If you dabble regularly in share investment, the question might arise as to whether you have moved beyond being a passive investor in shares to someone who actively trades shares. It’s a crucial question to consider because it will determine how you’re taxed on any profits or losses you make on your share portfolio writes Mark Chapman, Director of Tax Communications at H&R Block.
A share investor is generally someone who buys shares intending to hold them long-term to generate profit through growth in value and income through dividends. Any profits or losses made from selling as an investor would be subject to the CGT rules.
A share trader, that is, someone carrying on the business of dealing in shares, buys and sells shares purely for short-term profits and generally has some or all of the following hallmarks:
- a substantial volume of transactions;
- a clear profit-making intent; and
- a substantial commitment to conducting activities in a business-like manner (eg a large investment of capital, a well-developed business plan, extensive research and properly maintained books and records).
Someone who buys and sells shares as part of a business treats those assets as trading stock, and gains on their disposal will be treated as ordinary income rather than capital gains.
ITAA97 s 8-1 provides that “you can deduct from your assessable income any loss or outgoing to the extent that … it is necessarily incurred in carrying on a business for the purpose of gaining or producing your assessable income”.
As such, this is a key advantage of running a business of share trading; if losses are made, they can then be offset against other income.
For share investors, any losses will be on capital account which makes it difficult to get the full benefit since capital losses can only be offset against other capital gains arising either in the same year or a future year.
By contrast, the key advantage for a share investor arises if the investor is showing a profit, which will be taxed as a capital gain. The 50% capital gain discount will apply to all shares sold that are held for more than 12 months — the effect is to reduce the tax payable on capital gains by half.
If the nature of the activity changes from investing to trading, the shares change from being CGT assets to trading stock. When this happens:
- CGT event K4 occurs and a capital gain or loss arises on the shares, based on their market value at the time of the change; and
- any unused capital losses from previous years (when the taxpayer was an investor) remain as capital losses and cannot be converted into revenue losses.
If the nature of the activity changes from trader to investor, the shares are no longer trading stock.
If you’re not sure whether you’re an investor or a trader, you might need to apply to the ATO for a Private Ruling.
Deductions available
For both investors and traders, you will pay income tax on any dividends that you receive whilst you hold the shares, against which you can offset:
- interest on borrowed funds where you have financed your portfolio using those funds;
- borrowing costs incurred in arranging finance, such as legal expenses, loan establishment fees, etc (deductible over five years or the term of the loan, whichever is shorter, unless the amount is $100 or less in which case its immediately deductible);
- bank charges for bank accounts to manage your investment income and expenses;
- management fees or retainers paid to a financial planner (but not the initial costs of drawing up an investment plan);
- the cost of running a home office to manage your share portfolio (including telephone, computer and internet expenses);
- the cost of investment-related journals and subscriptions;
- costs of obtaining tax advice; and
- travel costs associated with your share porfolio, such as trips to see your financial planner or stockbroker, or the cost of attending AGMs.
You can also claim depreciation on any assets used to manage your portfolio, such as computers, laptops, etc, with the deduction apportioned between private/domestic use and use in managing your shares.