ABN to a stockbroker. He says that the biggest stumbling block from being accepted as running a share trading business is the volume of trades you make each year. Generally speaking, the more trades you make the greater the chance of being accepted as a share trader.
According to the ATO, being accepted as carrying on a share trading business doesn’t hinge on the amount of money that you have available for share trading. The ATO writes: “The amount of capital that you invest in buying shares is not considered to be a crucial factor in determining whether you are carrying on a business of share trading. This is an area in which it is possible to carry out business activities with a relatively small amount of capital. Conversely, you may also invest a substantial amount of capital and not be considered to be a share trader.”
Not a share trader for tax purposes? Don’t fret, there are other perks for share holders
One of the big perks for share holders is the ability to claim as a tax deduction any interest costs on an investment loan to buy shares. And if you pay the interest up front before the end of the financial year (say before 30 June 2009) then you can shove it onto your 2008/09 tax return for an instant deduction.
The catch here is that the shares purchased with the loan must pay dividends, or have a history of distributing dividends to shareholders. Therefore, always check up on the dividend paying history of the company.
According to Prince, if the company has never declared a dividend, there’s a strong possibility the interest expense may not be tax deductible. Be careful of speculative stocks such as mining companies and the like; the tax office won’t be too pleased to see you claiming a tax deduction for buying stocks that can barely pull a profit let alone pay dividends to shareholders.
If you’ve borrowed money to buy a stock that doesn’t distribute a dividend, not all is lost, writes Prince. He offers an example that we’ve included below.
Angela borrowed $30,000 to buy shares in a mining company that didn’t declare a dividend. She paid $30,000 for the shares and sold the shares today for $40,000. Over that period she paid $3,000 in interest on the investment loan. The Tax Office advised her that the interest isn’t tax deductible as her mining shares didn’t pay dividends. In this case, the interest can be added to her cost base:
Capital Proceeds $40,000
Purchase Price $30,000
Non-Capital Costs $3,000 $33,000
Net Capital Gain $7,000
As you can see, the interest cost reduces the capital gain from $10,000 to $7,000.
And finally, because this is an article on tax – we must highlight that this is for general information only and does not relate to your situation specifically, so please check with your accountant for more information.
Other articles in this week’s newsletter