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Day Trader & Investor Status for Tax Purposes
There is a big difference between what stock market enthusiasts mean by the terms “share trader” and “share investor” and what the taxman takes these words to mean.
Lee Hadnum from TradersTaxClub >> explains the pros, cons and implications of each.
What's the Difference?
A share trader is taxed in a completely different manner to a share investor.
The fundamental difference is that a trader will hold shares as his ‘stock’, much as a motor dealer holds cars or a supermarket cans of beans. In comparison, an investor is believed to hold shares as assets, which are used to generate income - dividend income in this case.
The important difference between share traders and share investors is that share traders pay Income Tax wheras share investors pay Capital Gains Tax.
Which is Better, Being Classed as a Trader or an Investor?
Before the 2008 budget for most share speculators there were not significant differences between share trader and share investor status.
Share trader status allowed more expenses to be offset, whilst share investor status allowed taper relief and the annual exemption to be offset. Given that many share speculators held shares for only a short period this meant that for both share investors and share traders the tax rate was likely to be 40% (assuming they were higher rate taxpayers).
Of course there were always the genuine share investors who held shares long term and qualified for an effective CGT rate of 24% or even 10% if they invested in AIM shares.
The withdrawal of taper relief from April 2008 and the introduction of a fixed 18% rate of CGT means that in most cases share investors will now have a significant tax advantage over share traders. In particular it is unlikely that the additional tax relief on expenses would cover the massive reduction in the tax rate that now applies to share investors.
Share trader treatment does have an ancillary benefit in that the treatment of any losses you incur is much more flexible. So rather than just being carried forward and offset against any more capital gains, you can actually offset the losses against any other income for the tax year of the loss.
You could therefore offset the loss against any employment income, interest income or trading income you may have. If you’ve suffered a tax deduction at source eg for salary payments or interest receipts, you’ll be looking to get a tax refund from the taxman.
However if a share speculator claimed share trader status in order to benefit from the loss relief, the Revenue would usually closely review the trading status.
The significant tax benefits associated with share investor status would indicate that this is an area that the Revenue will pay more attention to in the future.
Will you be classed as a share trader?
HMRC fall back on what they term the ‘badges of trade’ to determine whether an individual’s activity is trading or investment in nature.
There is no straight answer as regards to purchasing shares, however, in general the following principles have been established through a number of judicial decisions, where there has been some doubt as to whether a series of transactions (or in some cases one transaction) can be defined as amounting to a ‘trading activity’:
1. Motive of the taxpayer
This is crucial, although it is also often the most difficult area to actually prove to the Revenue’s satisfaction.
If the Revenue believe that the motive in buying and selling the shares was the realisation of profit, this would be a significant factor when deciding whether to treat the transaction as trading.
Clearly this is a vague notion and in practice can be difficult to rely on and they will not rely solely on your own opinion of your intention, rather they look at the facts of the transaction to ascertain the ‘true position’. Matters to be considered will include:
• whether the share purchase is an isolated event. The test that HMRC will apply is whether the operations involved in the transaction are of the same kind or character, and carried on in the same way as other typical share traders.
• whether the taxpayer has any other employment/self employment or whether this is his sole ‘occupation'.
• whether on the sale of the shares, the taxpayer reinvests the proceeds in buying more shares.
2. The Actual Transaction
They will also look at the circumstances of the actual transaction to identify whether any aspect of this indicates a trading motive.
In particular they will assess:
• The length of time between the purchase of the shares and the disposal of the shares
• Whether the shares were ‘acquired’ by way of inheritance or whether they were purchased. Clearly shares that were inherited and subsequently sold would be less likely to be classed as trading, and more likely to constitute an investment activity.
• Whether any finance was obtained for the share purchase.
• what was the cause of the sale. The sale of the shares for an ‘emergency’ may make the likelihood of the transaction being trading less likely.
• The frequency of the share transactions, ie the number of share purchases and disposals the taxpayer enters into. This will be a KEY factor that will be considered in practice. They will be looking for evidence of a ‘continuous and habitual’ activity, ie regular purchases and disposals of shares as opposed to infrequent and sporadic share purchases and disposals
Whilst the above factors are all considered, the general view of the Revenue is that the purchase of income producing assets would usually be considered investment assets.
Shares are by their nature more likely to be held as investments and in particular one judge has said:
“...Where the question is whether an individual engaged in speculative dealings in securities is carrying on a trade, the prima facie presumption would be ... that he is not.”
It used to be only in exceptional circumstances that an individual’s share transactions would be considered to amount to a trading activity. However given the changes to the tax rate for investors it is likely that where there is a systematic and frequent activity of buying and selling shares the Revenue will pay much more attention to the trading argument.
You can learn more about trader tax status along with lots of tax saving tips at www.traderstaxclub.com >>
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