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Share Investing vs Share Trading, and how it affects your tax

In our last article Income Investing vs Growth Investing, we mentioned the significant differences in the taxation rules. Let’s investigate the tax rules and how this might affect your tax obligations in share portfolios. There are some common misunderstandings around...
Trading Themes
5 Min Read
In our last article Income Investing vs Growth Investing, we mentioned the significant differences in the taxation rules. Let’s investigate the tax rules and how this might affect your tax obligations in share portfolios. There are some common misunderstandings around this topic for new traders. Depending upon how often you trade in and out of companies, you may be classified as a trader. Investors and traders are subject to different tax rules, which can significantly affect tax liabilities. How does the ATO ruling apply under tax law, and how does it impact your tax?

How you obtain shares

You can obtain shares in several ways, most commonly by buying them. Keep track of your share transactions to claim everything you are entitled to, and accurately work out your tax. If you are an investor, your gains and losses are subject to the Capital Gains Tax (CGT) system. If you hold an asset for at least 12 months, you can take advantage of the 50% CGT discount. However, it is important to remember, losses can only offset future capital gains and not other income types tax liabilities. Depending on whether you are a share trader or a share investor, you will deal with income and expenses differently. A share trader conducts business activities to earn income from buying and selling shares. A share investor invests in shares to earn income from dividends and capital growth but does not carry on business activities.

Paper losses

Capital losses only happen when you dispose of the investments, e.g. selling off your shares. If the price drops but you continue to own the investment, it’s known as a ‘paper loss’. You cannot claim ‘paper losses’ on investments. If you have a capital loss from the disposal of investments, you can offset this against capital gains. You cannot offset the loss against other types of income tax liabilities. You can declare the loss in your tax return, and it can then be carried forward as an offset against future capital gains.

Deductions when obtaining shares

You can not claim a deduction for some of the costs associated with the purchase of your shares; such as brokerage fees and stamp duty. However, you can include them in the cost base (cost of ownership – which you deduct from what you receive when you dispose of the shares) to work out your capital gain or capital loss. You need to keep proof of all your share transactions from the beginning, to ensure you can claim everything you are entitled to.

Records you need to retain:

  • The date of purchase and reinvestment.
  • The purchase amount or value.
  • Details of any non-assessable payments to you.
  • The date and amount of any calls (if shares were partly paid).
  • The date of sale and sale price (if you sell them).
  • Brokerage costs or commissions paid to brokers when you buy or sell.
  • Details of events such as share splits, share consolidations, returns of capital, takeovers, mergers, demergers, and bonus share issues.
  • Details of capital losses made in previous years – you may be able to offset these losses against future capital gains.
  • Dividend or distribution statements (Standard Distribution Statements or Attribution managed investment trust member annual (AMMA) statement).

Nature of activity and the purpose of profit making

A share trader carries on business activities for the purpose of earning income from buying and selling shares. Shares may be held for either investment or trading purposes, and profits on sale are earned in either case. A person who invests in shares as a shareholder (rather than a share trader) does so with the intention of earning income from dividends or capital growth but is not carrying on trader business activities. You need to consider not only your intention to make a profit but also the facts of your situation. This includes how your activities have been carried out.
  • The purpose behind your trading activities.
  • The frequency and volume of your trades.
  • The organisation and business-like manner of your activities, including technical analysis, looking at daily trends and your expertise and skills, would also be relevant.

Amount of capital invested

The amount of capital you invest in shares is not a crucial factor in determining whether you are carrying on a business of share trading. It is possible to carry on business activities with a relatively small amount of capital. On the other hand, you could invest a substantial amount of capital and not be considered a share trader.

Can I change from an investor to trader, or trader to investor?

Yes, you can! If you re-classify your activities, the way you treat your shareholdings will be affected. Now let’s look at switching:
Changing from investor to trader
If you re-classify your activities, the way you treat your shareholdings will be affected. You can expect the ATO to request evidence that:
  1. the nature of your activities has changed.
  2. you have reported your income correctly in the past.
If they review your tax returns and find that you have incorrectly claimed losses, you may be subject to penalties.
Changing from trader to investor
If your activities change from trader to investor, your shares are no longer trading stock. At the time of the change, you treat your shares as if:
  1. just before you stopped trading stock, you sold them to someone else (at arm’s length and in the ordinary course of business) for their cost.
  2. you immediately bought the shares back for the same amount.

Tax treatment of share investors and share traders

Cost or receipt Share investor Share trader
Profit from the sale of shares Subject to capital gains tax Assessable as ordinary income
Loss from the sale of shares Used to offset capital gains or carried forward to offset future capital gains.

Cannot be used to offset income from other sources.
Deductible against income
Dividends and similar receipts Included in assessable income Included in assess income
Purchase price of shares Taken into account in calculating capital gain or loss when shares are sold Deductible in the year incurred
Transaction costs of buying or selling shares Included in assess income Deductible in the year incurred
Costs (such as interest on borrowed money) incurred in earning dividend income from shares Included in assess income Included in assess income

This looks easy, right? Now that you understand, you can aim to maximise tax deductions, well, not quite, as this could be deemed as tax avoidance.

Pitfalls – What is a wash sale?

Wash sales typically involve the disposal of assets such as crypto and shares just before the end of the financial year, where after a short period of time, the taxpayer reacquires the same or substantially similar assets. This is a wash sale and is done to create a loss to offset against a gain already derived or expected to be derived, in certain circumstances, in a tax return.

A wash sale is different from the normal buying and selling of assets because it is undertaken for the artificial purpose of generating a tax benefit for the current financial year. The taxpayer disposes of and reacquires the asset for the deliberate purpose of realising a capital gains loss and obtaining an unfair tax benefit.

Conclusion

Understanding if you are an Investor or Trader will help ensure you meet your tax obligations correctly. Do not be tempted to wash sales to avoid paying your fair share of tax. Remember, you are not paying more tax; it just changes how your tax is calculated. The ATO’s sophisticated data analytics can identify wash sales through access to data from share registries and crypto asset exchanges. When the ATO identifies this behaviour, the capital loss is rejected, resulting in an even more significant loss to the taxpayer.

Safe trading!


Written by
Alastair Kennelly

References:

ATO Tax Treatment – https://www.ato.gov.au/individuals-and-families/investments-and-assets/capital-gains-tax/shares-and-similar-investments/share-investing-versus-share-trading
ATO Wash Sales – https://www.ato.gov.au/media-centre/wash-sales-the-ato-is-cleaning-up-dirty-laundry

The information provided is of general nature only and does not take into account your personal objectives, financial situations or needs. Before acting on any information provided, you should consider whether the information is suitable for you and your personal circumstances and if necessary, seek appropriate professional advice. All opinions, conclusions, forecasts or recommendations are reasonably held at the time of compilation but are subject to change without notice. Investments can go up and down. Past performance is not necessarily indicative of future performance.

Alastair Kennelly
Guest Author
Alastair has worked in the Financial Services arena for over 17 years. His wealth of experience spans from large investment firms through to bespoke wealth management and personal advisory services.
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