Q & A – Share Trading – Income vs Capital

Am I a Share Trader?

To be classed as a share trader, you may be asked to provide evidence that demonstrates you are carrying on a business of share trading.  A ‘business’ for tax purposes includes ‘any profession, trade, employment, vocation or calling, but does not include occupation as an employee’.

The question of whether a person is a share trader or a share investor is determined in each individual case. This is done by considering the following factors, which in the past have been used in court cases:

1. Nature of activity and purpose of profit making
2. Repetition
3. Organisation in a business like manner
4. Volume of trading

Nature of activity and purpose of profit making relates to the fact that Share Traders carry out their business activities for the purpose of earning income from buying and selling shares. A share investor on the other hand invests to earn income from dividends and receipts, but is not carrying on a business activity.

Repetition is a significant characteristic of business activities. To be classified as carrying on a business in this kind of scenario, there needs to be frequency of transactions and/or repetition of similar transactions.

If there are one off transactions then it is most likely they aren’t carrying on a business and therefore cannot be classified as a share trader.

It would be reasonable to expect a share-trading business to involve the study of daily and longer-term trends, analysis of a company’s prospectus and annual reports, and the seeking of advice from experts. Any qualifications, expertise, training, or skills you may have in this area would be relevant to determining whether your activities constituted a business.

To be classified as carrying on a business of share trading, the ATO will also look at the volume of trading. The higher the volume of your purchases and sales of shares, the more likely it is that you will be carrying on a business.

What are the Tax Consequences relating to Share Trading?

If you can demonstrate you are carrying on a share trading business, all share trading profits are subject to tax at your marginal tax rate.  Any losses you incur can be offset against your salary and wages, investment income and any other business profits you derive, subject to non commercial loss measures.

The fact that you may be a salary or wage earner, investor or someone carrying on business as a plumber, accountant, dentist etc, does not alter the fact that you may be treated as carrying on a share trading business. The classification is merely for the purposes of determining how your gains and losses will be taxed. You can’t however, take advantage of the 50% capital gains discount on shares held for more than 12 months. But as a share trader, you probably wouldn’t hold shares for this long anyway.

What if the factors of being a Share Trader don’t fit me?

If the factors of being a share trader don’t fit, you are a share investor. Investors report their activity different to share traders. A share investor invests in shares with the intention of earning income from dividends and capital growth, but does not carry on business activities. If you have been classified as a share investor then there are a few perks to take advantage of.  Profits made on shares are not classed as assessable income, but as a capital gain and are subject to capital gains tax. If the shares have been held for more than 12 months then they are eligible to receive the 50% capital gains discount.

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Commercial Property and your SMSF

A Self Managed Superannuation Fund (SMSF) can hold both commercial and residential property, whether via direct ownership or through a limited recourse borrowing arrangement. A SMSF can also acquire Business Real Property from a related party when acquired at market value. Nominal Stamp Duty can apply to the transfer.

In addition, if the property satisfies the definition of Business Real Property, the tenant can be a related party of the SMSF. For example, a small business owner may purchase a commercial property through their SMSF and then have the superfund lease the property back to the business which is run by the members of the SMSF.

This article focuses on related party commercial lease arrangements and satisfying the Superannuation Industry (Supervision) Act 1993 (SISA) regulations to maintain a complying SMSF.

Business Real Property

If the members / trustees of a SMSF want to own commercial property within their SMSF and lease it back to a business that is a related party of the superfund, the property must comply with the definition of “Business Real Property” (BRP) under the SIS Act.

To comply with the definition of a BRP under the SIS Act, the SMSF must hold an eligible interest in the property and the property must comply with the business use test, which requires the property to be used wholly and exclusively in the running of a business.

Should the property not fall within the definition of BRP under the SIS Act, then it will be considered to be an in house asset and will be subject to the 5% cap rule relating to in house assets.

Commercial Lease

For compliance purposes it is essential that when BRP is leased by a SMSF to a related party, the Trustee of the superfund treats the lease transaction as if it was dealing with a third party tenant i.e. commercial arm’s length terms. This includes enforcing all lease obligations such as rent amounts, outgoings payable, rent reviews etc.

In order to demonstrate the lease is on a commercial and arm’s length basis, the SMSF should hold a formal lease between it and the tenant. The terms of the lease should also be independently verified. The trustees can source this information through a real estate agent working in the property area, property valuer or obtain supporting benchmarking evidence themselves.

A lease is a legally binding agreement between a landlord and a tenant that creates an interest in the property that is subject to the lease. In order for the interest in the property to be binding the agreement needs to be documented in writing. This means that a “hand shake” deal or verbal agreement to lease a property will not be binding – it must be in writing.

In summary, when an SMSF holds commercial property and leases it to a related party, it should:

1.            have the investment contained in its investment strategy;

2.            make sure that the property falls within the definition of a BRP under the SIS Act;

3.            have a written commercial lease agreement in place – on commercial terms; and

4.            ensure that the terms of the lease are complied with at all times.

Disclaimer: The content of this Article is general information only. GeersSullivan recommends you seek professional advice before taking any action based on the content of this Article. Please contact our Superannuation Manager Helen Cooper on (08) 9316 7000 should you wish to discuss your specific circumstances in more detail.

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