44 – Investor or trader?

Dover requires all equity or property based investments to be held for a minimum holding period of ten years. This is a common sense precaution to make sure clients are never near the speculative high risk end of the market and are true investors, making decisions based on long term expected dividends and capital gains.

This Friday Reflection helps explain why: Smell the serenity.

Dover does not allow share trading type activity, particularly individually managed accounts. We see these as too risky and just big accidents waiting to happen. And individually managed accounts are not allowed under our licence.

So you can imagine my surprise when I opened an e-mail from a Dover adviser asking about the tax implications of buying BHP at $20.00 a share in late 2015 and selling at $15.00 a share in early 2016.

The question was “could a client’s loss of $5.00 per share, a total of about $20,000, be claimed as a tax deductible loss against his salary income in the 2016 year?”.

The answer was “no”. Let me explain why.

Many accountants and financial planners talk as if there is some right of election, a box to be ticked somewhere, to choose whether you are a trader taxed on your profits and losses as ordinary income or an investor taxed on your profits and losses under the concessional capital gains rules.

This is not so. The distinction is based purely on the facts. Intention, or at least a taxpayer’s claimed intention, is one fact and is relevant to the enquiry. But it’s only one fact, and will usually be self-serving and therefore given little weight on its own without collaborative facts.

The ATO view 

The ATO will usually look at:

  1. the purchases patterns, looking for regularity and system;
  2. share trading software packages
  3. advice from mentors/experts
  4. a history of returning profits as ordinary income (ie no CGT exemption claimed).

You can read an article by Misa Han published in the Australian Financial Review on Friday 19th February 2016 here: Childcare worker denied a deduction for day trading.

Why be a trader?

In the long run most shares will appreciate in value and therefore most taxpayers will in the long run be better off under the capital gains tax regime, enjoying the 50% discount on most gains on most assets held for more than 12 months.

It is a rare case where the facts support a conclusion that a taxpayer is a trader. Not many people are in fact traders. It’s a high bar that few can clear.

It is an even rarer case where facts occur that makes a taxpayer want to be a trader. This rare case is where the taxpayer:

  1. has not made past profits taxed under the capital gains rules
  2. has made a loss on a share, or similar asset and
  3. does not expect to make future profits taxed under the capital gains rules.

The ATO has issued a Taxpayer Alert dealing with taxpayers who seek to reclassify themselves as “share traders” following a significant market loss. You can read Taxpayer Alert 2009/12 here: Taxpayer Alert 2009/12.

Normally traders pay more tax than investors. From a tax planning point of view being a trader is a not a pleasant experience: there is no 50% CGT discount on capital gains.

The good news is the adviser had not broken Dover’s rule against equity investments with minimum holding periods of ten years. The client is a new client, and the adviser was helping clean up someone else’s mess.

I suggested a FOS complaint…

The Dover Group