Private ruling: Nature of profits earned from trading margin foreign exchange contracts.
Published: December 2013
Ruling period: Income year ended 30 June 2013
Date scheme commenced: 1 July 2012

Ruling: Q1: Are your margin foreign exchange contracts (Margin FX contracts) traded with an on-line broker considered to be transactions on capital account? | A1: No.

Relevant facts and circumstances: You commenced trading Margin FX contracts with an on-line broker sometime during the income year. From that time, until the end of the financial your monthly trading volumes were on average approximately 25 transactions per month. It is noted from your supplied transaction listing that these numbers are for closed out transactions - that is for the period in question there were approximately 25 purchase activities per month, and 25 sale activities per month. A total of approximately 50 transactions per month were undertaken. You only traded in one particular cross currency pair using a margin account. You make deposits directly to your trading account. Only the outcome of your closed out trade is deposited to, or debited from, your trading account. There is no ownership of the underlying asset traded.

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 15-15 | Income Tax Assessment Act 1997 Section 25-40 | Income Tax Assessment Act 1997 Section 70-10 | Income Tax Assessment Act 1997 Section 102-10

Reasons for decision: Detailed Reasoning - Margin FX contracts: A derivative is a class of financial instrument in which the value of a derivative is based on the value of some underlying asset. Derivatives are in substance an agreement between two parties to purchase or sell to each other some goods at a specified time in the future. Margin FX contracts are a type of derivative where you may make a profit or incur a loss arising from fluctuations in the price of the contract. The price of the Margin FX contracts is based on the price of an underlying currency. However, you do not own or have any interest or right to the underlying currency or have an ability to trade it on an exchange by owning a Margin FX contract. Margin FX contracts are entered into with your broker, not a third party. The amount of any profit or loss made on a Margin FX contract is the net of the difference between the price of the contract when your position is opened and the price of the contract when the position is closed. The trading of Margin FX contracts is in keeping with trading of futures, or contracts for differences. In both these cases, the activity is of an income nature. Both activities involve the entering into of contracts which are then closed out by creating equal and opposite transactions. As there is no ownership of the underlying asset, no asset has been purchased or sold. It follows that these transactions cannot be accounted for as capital transactions, as no capital asset has changed hands. | Detailed Reasoning - Carrying on a business of trading Margin FX contracts: If you are carrying on a business of trading Margin FX contracts the profits are to be treated as assessable income, and losses are allowable as deductions. However, Margin FX contracts would not represent trading stock. You only take your net closed out position into account when calculating your profit or loss. Business profits are included as part of your business income at label I15 - Net income or loss from business. | Detailed Reasoning - Speculative transactions: If you are not carrying on a business of trading Margin FX contracts the activity will still be of an income nature. Your profitable trades will be assessable as ordinary income, and should be included at label I24 - Other income on your tax return, while your trades resulting in a loss should be included at label D15 - other deductions. | Detailed Reasoning - Application of the law to your facts: You are trading Margin FX contracts, which are by nature an income product. Whether your activities are considered to constitute a business being carried on, or are of a speculative nature the profits will be considered to be ordinary income, and your losses will deductible against your ordinary income. In either case, profits from trading Margin FX contracts are not of a capital nature and must be included in your tax return as ordinary income.