Trading vs Investing (part two)

I wrote recently about how the tax office decide whether someone is an investor or a trader, and promised to write about the advantages of each. If we look at this from a tax perspective, there are many benefits to being a trader:

  • The first is something called the entrepreneurs tax offset. This is claimable if you have a gross revenue of under $50,000 and record a profit. If you have a gross revenue of over $50,000 then your offset decreases until you have revenue of over $75,000 when it is no longer claimable. This basically means you can offset 25% of the tax payable on the profit that your business made.
  • The second is the 50% tax break for small businesses purchasing assets (over $1000) before the 01/01/2010. For example if you as a trader were to buy a laptop worth $1500 for trading purposes, then you could potentially claim $750 of it immediately, as well as the depreciation for the first year. This means you could claim $975 of the laptop in the first year alone!
  • In regards to depreciation of assets, you can claim more outright as a trader than you can as an investor. As an investor any assets purchased valued between $300 and $1000 must go into what is called the low value pool. This means that 18.75% of it is claimable in the first year and 37.5% is claimable in subsequent years. With a business assets up to $1000 in value can be claimed outright as a low cost asset!
  • With capital gain events, if you make a loss then you have to wait until you have another CGT event to offset those losses. If you are running a business with a gross revenue of over $20,000 (which you would probably want to be able to justify running your trading as a business) then you can offset your losses against other income to reduce tax. Of course you don’t want to be making losses but this is a handy advantage to have up your sleeve if the market tanks on you.
  • Lastly, sometimes it is easier to claim more as a share trader than as a share investor. An investor can hardly justify claiming large portions of internet costs, computer and costs, magazines etc if they are only making 2 purchases a year!

As an investor, however, there are still some advantages to consider:

  • Any shares held for over twelve months can become eligible for a 50% discount, meaning that you only need to pay tax on half of the gain made.
  • If you already have capital losses from previous events, these can only be used up against other capital gains. So this would be a time where being an investor could have a tax advantage over being a trader.
  • Record-keeping is often a lot easier, and you don't need to account for stock-on-hand each year until it's actually sold.

In many cases, as you can see, there is often an advantage in both sides and this is where it's good to plan with your accountant which case you want to build.

No more tax returns?!

It’s that time of week again, for the Share Trading update. It’s been a very interesting week this week with David taking the lead and sitting on 24,319, but James isn't very far behind at all. But it is still early and anyone still has the chance to win.

Next week is the last chance to join this round if you’re interested in building up extra knowledge about trading shares or just want to have some fun. Just email me and I’ll get you started!

On a different but interesting note,

We found a very interesting article in the news this week that we thought that you may like to be aware of. In short, the Tax Office are thinking about calculating all basic individual tax returns for you and just sending you what they think you should get as a refund. Obviously this wouldn't apply to investors and businesses but it could be a good move to make things easier for most people. The other thing with this is that it would free up more Tax Office resources to look at other taxpayers instead, so it would be even more important to always remember to keep your receipts and records in good order!

Oh, and we also posted that article on our facebook page as well. You should check that out too and see the other interesting things that we find from time to time.

Trading vs Investing

Many of us hold shares. Not all of us however are share traders. So how do you know whether you are a share trader or a share investor?

Well there is not usually a definitive yes or no; whether an entity is trading or investing is often subject to some elasticity. The ATO however have certain qualifiers which they use to determine the difference.

Some of the questions they consider include:

  • Is the entity seeking to make a profit? Of course it is the goal of most people to make a profit, so the ATO need more proof than that to justify an entity being called a trader.
  • How regularly is the entity buying and selling shares and what is the volume of shares transacted? Someone who might buy $5000 worth of shares a couple of times a year and maybe sell one lot a year can hardly be said to be making a business out of the shares. On the other hand someone buying a new lot of shares every week and selling as often clearly would be.
  • What was the reasoning and purpose behind the share purchase? It is a common thing for investors to purchase shares to receive dividends, and hold for the long term. Though they may make a large capital gain that is not their sole purpose from buying. Traders on the other hand may make a purchase with the clear intention on making as much gain in as little time as reasonable, and any dividends picked up are bonuses.
  • What is the timeframe on buying and selling shares? Traders like to get in and out of trades reasonably quickly, although this will vary trade to trade, and one trade can go many months. Investors on the other hand can hold shares for many years without selling.
  • What sorts of records are being kept to do with the transaction of the shares? All businesses need to keep good records. Therefore if you want to convince the ATO that you are in the business of share trading, it’s a good idea to keep good records. Records of share analysis and financial reports as well as your own tax records are good examples of this.
  • How much money is being involved? Both traders and investors can involve large amounts of money, but if an entity is regularly pumping large amounts of money in to buy more shares, and then reinvesting profits, on a regular basis then this behaviour mimics the behaviour of a trader.

So there are a number of things that we can look at in making that judgement call. Sometimes a case can be built either way, so it then comes down to having a solid argument to defend for if the tax office ask questions about it. Next time that I get on here, I'll write about some of the advantages of being treated as a trader or investor so you can see the difference in each.

Running late?

Like every Friday afternoon now, first let's see the sharemarket game update. James is still winning and up to $21,737 after only two weeks but it's early days yet and a few players including our last winner David R not too far behind.

It's still not too late to join this round of the sharemarket game, so show us your stuff and take up the challenge. Just email me to find out how to get started.

The other thing we need to tell you about is the tax office lodgement program. What that means for you is that if you're planning to change accountants or haven't done anything with your new accountant yet, and you want us to be involved in that process somewhere,  then the tax office usually like to know about it before 31st October where possible. So if that's you, maybe best to let us know about it sometime in the next two weeks so we can help organise an extension for you.

Have a great weekend!  =]

Looking back to look forward

Dr Ken Henry is the bloke behind what is commonly known as the 'Henry Review'.  The purpose of his existence during recent history and up until December this year is to analyse the current tax system in some level of detail, and put forward his recommendations to the Government on how to reform it for the better.

Every so often, Dr Henry has been invited to speak at various functions, and his tax reform speeches are published online about a day afterwards.

Believe it or not, those speeches actually make for quite interesting reading (ahem... if you're into that sort of thing).

The most recent of these is about how the tax system has already gone through review processes, on many occasions now, and that's precisely what's got us into the mess that we face today. He, as you would presume, writes (speaks?) a little more eloquently about the subject than I.

'The Lessons From Tax Reform Past', for those who have neither the time nor inclination to read the link, are, in order;

  • The case for reform must be compelling
  • Uncertainty and risk impose costs, too
  • Simplicity often gets left behind
  • Perceptions of equity matters a lot
  • Governments need effective tools to improve people's lives

In particular relation to that last point, Dr Henry also writes about the whole purpose of such reform.  Towards the conclusion to his speech, he offered the following statement;

"Successful tax reform is not just about increasing GDP or revenue, or making the system easier to understand, or more sustainable, or fairer, or better able to assist governments to address various social problems. It is concerned with all of these things. Successful tax reform means improving the wellbeing of the Australian people."

Hopefully, his recommendations are taken seriously...

Who's afraid of the big bad wolf?

First of all, just a reminder that the new House of Wealth sharemarket game, for Q2/2010, started today. The last round was great fun, with one of our new clients managing to overhaul my profits in the final stages of the game to claim the win and leave me in second place, for the second time in a row. Andrea & Stephen rounded out the top 3, after winning the Q4/2009 series, which is a brilliant effort on their part, too.

It's a great way to learn how the market works before risking too much skin in the real world. In the next couple of days, we'll be talking to Andrea & Stephen about their investing strategies and ideas, so that you can learn from their proven methods as well. So, if you'd like to play this round, please contact Dannielle and she'll get you hooked up.

Moving on;

Audit insurance is quickly becoming more and more common in the accounting industry. In short, it's (yet another) form of insurance that you can pay for, which is supposed to cover your accounting fees in the event of an audit from the tax office.

To be perfectly honest, in most cases... it's a rort. Waste of money; consider donating it to charity instead.

For most investors that we deal with, the cost is likely to outweigh the potential benefit. Full-blown audits are relatively rare, as the tax office data-matching and analysis often means they know the answers before having to ask the question. Usually, the inquiry is a simple question that is dealt with quickly and easily. And so if there are any accounting fees necessary, they're usually quite small.

Provided, of course, that the client has their records in good order.

Do you?

Kicking the bucket

Ok, another fun update on trusts. Today's AFR and various other media outlets are reporting that the tax office wants to take a harder stance on trusts that are using what's commonly referred to as 'bucket companies'.

For background; bucket companies work when a discretionary trust has substantial net income and / or when all of the individual beneficiaries exceed the 30% tax bracket. The remaining profit from the trust is then given to a company for tax purposes, whilst the trust continues to hold the funds with an (unpaid) entitlement for the company. Ie, the cash never leaves the trust and is simply retained and reinvested instead.

The benefits are obvious; all the benefits of using a trust, plus tax is capped at a maximum 30% and the trust has free reign to continue investing without loss of capital.

Is the bucket still a viable structure?
Is the bucket still a viable structure?

This strategy, however, is something that both myself and my old man (Dale Gatherum-Goss), have been cautious about for some time now. The potential danger, as it appears the tax office is now looking at, is that generally speaking there is going to be tax to be paid somewhere along the line whenever funds leave a company. So from that, we can see that by not actually paying the entitlement it is then possible that the company should be receiving interest on the funds owed to it. This could potentially be seen as a similar arrangement, for example, as a debit loan scenario involving a company and its directors.

Having said that, it is a consideration only at this point and not one that most people need to worry too much about. If - and it is only an 'if' so far - the tax office does go down this path, it will be a complete backflip on previous tax rulings that they have released. I would expect that given the way many accounting firms' partners structure their affairs, including many at the Big4, the industry itself will be the first to object to any change in the law here.

At first glance, it sure looks like Michael D'Ascenzo isn't a big fan of the structures lately. More likely, though, is that the tax office is simply looking to provide greater clarity and in doing so, close various loopholes currently open to exploitation.

Adding control

Over the next week or so we'll be telling you all about a couple of changes in the weird and wonderful world of trusts as interpretations of recent - and ongoing - case law start coming to light. Information from our legal team is still filtering through, so we'll be sure to keep you posted as the fine print is digested and can be translated into something that makes sense to everyone.

The first of these changes is the introduction of a new role available for any future trusts that you might be looking to set up. This role is called the 'controller', and does exactly as it suggests.

Always nice to have control...
Always nice to be in control...

The idea being, that this third party can veto or approve any changes to the structure that the trustee may wish to make. Such changes could include adding or removing any of the beneficiaries, adjusting the vesting date, or, editing the trust deed. This gives better control over the structure, particularly in the unfortunate circumstances of it being examined in court.

The role is not a mandatory one, but future deeds will at least have the potential to appoint such a person. Advice to date suggests that this controller should ideally be a natural person, and a third party to the existing appointor and trustee. So, appropriate persons could include your solicitor or other professional advisor, or perhaps a trusted friend.

Even if the position will remain vacant to begin with, we do recommend that new trusts should be created with this role available so that it can be filled at a later stage. We have also been advised, though, that older deeds cannot add the position to the existing structure without re-settling the trust.

Of course, as always, just shout if you want more information or guidance on this or any other structural issues. We'll be happy to help.

Forest for the trees

Buying trees don't always yield much of the green stuff for you...

Following on from other recent posts about goal-setting, I thought it might be worthwhile to look at one of the traps that we see people falling into from time to time. The agri-business sector has, for a long time, been promoted as an avenue towards paying less tax by borrowing money to 'invest' in trees or olives or other such things that tend not to provide much of a yield or growth.

Many of these managed investment schemes also tend to pay ridiculously high commissions to financial planners and accountants when they recommend such products to their clients.

Important note - we never have.

Sure, paying less tax is always nice. I won't argue with that idea. But, it is far more important to keep sight of your goals and act with those in mind.

Dale used to teach us this focus by asking one simple question; "Does that idea bring you closer to, or, further away from, your goals?'

I think that this is a good way to look at any financial decision. Does buying a collection of trees bring you closer to your goals? Generally not, I'd suggest, unless you own a nursery or can see potential to flog them at a profit come December. Very rarely do we see anyone make a profit out of these things.

A couple of these companies have gone under in the last twelve months, too, which might also give a good indication of just how sound this type of 'investment' might be...

There are much more important things to focus on than paying less tax. A massive tax bill usually means you've made a massive profit - and that's hardly something to get too upset about. It also highlights the importance of talking these things over with your accountant well before the financial year is already over, to make sure that you're still on the right track and not getting sucked into schemes that usually just don't add up.

For research, of course

We received notice last night of a tax office response to a court case held last year, which determined that a travel agent was able to claim the significant costs of overseas travel to further his knowledge base and thus increase his income from his regular employment.

If you've got the time and inclination, you can read about it, here; Carlos Sanchez v Commissioner of Taxation.

Whilst this may not necessarily be directly related to your own circumstances (although I know that there are one or two agents reading this), these sorts of things do provide interesting insight about the thought processes at tax office and how they deal with these sorts of issues.

In this case, the travel agent in question earned a little under $40k in the 2005 year (made of retainer, commissions and bonuses), which increased to some degree in the following two. The agent also claimed around $10k in travel expenses - a good quarter of his income - despite being on annual leave at the time and receiving no allowance from his employer.

The tribunal stated;

The Tribunal was satisfied that the applicant's calling as a travel sales consultant required degrees of knowledge and skill that would benefit from personal experience of the travel components he sold to his customers, and that the 2005 overseas travel directly contributed to that knowledge and skill, and also contributed (or was likely to contribute) to his earning increased income.

The Commissioner accepted this view and allowed the majority of the deduction. It is important to note that the agent took comprehensive notes during his travels and this contributed strongly to the treatment of his case. It's also important to note that the tax office eventually disallowed a good portion of the agent's claims on the basis that he could not properly substantiate them. So even though the basis of the claim was decided to be alright, the tax office still went through with a fine tooth comb to make sure that the actual cost could be proven.

So! Lessons to be learned from this, in all of your potential deductions; keep damn good records. And if you're doing something significant, keep extensive notes about the how and why of what you're trying to achieve. It might seem a little painful at the time (especially if you're supposed to be out exploring Spain instead - for research, of course) but it may count for a lot in the long run.