One question that befuddles traders and investors is working out the difference between traders and investors for tax purposes.
Even the benefits and drawbacks of the two classes of market participant can seem confusing! So let’s have a closer look at the Australian Tax Office’s rulings.
What the difference?
The ATO treats the definition of an investor or trade on an individual case basis.
There are certain criteria that need to be met for someone to be treated as a trader rather than investor. In general, most individuals are treated as investors by default.
So, how do you get to be treated as a trader? In short, it comes down to whether you run your trading like a business.
According to the ATO website, the key hurdles to be met include:
1. the nature of the activities, particularly whether they have the purpose of profit making
2. the repetition, volume and regularity of the activities, and the similarity to other businesses in your industry
3. the keeping of books of accounts and records of trading stock, business premises, licences or qualifications, a registered business name and an Australian business number
4. the volume of the operations, and
5. the amount of capital employed.
What does this all mean? Basically, to be classified as a trader, the perfect trader would need to have a home office set up, with computer and internet, and a decent sized trading account (although that’s not crucial).
In some example rulings, the ATO suggests that a trader carrying out just 60 transactions in a year could qualify as a trader. And that’s not trades, that is, open and closed positions, that’s just opening or closing a trade.
To anyone who has traded for any length of time, 60 transactions would be seen as hardly any trades at all. Some traders do that in a day!
The other factor that the tax office looks for is repetition. So, if you are trading around the same amount, risking about the same and looking to make broadly the same amount, that will help you achieve trader status.
You are also able to meet the repetition hurdle by having an in-depth trading plan. According the ATO, a trading plan should include some or all of the following criteria, such as an analysis of each potential investment, an analysis of the markets and market sectors you trade, an understanding how profit will be made and a clear basis for making you trading decisions.
How are they treated?
The most important factor is, of course, capital gains tax. Your classification by the ATO will affect the way you are treated for capital gains purposes.
For investors, any losses incurred from trading, including shares, options, CFDS and forex, will be treated as a capital gains loss for tax purposes.
In this case, you can offset these losses against any capital gains you make in this year, or in previous or future years.
For those classified as traders, however, they must claim any wins as assessable income and can only claim losses against other income.
With share CFDs, however, note that there are no franking credits and the 50% discount for holding an asset for longer than 12 months does not apply. And that goes for whether you are an investor or trader.
What do you want to be?
So, the important question is whether it is better to be an investor or a trader. As always, it depends on your personal circumstances.
For example, a share trader will not qualify for the 50% capital gains tax discount, explained below. For share investors, capital losses can only be used only to reduce capital gains, whereas revenue losses by share traders can be applied against any income or gain.
For example, a trader can offset any costs such as education, books and magazines, as they incur. So each year a trader can get a deduction for costs that have incurred.
On the other hand, an investor can also claim these types of costs, but only once they have realised a capital gain, and in those cases the costs are used to offset the capital gains.
Finally, it wouldn’t be an article about tax and trading without this little disclaimer: always check with your accountant for a comprehensive understanding of your own personal circumstances.
The long and the short
According to the Australian Taxation Office website, while the tax office considers each case on its individual features, it helps outline the difference in broad terms.
A share trader is a person who carries out business activities for the purpose of earning income from buying and selling shares.
This person’s position may be briefly summarised as:
- receipts from the sale of shares constitute income
- purchased shares would be regarded as trading stock
- the nature, regularity, volume and repetition of the share activity are consistent with those of a share trading business
- costs incurred in buying or selling shares are an allowable deduction in the year in which they are incurred, and
- dividends and other similar receipts are included in assessable income.
A share holder is a person who holds shares for the purpose of earning income from dividends and similar receipts.
This person’s position may be briefly summarised as:
- the cost of purchase of shares is not an allowable deduction, but is a capital cost
- receipts from the sale of shares are not assessable income – however, any net profit is subject to capital gains tax
- a net loss from the sale of shares may not be offset against income from other sources, but may be carried forward to offset against future capital gains made from the sale of shares
- costs incurred in buying or selling shares are not an allowable deduction in the year in which they are incurred, but are taken into account in determining the amount of any capital gain
- dividends and other similar receipts are included in assessable income, and
- costs (such as interest on borrowed money) incurred in earning dividend income are an allowable deduction at the time they are incurred.
Source: ATO website