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 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