Edited version of private ruling

Authorisation Number: 1011678360258

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Ruling

Subject: Futures, commodities and Forex trading

1. Are realised profits from trading futures assessable income, and realised losses allowable deductions?

Yes.

2. Are you assessable on net foreign exchange trades/cash FX translation gains as a result of sales?

Yes.

3. Are the net trades purchases of foreign exchange/cash FX translation losses allowable deductions?

Yes.

4. Are commissions, broker interest paid, other fees (market data fees) allowable deductions?

Yes.

5. Are 'cash settling MTM' amounts assessable income?

No.

6. Are interest accruals in the Net Asset Value in Base Currency of your statement assessable income?

Yes.

7. Are you entitled to amortise the cost of training packages that you purchased?

No.

This ruling applies for the following period

Year ended 30 June 2010

The scheme commenced on

1 July 2009

Relevant facts and circumstances

You commenced live trading of futures, options and currency pairs.

You have undertaken extensive training with two investment information service providers.

You purchased:

· home study course with DVD instruction (futures, foreign exchange and options)

· software plus software updates

· online data - daily updates from each respective markets

· broker training and support

· local monthly traders clubs

· monthly newsletters

· trade sheets and spreadsheets to record and keep track of trades

· training manuals and videos.

The service provides training and support. The service teaches and supports clients in the correct principles for trading and provides the on-line trading platform together with specific training on how to use them. Clients are taught about the advantages of investing and trading on-line, how to design a solid trading strategy and different techniques for trading. As part of the trading program you trade in a simulated environment for three months. The service also provides daily and weekly market analyses and updates, and what is the important focus on in current markets.

The other service provides an education program consisting of e-learning modules and a training manual which provides all of the information necessary to trade options successfully. You may also redo the program at any time. You are entitled to on-going support, from this service provider, including ongoing mentoring, daily and weekly educational webinars that provide the opportunity to see how the strategies work and when to use them. Current trades are reviewed and analysed and there is the opportunity to ask questions about the whys and wherefores of the different strategies.

You have provided a copy of your trading plan. You significantly revised your trading plan after attending an additional training course.

You initially had an amount available to trade from personal savings. You top up your trading account during the year when your personal savings allow. You currently have less than $20,000 invested.

The service provider's software enables you to eliminate the necessity to undertake technical analysis by giving clear and concise entry and exit signals. It also gives signals of stops. When a signal is identified you use the spreadsheet to input the suggested stop and current price on the electronic trading platform. The spreadsheet then calculates the risk in $AUD. Whether you enter a trade or not depends on whether the risk calculated is less than or equal to your maximum risk per trade. Each day you check whether there is a signal and if none, you update your stops. If there is an exit signal you close the trade. You use a trading platform to place trades daily.

You also use a broker to place options trades.

You study the development of markets daily using resources provided in the daily reports and webinars, newspapers and financial review, and the daily stock market reports on SBS. You also read weekly reports and newsletters provided to you and attend a webinar conducted by your broker. You also receive daily updates from a daily share information service and subscribe to a monthly newsletter.

You trade Eurodollars, livestock, silver, gold and currency pairs.

In the year ended 30 June 2010 you have entered into futures and foreign exchange transactions, bear call spreads, bull put spreads, bought calls and sold calls.

You record each futures and forex trade in a diary when the trade is registered. On entering a trade you record entry price, stop price and maximum risk per trade. You update your records daily to reflect any changes to your stops and closing price. On exit, you record the exit price and amount of profit or loss you made on the trade. You prepare a monthly graphical representation of your 'net liquidation value'.

You have a spreadsheet which you update with details of your trades, which also calculates a number of statistics in relation to completed trades.

Your service provider provides you with daily statements of your account. You can also request special statements based on particular periods of time.

The brokers provide you with a daily statement of new trades, open positions, closed trades and broking account balances.

You spend two and a half to three hours per week on your futures and options trading activities. You spend about four to five hours per week on foreign exchange trading.

Your other income producing activities as an employee are for 30 hours per week.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 6-5

Income Tax Assessment Act 1997 Section 8-1

Income Tax Assessment Act 1936 Section 82A

Income Tax Assessment Act 1997 Division 775

Income Tax Assessment Act 1997 Section 775-15

Income Tax Assessment Act 1997 Section 775-30

Income Tax Assessment Act 1997 Section 775-45

Income Tax Assessment Act 1997 Section 775-55

Income Tax Assessment Act 1997 Section 775-105

Income Tax Assessment Act 1997 Section 775-230

Income Tax Assessment Act 1997 Section 775-245

Reasons for decision

Assessable income includes ordinary income and statutory income of a resident of Australia whether from sources in or out of Australia. Statutory income includes amounts that are included in assessable income by specific provisions in relation to assessable income.

Section 8-1 of the Income Tax Assessment Act 1997 (ITAA 1997) allows a deduction for all losses and outgoings to the extent to which they are incurred in gaining or producing assessable income, or necessarily incurred in carrying on a business for the purpose of gaining or producing assessable income, except where the outgoings are of a capital, private or domestic nature.

In order to determine whether profits from trading options, futures and foreign exchange are assessable income and losses from trading options, futures and foreign exchange are deductible it is first necessary to determine whether you are carrying on a business of trading options, futures and foreign exchange.

Share Trading Business

A business for tax purposes includes any profession, trade, employment, vocation or calling, but does not include occupation as an employee. This definition would include a business of shares and options trading.

Whether activities undertaken constitute the carrying on of a business is essentially a question of fact. Whilst each case might turn on its own particular facts, the determination of the question is generally the result of a process of weighing all the relevant indicators.

Taxation Ruling TR 97/11 discusses whether a taxpayer is carrying on a business of primary production. Although this Ruling specifically relates to carrying on a business of primary production, the indicators discussed are relevant to any type of business. The Ruling summarises the Courts' decisions that the following indicators are relevant: 

· whether the activity has a significant commercial purpose or character

· whether the taxpayer has more than just an intention to engage in business

· whether the taxpayer has a purpose of profit as well as a prospect of profit from the activity

· whether there is repetition and regularity of the activity

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

· whether the activity is planned, organised and carried on in a businesslike manner such that it is directed at making a profit

· the size, scale and permanency of the activity

· whether the activity is better described as a hobby, a form of recreation or a sporting activity.

The nature of the activity, the taxpayer's intention and the method of operation help determine whether a business of share trading is being carried on. Many of the relevant indicators are stated in the decision of the Full Federal Court in Ferguson v. FC of T 79 ATC 4261; (1979) 9 ATR 873. Bowen CJ and Franki J said in their joint judgment at FLR 314; ATC 4264-4265; ATR 876-877: 

The nature of the activities, particularly whether they have the purpose of profit-making, may be important. However, an immediate purpose of profit-making in a particular income year does not appear to be essential. Certainly it may be held a person is carrying on business notwithstanding his profit is small or even where he is making a loss. Repetition and regularity of the activities is also important. However, every business has to begin, and even isolated activities may in the circumstances be held to be the commencement of carrying on business. Again, organization of activities in a businesslike manner, the keeping of books, records and the use of system may all serve to indicate that a business is being carried on. The fact that, concurrently with the activities in question, the taxpayer carries on the practice of a profession or another business, does not preclude a finding that his additional activities constitute the carrying on of a business. The volume of his operations and the amount of capital employed by him may be significant. However, if what he is doing is more properly described as the pursuit of a hobby or recreation or an addiction to a sport, he will not be held to be carrying on a business, even though his operations are fairly substantial. 

There is no one factor that is decisive of whether a particular activity constitutes a business (Evans v. FC of T 89 ATC 4540; (1989) 20 ATR 922).

Significant commercial purpose or character

The 'significant commercial purpose or character' is closely linked to the other indicators and is a generalisation drawn from the interaction of the other indicators. It is particularly linked to the size and scale of activity, the repetition and regularity of activity and the profit indicators. A way of establishing that there is a significant commercial purpose or character is to compare the activities with those of a taxpayer who is carrying on a similar activity that is a business. Any knowledge, previous experience or skill of the taxpayer in the activity, and any advice taken by the taxpayer in the conduct of the business should also be considered but are not necessarily determinative. 

Trading in a systematic manner is an indicator of commercial purpose. This is demonstrated by a share trading strategy, which outlines the steps that a share trader plans to follow in realising their goal of making a profit. This will usually be in the form of: 'If I analyse the shares in this manner, purchase these types of shares, and assess them in this way then I should get there'.

You have provided a copy of your options, futures and forex trading plans, and a detailed explanation of trading strategy. You commenced trading futures, options and currency pairs. You use the service provider's trading platform to place trades electronically on the internet. You also use a broker to place option trades. You have entered into foreign exchange transactions and option trades during the year ended 30 June 2010. You maintain a diary of all your trades as well as electronic records of your trades. Your service provider provides you with monthly details of your trades and your broker also provides you with a monthly record of your option trades. You chart your monthly 'net liquidation value' to give you a pictorial representation of your progress. You have provided copies of documents detailing transactions undertaken from the investment service provider and broker. As you are involved in futures and options trading activity, we accept your activities have a commercial purpose.

Intention of the taxpayer

This indicator is particularly related to: 

· whether the activity is preparatory or preliminary to the ultimate activity

· whether there is an intention to make a profit, and

· whether the activity is better described as a hobby.

As you are involved in shares and options trading activity, we accept you have a profit making motive (as opposed to say a primary producer, who may have a motive of recreation, property investment or of creating substantial tax deductions). You have undertaken several training courses to enable you to trade successfully. Your service provider allowed you to trade in a simulated environment for three months prior to you commencing real trades. You traded in this environment for three months in early 2009. You are also using particular trading strategies with a view to making a profit. You receive daily share information reports and services and attend regular webinars in relation to trading. You devote six and a half to eight hours per week on your trading activities.

Prospect of profit

This indicator is considered to be very important.

Strong evidence of an intention to make a profit occurs when the taxpayer has conducted research into a proposed activity, consulted experts or received advice on the running of the activity and the profitability of it before setting up the business. 

You trade Eurodollars, all livestock, silver, gold and currency pairs. You have a trading plan for the options and futures. You will enter a trade on the daily cross if the angles are correct. If the angles are not correct you will enter the trade on the next day if the angles are correct. If still not correct, you will pass on the trade. You will exit a trade on a cross. You will allow profitable trades to run their course. You will trade with the highest open interest. You use trailing stops to maximise any profit. Your stop limit is calculated as one and a half times the average trading range for the past five days. The maximum risk you will take per trade is six percent of your account size. You have a monthly target of five percent profit. This information is sourced through your investment service provider. You keep detailed records of your trades in a diary and on computer. This trading plan maximizes your potential profits.

Repetition and regularity

It is often a feature of a business that similar sorts of activities are repeated on a regular basis. The repetition of activities by the same person over a period of time on a regular basis helps to determine whether there is the 'carrying on' of a business.  

You have made in excess of 600 transactions in conjunction with the trading plan you developed during the year. Futures, options and foreign currency are bought and sold within a relatively short period of time and there is regular turnover of these assets. You trade once a day, about 6.5 to 8 hours per week. 

Is the activity of the same kind and carried on in a manner that is characteristic of the industry

An activity is more likely to be a business when it is carried on in a manner similar to that in which other participants in the same industry carry on their activities. Lord Clyde in IR Commissioners v Livingston and Others (1927) 11 TC 538 at TC 542 said that: 

the test, which must be used to determine whether a venture is, or is not, in "the nature of trade", is whether the operations involved in it are of the same kind and carried on in the same way, as those which are characteristic of ordinary trading in the line of business in which the venture was made. 

Copies of transactions undertaken and your trading plan indicate that the activity is carried on in a manner that is characteristic of others in the option, futures and forex trading industry. 

Organisation in a businesslike manner and the use of system

In Newton v. Pyke (1908) 25 TLR 127, the court suggested that business should be conducted systematically. A business is characteristically carried on in a systematic and organised manner rather than on an ad hoc basis. An activity should generally conform with ordinary commercial principles to amount to the carrying on of a business. 

Trading in a systematic manner is an indicator of organisation in a business like manner. This is demonstrated by a share trading strategy, which outlines the steps that a trader plans to follow in realising their goal of making a profit. This will usually be in the form of: 'If I analyse the shares in this manner, purchase these types of options or commodities, and assess them in this way then I should get there'. Stop Loss Limits would generally also be set.

You have completed a number of shares and options trading courses and are following trading strategies using sophisticated professional software and analytical tools. This software not only has trade set ups but also has complete trading rules to be followed. It provides the entry, exit, stop loss for each trade. Entry and exit criteria have been developed in addition to a risk management strategy. You also have your own trading plans.

You undertake trading activities on a daily basis. You spend six and half to eight hours per week trading.

You maintain a trading diary, as well as electronic records of all transactions and monthly portfolio statements.

You study the development of markets daily using resources provided in the daily reports and webinars, newspapers and financial review, and the daily stock market reports on SBS. You also read weekly reports and newsletters provided to you and attend webinars conducted by your brokerage. You also receive daily updates a daily share information service and subscribe to a monthly newsletter.

Based on the above information, the Commissioner considers you are operating your futures, foreign exchange and options trading activity in a business like manner.

Size and scale of the activity

The larger the scale of the activity the more likely it will be that the taxpayer is carrying on a business. However, the size and scale of activity is not a determinative test (FC of T v. Walker 85 ATC 4179; (1985) 16 ATR 331).

The amount of capital employed in the activity is not a determinative factor and must be considered in line with the other indicators. An example is provided by Case X86 90 ATC 621; AAT Case 6297 (1990) 21 ATR 3747 where the taxpayer invested $100,000 and was found not to be carrying on a business whilst in Case W8 89 ATC 171; AAT Case 4847 (1988) 20 ATR 3182 the taxpayer invested $1,300 and was found to be carrying on a business. However, the larger the amount of capital invested, the more likely it is that the person is carrying on a business.

Whilst the amount of capital you have invested is relatively small you have made in excess of 600 trades in a year.

Futures, foreign exchange and options trading

The discussion of the above factors indicates that a business of futures, foreign exchange and options trading is being conducted albeit in a small way. Accordingly, any gains from trading in futures, foreign exchange and options will constitute assessable income under section 6-5 of the ITAA 1997. Losses from trading in futures, foreign exchange and options will be deductible under section 8-1 of the ITAA 1997. 

Cash settling MTM

These amounts relate to the unrealised gains or losses from trades which you have not closed out. As this amount does not relate to a realised loss or gain unless you are using the accruals method of accounting for your trading you will not be able to deduct this amount, nor will it be assessable income.

Foreign Exchange

The forex regime in Division 775 of the ITAA 1997 generally applies to gains and losses on rights and obligations acquired or assumed under transactions entered into from the beginning of the 2003-04 income year. The forex regime works in conjunction with the foreign currency translation rules.

The trading (purchase and sale) of foreign currency may give rise to income or deductions. Where these activities happen instantaneously there will be no currency exchange rate effect.

Taxpayers make a foreign exchange (forex) realisation gain if they dispose of foreign currency, or a right, or part of a right to receive foreign currency for more than they paid for it, to the extent that the gain is due to fluctuations in the value of the foreign currency. This will usually be where the proceeds on disposal of the foreign currency, measured in Australian dollars, are greater than the cost of acquiring the foreign currency, measured in Australian dollars.

Taxpayers make a forex realisation loss if they dispose of foreign currency; or rights; or parts of rights to foreign currency for less than they paid for them. That is to the extent that a loss is due to fluctuations in the value of the foreign currency.

As you are trading futures on exchanges in the United States in US currency the forex provisions will apply to these trades.

Limited balance election

You may make elections under section 775-230 of the ITAA 1997 to have the limited balance exemption apply to your accounts. In broad terms, these elections enable you to disregard forex realisation gains and losses arising from FRE 2 (withdrawals from the accounts) provided the credit balance of these accounts at the time of withdrawal is not more than the equivalent of $AUD 250,000.

The tests for determining whether the limited balance test is passed are contained in section 775-245 of the ITAA 1997. In brief, where an accounts balance exceeds the equivalent of $AUD 250,000 for a period in excess of 15 days, the limited balance test is failed.

You have stated that the maximum amount you trade is much less than $AUD 250,000. Consequently, if you make the election, you will pass the minimum balance test. Therefore, it is not necessary to include any foreign exchange translation gains or losses in your assessable income.

Commission, broker interest and fees

Section 8-1of the ITAA 1997 allows a deduction for all losses and outgoings to the extent to which they are incurred in gaining or producing assessable income, or necessarily incurred in carrying on a business for the purpose of gaining or producing assessable income, except where the outgoings are of a capital, private or domestic nature.

As it has been determined that you are carrying on a business of trading in futures, foreign exchange and options expenses that are incurred for the purpose of earning that business income will be deductible. As the commission, broker interest and fees are incurred in relation to your futures, options and foreign currency trading the commission, broker interest and fees will be deductible.

Self- education expenses

The courses and seminars you have purchased and undertaken are examples of self-education expenses.

The Commissioner of Taxations view on the deductibility of self-education expenses under section 8-1 if the ITAA 1997 is detailed in Taxation Ruling TR 98/9.

TR 98/9 includes the following principles of self education deductibility:

A deduction is allowable for self education expenses if the taxpayer's income earning activities are based on the exercise of a specific skill or knowledge and the subject of self education enables the taxpayer to maintain or improve that skill or knowledge.

A deduction is not allowable for self education expenses if the subject of self education is designed to get employment, to obtain new employment or to open up a new income earning activity; that expenses intended to enable the taxpayer to practise in another area will not be allowable deductions.

Whilst the Commissioner has ruled on your status as a futures, foreign exchange and options trader for the year ending 30 June 2010, it is considered this status commenced in June 2010, when regularity of your trading activities commenced. Prior to that, the Commissioner considers your shares and options trading activities were of a preliminary or experimental nature and that your self education activities were for the purpose of opening up a new income earning activity rather than improving an existing skill.

Additional information

Non-Commercial Loss Provisions.

Division 35 of the ITAA 1997 restricts losses from non-commercial business activities being offset against income from other sources, unless the activity satisfies one of the commerciality tests. The loss is deferred and may be offset in a later year against profits from the same activity, or against other income where one of the commerciality tests is met. The Commissioner has issued Taxation Ruling TR 2001/14, which comprehensively deals with the non-commercial loss provisions.

Based on the information you have provided regarding your futures, options and foreign exchange trading activities, the non-commercial loss provisions as per Division 35 of the ITAA 1997 may apply.

However under the non-commercial loss measures, any trading loss can be deducted from other income if at least one of the following tests detailed in section 35-10 of the ITAA 1997 is satisfied in each year. The tests as per section 35-10 are:

(a) at least $20,000 of assessable income in that year from the business activity (section 35-30)

(b) the business activity results in a taxation profit in three of the past five income years (including the current year) (section 35-35)

(c) at least $500,000 of real property, or an interest in real property, (excluding any private dwelling) is used on a continuing basis in carrying on the business activity in that year (section 35-40), or

(d) at least $100,000 of certain other assets (excluding cars, motor cycles and similar vehicles) are used on a continuing basis in carrying on the business activity in that year (section 35-45). 

There are a limited range of situations where the Commissioner may exercise his discretion to allow non-commercial losses in other circumstances.

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