Edited version of private ruling

Authorisation Number: 1011582334777

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Ruling

Subject: Share trader or investor

1. Are you in the business of share trading?

No.

2. Are your shares trading stock?

No.

3. Are you carrying out or carrying on a profit making undertaking or plan?

No.

4. Are you eligible for the 50% capital gains tax (CGT) discount on the sale of your shares held for longer than 12 months?

Yes.

This ruling applies for the following period:

Year ending 30 June 2010

The scheme commences on:

1 July 2009

Relevant facts and circumstances

This ruling is based on the facts stated in the description of the scheme that is set out below. If your circumstances are materially different from these facts, this ruling has no effect and you cannot rely on it. The fact sheet has more information about relying on your private ruling.

You are an Australian citizen and an Australian resident for tax purposes.

You purchased shares in listed companies on the Australian Stock Exchange.

You acquired these shares over a period of time, as the trading volumes were low and as your cash flow permitted. In the 2009-10 income year three parcels of shares were acquired within a few days of each other and held for a number of months. You had a particular number of sell contracts. These sales all occurred in mid 2009.

Your intention was to hold these shares for long term investment and retirement purposes.

You are director of companies and you have a background in dealing on international transactions.

You were required to liquidate a portion of your shareholdings due to the current economic conditions. You needed to raise funds for your business, as financiers became reluctant to advance additional funds to you.

Your broker sold your shares in parcels as the sales volume of the share market was dictated by the demand of the buyer and this enabled you to sell the shares at a better price.

As a result you have a capital gain.

Reasons for decision

While these reasons are not part of the private ruling, we provide them to help you to understand how we reached our decision.

Summary

You purchased shares over a period of time with the intention of holding the shares for your retirement. You did not trade shares. You sold some of your shares when you required funds for your business interests. Your activities are not the activities of a share trader. You are not considered to be in the business of share trading.

Detailed reasoning

Reasons for decision

There are two possible scenarios as to how share trading activities can be treated for income tax purposes. These scenarios, and their consequences, are as follows:

1) Business Income: in this scenario, you would be a share trader, the shares would be regarded as trading stock and any income would be included in your assessable income.

2) Investment/Speculator: in this situation, you would be regarded as a share investor or speculator. The shares would be CGT assets, any gains earned from the disposal of the shares would be income as a capital gain and any losses sustained from the disposals would be a capital loss. Any dividends and other similar receipts would be included in your assessable income.

Business is defined in section 995-1 of the Income Tax Assessment Act 1997 (ITAA 1997) as 'any profession, trade, employment, vocation or calling, but does not include occupation as an employee'.

In FC of T v. Radnor 91 ATC 4689; (1991) 22 ATR 344, Hill J stated, 'ultimately, the question of whether the respondent was carrying on a business of dealing in shares is a question of fact and degree, a question of impression'.

There has been much judicial comment as to what is meant by the phrase 'carrying on a business', however the difficulties associated with the question are probably best summed up by the following comments in Martin v. Federal Commissioner of Taxation (1953) 90 CLR 470; (1953) 10 ATD 226; (1953) 5 AITR 548:

The test is both subjective and objective: it is made by regarding the nature and extent of the activities under review, as well as the purpose of the individual engaging in them, and, as counsel for the taxpayer put it, the determination is eventually based on the large or general impression gained.

Whilst the existence of a business or otherwise is a question of fact, a number of factors have emerged from case law which are relevant in considering this question. These factors were brought together and relied upon in reaching the decision in Case X86 90 ATC 621; AAT Case 6297 (1990) 21 ATR 3747 (Case X86). Block J subsequently applied them in Shields v. Deputy Commissioner of Taxation [1999] AATA 4; 99 ATC 2037; (1999) 41 ATR 1042.

The question is essentially one of fact. In deciding this issue case law has established the following factors as generally relevant considerations:

· the nature of the activities and whether they have the purpose of profit-making

· the complexity and magnitude of the undertaking

· an intention to engage in trade regularly, routinely or systematically

· operating in a business-like manner and the degree of sophistication involved

· whether any profit or loss is regarded as arising from a discernible pattern of trading

· the volume of the taxpayer's operation and the amount of capital employed, and more particularly in respect of a share trader

· repetition and regularity in the buying and selling of shares

· turnover

· whether the taxpayer is operating to a plan, setting budgets and targets, keeping records

· maintenance of an office

· accounting for the share transactions on a gross receipts basis, and

· whether the taxpayer is engaged in another full time occupation.

Taxation Ruling TR 97/11 Income tax: Am I carrying on a business of primary production? summarises these indicators. Although TR 97/11 specifically refers to primary production, the same principles apply to all businesses. Paragraphs 15 and 16 of TR 97/11 state that no one indicator is decisive but they must be considered in combination and as a whole.

In Case W8 89 ATC 171; AAT Case 4847 (1988) 20 ATR 3182 (Case W8) a trainee accountant purchased 21 parcels of shares between April 1986 and February 1987. All the shares were sold between September 1986 and April 1987, no share having been held for more than five months. A small loss made on four parcels was claimed as a deduction under subsection 51(1) of the Income Tax Assessment Act 1936 (ITAA 1936). The AAT held that the shares were purchased as trading stock during the 1987 income year within the meaning of section 28 and subsection 160L(3) of the ITAA 1936. As the shares were bought and sold repeatedly with a view to making a profit and all shares were sold within a year of acquisition, the person was in the business of share dealing.

The decision of the Board of Review in Case S33 85 ATC 297; (1985) 28 CTBR (NS) Case 38 (Case S33) indicated the importance of commercial decision making with regards to the process for selecting shares. The evidence considered by the Board included the history, performance, activities and management decisions of the company in which the shares were held. A study of these aspects by the taxpayer, plus the nature of financial and investment advice received, formed the basis for selecting shares. This process, combined with other facts (such as profit motive, repetitive transactions, volume of operations and capital) indicated a business of share trading.

In Case X31 90 ATC 296 the taxpayer was a partner in a craft business. After carefully studying the share market and regularly looking at the paper she decided to purchase two kilograms of silver as a trading commodity. She believed that the price of silver was likely to rise. However, the reverse happened. The taxpayer continued with her careful study of the market and bought a further two kilograms of silver in September 1980 and five kilograms in September 1981. Unfortunately the price of silver continued to fall. The taxpayer treated the silver as trading stock and claimed the difference between the purchase price and market value as a deduction. The Commissioner denied the deduction on the basis that the taxpayer was not engaged in a business of trading in silver. The Tribunal held that the taxpayer was carrying on such a business albeit in a small way because there was an element of regularity and repetitiveness. It found that each purchase was a commercial decision, carefully made after regular analysis of the market. Therefore, it allowed the taxpayer's claim for a deduction against her assessable income.

Whilst it was acknowledged that this was a borderline case, the taxpayer's dealing in silver constituted a business. In deciding that the taxpayer was carrying on a business, the Tribunal was influenced by the element of regularity or repetitiveness in the taxpayer's transactions and the fact that each purchase was a commercial decision made after careful and regular analysis of the market.

In contrast to these decisions, Case X86 disallowed losses under subsection 51(1) of the ITAA 1936 on two parcels of shares sold after the 1987 stock market crash. Instead, the losses were quarantined under the capital gains provisions of the ITAA 1936. It was found that there was a lack of a sophisticated share trading technique, a business plan, market research in shares invested, and a contingency plan in a falling market or a large number of transactions. The applicant's activities did not exhibit a system of operation of a business in share trading. The applicant had only a limited contact with the share market, which he then entered for the purpose of making quick profits by generally buying and selling shares in speculative mining. The applicant was not engaged in a business of share trading but rather that he was a speculator in the share market. The taxpayer was unable to satisfy the AAT that he had established a proper pattern of trading in shares and that the share trading was not done in a regular, routine and systematic manner. This was despite arguments that he traded in speculative shares, received regular advice from his accountant, had discussions with his stockbroker, and that there was a continuity of business, the aim of which was to make a profit.

In Case 35/94, 94 ATC 318 (1994) 28 ATR 1246 (Case 35/94) the taxpayer was a real estate investment adviser. From 1982 to 1987 he was employed on a salary and wage basis by C Corp and later became an independent consultant. In his income tax return for the year ended 30 June 1990, he claimed a deduction under section 51 or 52 for a loss totalling $1,170,346 on the sale of shares. The major part of the loss was in relation to shares purchased in C Corp which had been acquired between May 1985 and March 1987. This company was subsequently de-listed in October 1989 following a request by the directors. Other share transactions involved eight listed companies, where generally the taxpayer sold the shares within a few months of acquisition, although some were held for 12 months or more. The taxpayer's submissions that he had been carrying on a share trading business were rejected. Also rejected was the alternative argument that the transactions were commercial transactions entered into with a profit-making intention.

These cases provide an explanation of the difference between a share trader and a speculator. A share trader was seen as one whose dealings were seen as part of a more extensive business of buying and selling shares. The transactions have the character of a continuing business enterprise. A speculator makes individual forays in particular stock with a view to resale. The difference was determined by following a two-stage test:

(a) Is there a discernible pattern of trading in shares?

(b) If not, is there an evident intention to trade regularly, routinely and systematically?

Applying the relevant cases and indicators to your circumstances

The nature of the activities and profit making intention

The question is whether a taxpayer's activities may be characterised as those of a share trader with an active turnover of shares and the intention to make a profit from sales, or a passive investor with an intention to earn income from dividends and capital growth.

The intention to make a profit is not, on its own, sufficient to establish that a business is being carried on. Shares may be held for either investment or trading purposes, and profits on sale are earned in either case.

It is necessary to consider not only the subjective intention to make a profit, but also the objective facts of the case. This includes evidence of how the activity has actually been carried out, or evidence of how the activity will be conducted.

It might be expected that shares purchased for the purpose of making a profit on sale would be re-sold within a relatively short period of time, whereas shares held as an investment would be held over the longer term.

You did not trade in shares on any regular routine basis. The shares were purchased for you by your stock broker, there was no business-like approach. You purchased the shares as a long term investment.

The parcels of shares acquired in the 2009-10 income year were acquired within a few days of each other and held for a number of months. Shares were sold to fund your business.

You did not employ sophisticated share trading techniques in managing your share acquisitions. You did not operate any trading or business plan.

Although you invested a large amount of capital in the share market, you acquired the shares with the intention to hold the shares as a long term investment for your retirement. You did not monitor the shares as you did not intend to sell your shares.

Your share transactions were not complex, the shares were sold when you required funds for your business.

Whether the activity is of the same kind and carried on in a similar manner to that of the ordinary trade in that line of business

It is usual for a business of share trading to display certain characteristics. For example, short-term holding of shares with active regular turnover through continuous trades would be expected. The dynamics of share trading is more complex than the mere buying and selling of shares. For example, some form of structured trading technique might be expected with the intent to maximise profits. Also, diversification in shares held is a common technique used by traders to spread and minimise risk whilst maximising trading in the markets and the use of stop loss measure.

You did not have a business plan to conduct your share activity. Your investment strategy was to buy shares and hold them until your retirement. In addition, no analysis was used as part of your investment strategy or consideration was given to minimising the risk of losses by holding a diversified portfolio of shares or putting in place stop loss measures to limit trading losses.

The repetition and regularity of the activities

Repetition is a significant characteristic of business activities. Repetition refers to the frequency of transactions or the number of similar transactions. The repetition of activities by the same person over a period of time on a regular basis leans towards an activity being classified as a business.

In Radnor, Hill J considered that the taxpayer was not carrying on a business of dealing in shares, primarily because there was no pattern of buying and selling - the low volume and frequency of transactions were emphasised in finding that a business was not being carried on. Similarly, in Case X86, there was no discernible pattern of buying or selling and the applicant was not considered to be carrying on a business of share trading.

You held shares in different companies. You purchased shares with the intention of holding them. The sale of your shares all occurred in mid 2009. Prior to this date you limited your activity to purchasing shares.

Organisation in a business-like manner, the keeping of books, records and the use of a system

In general, most businesses have some form of forward planning to take account of contingencies and market fluctuations, as well as setting profit targets, budgets, periodic financial reviews, record keeping systems, an appropriate office and so forth. It would be reasonable to expect a share trading business to involve study of daily and longer-term trends, analysis of a company's prospectus and annual reports, and the seeking of advice from experts. As indicated in Case X86, a share trader would normally have a business plan, budget and set goals and targets. These would be quite detailed and be more than just general statements or goals.

You have kept and maintained records of your share purchases and sales. There is no indication that you carried out regular financial reviews of your trading activities or that any forward planning of share trading activity was undertaken.

Profit/loss arising from discernible pattern of trading

For the 2009-10 income year you had three buys and fifteen sell contracts. Your buying and selling for this income year was irregular and as such, it could not be said that you have a discernible pattern of trading.

The volume of operations and the amount of capital employed

The amount of capital employed in the activity is not a determinative factor and must be considered in line with the others. For example in Case X86 the taxpayer invested $100,000 and was found not to be carrying on a business, whilst in Case W8 the taxpayer invested $1,300 and was found to be carrying on a business. However, the larger the amount of capital that is invested, the more likely it is that the person is carrying on a business.

The amount of capital you invested is considerable to that invested by some commercial share traders.

Another occupation

Your have business interests.

Conclusion

When considering whether someone is carrying on a business of share trading compared to share speculating, all of the above given factors have to be weighed up. In doing so, equal weighting may not be given to all of the factors. Rather, depending on the taxpayer's situation, it may be necessary to give more weighting to one factor than another.

We acknowledge there is an investment of a significant amount of capital and you had a long term profit making purpose in mind. However, as noted above the intention to make a profit is not, on its own, sufficient to establish that a business is being carried on. Given the objective facts surrounding the circumstances of your case, the activity is similar to those noted in Cases X86 and 35/94 as your trading levels were low and irregular in the 2009-10 income year. Your decision to invest was based on long term investment. You sold the shares to finance your property interests.

After weighing up the relative business indicators and objective facts surrounding your case it is considered that you are not carrying on a business of share trading.

As such, you are not entitled to claim a deduction under section 8-1 of the ITAA 1997 for losses you made in relation to this activity. The shares were not considered to be trading stock and you did not have a profit making undertaking. As a share speculator, any gains made will be assessable as capital gains and any losses made will be regarded as capital losses under Part 3-1 of the ITAA 1997.

CGT discount

Section 115-10 of the ITAA 1997 enables certain capital gains made by individuals to be considered discount capital gains if the requirements in section 115-15 of the ITAA 1997, section 115-20 of the ITAA 1997 and section 115-25 of the ITAA 1997 are satisfied. If so, these capital gains will be eligible for a 50% discount.

Section 115-15 of the ITAA 1997 requires that the capital gain be made after 11.45am (by legal time in the Australian Capital Territory) on 21 September 1999.

Section 115-20 of the ITAA 1997 requires that the cost base has been calculated without reference to indexation.

Section 115-25 of the ITAA 1997 requires that you must have owned the property for at least 12 months.

Therefore, where the above conditions are met, the 50% CGT discount would apply.

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