Share investor or share trader: The difference affects your tax

I’ve been overseas for the last few weeks on holiday (well deserved, of course!) and have blissfully missed all the electioneering since the federal election was called – if only I could have stayed away another week!

The tax promises made by the various parties in the election campaign have been well covered. In any event, whichever party forms government after September 7 will need to legislate its promises and it’s then that we will see the real details of the promises they have made.

So, with that in mind, this week I look at a case where a taxpayer was unsuccessful before the Administrative Appeals Tribunal (AAT) in claiming he ran a share trading business. That meant he could not claim significant tax deductions. It was a matter of “nice try, but no cigar”! The AAT agreed with the man on a number of issues, but overall came down on the side of the Tax Commissioner – but it was a close call.

The case is important for an understanding of what factors the ATO and the AAT/courts will consider when deciding if someone is conducting a business. The tax consequences from that decision are considerable.

The man in this case was, during the relevant times, a full-time council employee. According to the taxpayer, he had been actively involved in the sharemarket for many years, which took him about 15 hours per week. He also claimed he had an arrangement with his employer where he could trade during business hours and then make up any time after hours. For the relevant tax years (income years ended 2010 and 2011), he lodged tax returns claiming significant deductions on the basis that he was carrying on a business of share trading. After an audit, the Tax Commissioner determined the taxpayer was a share investor, and was not carrying on a business of share trading, and issued assessments refusing the deductions.

The AAT considered each of the relevant factors established in case law (in particular, the factors listed in an important 1990 case) in determining whether or not the man was engaged in a business of share trading. In that regard, the AAT decision is a very useful guide to the factors that will be considered in determining whether a business (of any kind) is being carried on.

Although noting the “matter was finely balanced”, the AAT was of the view that the factors pointing against the existence of a share trading business were more significant than those pointing in favour of the existence of a share trading business. This highlights how fine the line can be between a successful and unsuccessful claim.

The Tribunal made the following points in relation to the “general factors” concerning the existence of a business:

• Nature of the activities and profit-making purpose – the Tribunal was satisfied that the nature of the man’s activities was “something more than a mere academic pursuit or a hobby”. It was also satisfied that there was an intention to make a profit. It said this factor supported the view that the taxpayer was conducting a share trading business. A positive start for the taxpayer.
• Complexity and magnitude of the undertaking – the AAT was however not convinced that restricting one’s activities to mainly “blue chip” companies makes the activity less complex; however, it was of the view that the factor of complexity went against the taxpayer. The Tribunal noted the taxpayer had utilised the services of Commsec and a number of other brokers and advisory institutions to assist in his research and decision-making. However, it did find that the magnitude of the transactions was “reasonably substantial” and therefore, in this respect, it held the factor of magnitude was in favour of the taxpayer. The Tribunal noted the taxpayer turned over in excess of $900,000 in the 2010 year and almost $400,000 in 2011. It also noted that some 40 transactions took place in 2010 and 25 transactions in 2011.
• Intention to engage in trade regularly, routinely or systematically – the AAT found there was a lack of regular or routine trading during the relevant years which it said pointed to the taxpayer being involved in a series of individual transactions on a speculative basis rather than as a share trader. It noted the taxpayer did not purchase any shares at all in seven of the 12 months in the 2010 year and that no share sales took place in five of those months. Further, it noted that in the 2011 year, only eight purchases appeared to have been made in a three-month period. The AAT said there was in a sense a system in which the taxpayer purchased and sold shares which was partly explained by a “business plan” (although “belatedly” prepared); however, it said that “while this was a plan of sorts, it was neither particularly sophisticated nor intricate, and for the most part appeared to be as much in the head of the [taxpayer] as it was writing”.
• Operating in a business-like manner and the degree of sophistication involved – while noting there were some elements suggesting business-like activities (e.g. a dedicated office at home), the Tribunal was of the view that the operation was “very simple, lacked any real sophistication and overall was not consistent with the operation of a business”.
• Profits/losses arise from a discernible pattern of trading – the AAT did not accept that the man’s business plan incorporated a pattern of trading. Although questioning the relevancy of this factor, the Tribunal said that, from the evidence, this factor pointed against the taxpayer having conducted a share trading business.
• The volume of the taxpayer’s operations and the amount of capital employed by him – the Tribunal was satisfied, noting the volume of the operations and the amount of capital employed by the taxpayer, that in relation to this factor, there was a share trading activity.

In relation to specific share trading factors, the Tribunal said factors in favour of the taxpayer included:

• turnover in gross terms was quite large, particularly having regard to the taxpayer’s salary (being below $200,000 a year);
• the taxpayer maintained an office specifically for the purpose of conducting his share purchase and sale activities; and
• records of transactions were kept for the purposes of doing accounting and tax calculations (although not necessarily on the gross receipts basis).

However, the Tribunal was of the view that, overall, the specific share trading factors in favour of the Commissioner pointed against the conduct of a share trading business. The factors in favour of the Commissioner identified by the Tribunal included:

• the buying and selling of shares was not regular or routine;
• there appeared to have been very little in the way of a plan although belatedly a written plan was produced; the AAT added that very little appeared to have been done in terms of setting budgets and targets; and the trading and the background research was simple and unsophisticated; and
• the taxpayer was engaged in another full-time profession as a council employee. In particular, the Tribunal expressed a view that “the employment of the [taxpayer] on a full-time basis is hardly consistent with the conduct of an on-going business…”.

The AAT also considered it significant that there was very little in the way of documentary evidence showing that the man conducted research in respect of companies in which he either purchased shares or considered purchasing shares.

The decision of the AAT was a close call, but the taxpayer narrowly lost. As can be seen from the factors considered by the AAT, the need for a good written business plan, including budgets, targets, etc, is essential. The fact that a person might otherwise have a full-time occupation doesn’t necessarily preclude the carrying on of a share trading business, but the factors examined in this case show what needs to be done to be successful in claiming that a business was being conducted.

Terry Hayes is the Editor-in-Chief of tax news reporting at Thomson Reuters, a leading Australian provider of tax, accounting and legal information solutions. Featured product is the 2013-14 edition of “The Essential SMSF Guide“, written by Tony Negline – see details here.