Private ruling: Income versus Capital
Date of advice: 10 October 2018
Published: December 2018
Ruling period: Year ended 30 June 20YY | Year ended 30 June 20ZZ
Date scheme commenced: 1 July 20XX

Ruling: Q1: Are you carrying on a business of share trading in the 20XX/20YY financial year? | A1: No

Relevant facts and circumstances: Company Director 1 commenced share trading in 19XX and tended to trade for profits or losses. At that time Director 1 regarded dividends as a bonus and frequently sold before a dividend date. Company A was established in winter 20AA with two Directors. Currently Director 1 and another person are directors and Director 1 is the Company Secretary. The company has two shareholders neither of which is Director 1. After establishment Company A received trust distributions over several years. Since 20BB it has received rent, bank interest and dividends. Director 1 commenced share trading through Company A in the year ended 30 June 20YY There is no formal and written business plan, Director 1 describes it as “to cyclic trade only large cap blue chips”. This was changed in 20AA/20BB to look for more frequent and smaller price fluctuations based on daily over-reaction to market information. In the second half of 20XX/20YY small caps were added to the stockholding for trading in a similar manner. Company A does not use stops or limits as Director 1 controls trading as well as the plan review process. As Director 1 does not allow your company sharebroker authority to trade on your behalf he does not see a need to employ stops or limits. He tends to trade on a XX% sell order or YY% for a buy order. The company tends to wait for at least one full trading session for both buys and sells so “gapping” has not been a problem in trading. The company has only established one trading account at Commsec. Director 1 has not engaged a share broker or professional adviser to guide trading, relying instead on the brokers provided by your electronic trading provider. He feels that his education and extensive experience examining various stock exchanges makes him competent to trade without additional professional guidance. Director 1’s research consists mainly of reading the paper, viewing broker research and analysing financial data. The company does not pay for specific software to analyse share movements. Similarly the company does not utilise specialised software to monitor profit and loss movements. You use broker reports and your accountant for CGT analysis. The company’s record of share trades is its broker account statements. In the 20XX/20YY financial year Company A had XX buy transactions and YY sell transactions. The pattern of trading is concentrated in specific periods with frequent periods of low or no trading activity. Director 1 reports that “you feel no pressure to buy or sell at any point” and this approach allows you to trade only when you see opportunity. During 20XX/20YY Director 1 had no formal employment. He estimates that he spent perhaps 2 to 3 hours per morning reviewing and analysing the company share portfolio. Director 1 maintains a home study which is used for company share trading. On 30 June 20XX Company A’s portfolio was valued at $X. On 30 June 20YY this portfolio was valued at $Y

Relevant legislative provisions: Income Tax Assessment Act 1997 Section 6-5 | Income Tax Assessment Act 1997 Section 8-1 | Income Tax Assessment Act 1997 Section 995-1 | Income Tax Assessment Act 1997 Section 100-25 | Income Tax Assessment Act 1997 Section 100-55

Reasons for decision: Detailed Reasoning - Detailed reasoning: 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, Company A would be a share trader, the shares would be regarded as trading stock and any income would be included in your assessable income, and 2) investment / speculator – in this situation, Company A would be regarded as a share investor or speculator. The shares will be capital gains tax (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 will 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 ITAA 1997 as 'any profession, trade, employment, vocation or calling, but does not include occupation as an employee'. In FC of T v. Radnor Pty Ltd (1991) 22 ATR 344; 91 ATC 4689, 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) AITR 548; (1953) 10 ATD 226: 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 is considered 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 86 ). Block J subsequently applied them in Shields v. Deputy Federal Commissioner of Taxation [1999] AATA 4; (1999) 41 ATR 1042; 99 ATC 2037: The question is essentially one of fact. In deciding this issue the case law has established the following factors as generally relevant considerations: a) the nature of the activities and whether they have the purpose of profit-making; b) the complexity and magnitude of the undertaking; c) an intention to engage in trade regularly, routinely or systematically; d) operating in a business-like manner and the degree of sophistication involved; e) whether any profit/loss is regarded as arising from a discernible pattern of trading; f) the volume of the taxpayer's operations and the amount of capital employed by him; and more particularly in respect of share traders: a) repetition and regularity in the buying and selling of shares; b) turnover; c) whether the taxpayer is operating to a plan, setting budgets and targets, keeping records; d) maintenance of an office; e) accounting for the share transactions on a gross receipts basis; f) 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 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 that all shares were sold within a year of acquisition, the person was in the business of share dealing. In contrast to this decision, 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 sophisticated share trading techniques, business plan, market research in shares invested, and contingency plan in falling market or 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. 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. | Detailed Reasoning - Application to your facts: After considering the above factors and the specific circumstances, the general impression gained is that Company A was not carrying on a business as a share trader during the 20XX/20YY financial year. Whilst Director 1 argued that he have carried out research on the specific companies that he invested into, and in most cases the shares in those companies were held “to cyclic trade only large cap blue stocks”, that alone is not indicative of whether the company was carrying on a business of share trading. We must consider all the objective facts of the case, including evidence of how the activities were conducted in regards to the repetition or regularity. The level of trading activity is low for an entity carrying on a business of share trading. The irregular trades conducted and large periods of inactivity are not indicative of an activity being carried on in a regular, routine and systematic manner, or of an entity which is following the markets on a daily basis. Director 1 has an informal and undocumented business plan which provides information on the type of trading strategies that you would apply to your activity. He does not see a need to use a “stop loss” to trigger sale requests once the price falls below a specified price. Also, your company business plan has changed twice in 2 years, indicative of an informal plan which is in the nature of a flexible guidance document rather than a firm business plan with specific objectives. Whilst Director 1 has maintained a home office and kept records, these are not determinative factors. Company record keeping is mainly restricted to simply downloading reports from a retail share broking service. There is little to distinguish between your use of your online broker and a normal retail investor. The company has not engaged professional advisers (apart from the broker advice available through your online broker), or a mentor to guide in difficult markets. Similarly the company does not use specialised software to analyse shares or markets and has not provided share trading profits or losses for the various financial years. While none of these is determinative, they do not support the view that the company is engaged in a share trading business. Director 1 did not have full-time employment, however this not a determinative factor in this case. As such the shares owned by Company A are not to be treated as trading stock for income tax purposes as the company is not regarded as carrying on a business of share trading. | Detailed Reasoning - Further Information: The transfer of shares from an entity or individual’s name to a company such as Company A (or any other entity) would involve a change of ownership and hence would have CGT consequences which may require the event to be declared. You should be aware of such potential CGT implications and ensure that such transfers are properly declared.