If an individual sells shares, the income tax treatment will depend on whether the taxpayer carries on a business of buying and selling shares, or instead, is merely investing in shares.  In particular, a loss on sale of a share might be deductible (eg, against salary) for a taxpayer who carries on a share trading business, but not for a taxpayer who merely invests in shares.   Whether a taxpayer carries on a share trading business is a question of fact, and often a point of dispute between taxpayers and the Australian Tax Office (“ATO”).  In a number of recent Administrative Appeals Tribunal (“AAT”) decisions, the AAT has upheld the taxpayer’s assertion that he or she carried on a share trading business.

Significance of a share trading business

For an individual who merely “invests” in shares, share sales are taxed under the capital gains tax (“CGT”) rules.  Under the CGT rules, broadly:

• only 50% of any gain will be taxable provided the shares have been held for 12 months; and
• a loss (called a “capital loss”) can be offset only against current or future year capital gains.  (It cannot be offset against income such as salary.)

However, for an individual who carries on a share trading business, the tax treatment of share sales is quite different.  In very simplified terms, broadly:

• 100% of any gain will be taxable (because the gain is business profit); and
• a loss will be deductible (because the loss is a business loss) and can generally be applied against the taxpayer’s other income for the year, such as salary.

So, in summary, from a tax perspective, generally speaking:

• if you’re making gains on share sales – it’s preferable not to be carrying on a share trading business (ie, it’s preferable to be merely “investing” in shares); but
• if you’re making losses on share sales – it’s preferable to be carrying on a share trading business.

What is a share trading business?

Whether an individual who buys and sells shares carries on a share trading business (or, instead, merely “invests” in shares) is a question of fact to be determined by the “large or general impression gained” from all the circumstances.  Factors tending to indicate the existence of a share trading business include repetition, profit-making purpose, business-like operations, a business plan, systems, significant volume of trades, and significant capital and time employed.   So:

• a taxpayer who acquires shares solely for dividend income and long-term growth would not be carrying on share trading business; whereas
• a taxpayer who trades shares for many hours each day aiming solely to profit from short-term price fluctuations, buys and sells many shares, has a clear, documented strategy in relation to their activity, uses share-research tools, and has no other employment would, very likely, be carrying on a share trading business.

In practice, however, a taxpayer’s circumstances usually fall somewhere between the above two extremes – making it difficult to determine whether or not their activity amounts to a business of share trading.

ATO skepticism 

Understandably, the ATO is generally wary of any taxpayer who asserts that they:

• did not carry on a share trading business in years where they made gains on share sales, but
• did carry on a share trading business in years where they made losses on share sales.

When the Global Financial Crisis (“GFC”) hit and share prices plummeted, the ATO became especially sceptical.  It issued a Taxpayer Alert in May 2009 warning taxpayers against “artificially adopting specific practices to present a pretence” of carrying on a share trading business.  The Alert was aimed at taxpayers who had treated themselves as mere share “investors” in previous years (being years in which they had made gains on share sales), but who, around the time the GFC hit, purported to have commenced a share trading business and sold shares for a loss.

The ATO’s scepticism may not have been justified in all cases.  For some individuals, starting a share trading business around the time of the GFC would have been a commercially rational and real decision (rather than a tax-motivated pretence).  For example, an individual who had been working in the financial industry and lost their job in the GFC with slim prospects of finding a new role in the short term, may have decided to apply their industry experience to trade shares for themselves, on a dedicated basis.  On the assumption that prices had already hit “rock-bottom” and would likely rise again shortly, such an individual may have acquired shares (or transferred shares they held in a long-term investment account into a trading account) with the expectation of making short-term profits from share trades.

Taxpayers successful at the AAT

Anecdotally, there seem to be many taxpayers who were denied losses (by the ATO) for the 2008 and 2009 income years, on the basis that, contrary to the taxpayer’s assertions, the taxpayer was not in fact carrying on a share trading business.

Some of those individuals have challenged the ATO through to the AAT.

The three most recent Tribunal decisions on this issue handed down during 2011 and 2012, have favoured the taxpayer.  (The decisions were The Taxpayer v Commissioner of Taxation [2011] AATA 545, Mehta v Commissioner of Taxation [2012] AATA 208, and Wong v Commissioner of Taxation [2012] AATA 254.)  In each case, the Tribunal decided that the taxpayer was carrying on a share trading business in the relevant income year (ie, 2008 or 2009) even though the taxpayer might not have been carrying on a share trading business in earlier income years when they made gains from share sales.

The ATO has not sought to appeal these decisions.

Significance of the AAT decisions

What is the significance of the recent AAT decisions for other taxpayers?

• For one, the decisions mean that a taxpayer who was denied losses (by the ATO) for a previous income year (especially during the GFC) on the basis that the taxpayer was not carrying on a share trading business, but whose circumstances are comparable to those of taxpayers in the recently decided AAT cases, could possibly now seek redress.  The usual path for challenging an unsatisfactory ATO income tax assessment or amended assessment is to “object” to the ATO (within a prescribed time frame – between 60 days and four years, depending on the circumstances); and, if the objection is unsuccessful, the taxpayer can then appeal to the AAT or the Federal Court (within 60 days of the ATO’s unfavourable objection decision).  Nevertheless, it is possible to obtain an extension of these time limits, and in some circumstances, taxpayers have been granted significant extensions (including of more than 4 years).  The strength of the taxpayer’s case is one factor taken into account in determining whether an extension of time should be allowed; so, if the taxpayer’s circumstances are comparable to those of the taxpayers in the recent AAT decisions, an extension might be possible.

• Looking ahead, the decisions may also affect the ATO’s prospective approach to taxpayers who assert that they are carrying on a share trading business.  Specifically, the ATO may be more likely to issue favourable private rulings on the point; and may be less hasty to challenge taxpayers who self-assess on the basis that they have been carrying on a share trading business.  However, any prospective change in the ATO’s approach might be more helpful to some taxpayers than others.  Due to legislative amendments that apply from the 2010 income year onwards, a taxpayer who is a ‘high income earner’ (ie, a taxpayer with a modified taxable income of $250,000 or more) is no longer able to deduct their share trading business loss for an income year against other income they make in the same year.  Instead, any share trading business losses incurred in or after the 2010 income year, must be “carried forward” and applied against subsequent year profits of the share trading business.