cfds vs shares, page-11

Here is a copy of the taxation ruling Re: CFD's
If you'd like I'll send you a copy of the PDF however it's all there at the ATO's site
Regards
Maka

Taxation Ruling
TR 2005/15
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Taxation Ruling
Income tax: tax consequences of financial
contracts for differences
Preamble
The number, subject heading, What this Ruling is about (including Class
of person/arrangement section), Date of effect, and Ruling parts of this
document are a ‘public ruling’ for the purposes of Part IVAAA of the
ministration Act 1953 and are legally binding on the
r. Taxation Rulings TR 92/1 and TR 97/16 together explain
Ruling is a ‘public ruling’ and how it is binding on the Commissioner.
Contents Para
What this Ruling is about 1
Date of effect 10
Taxation Ad
Commissione Ruling 11
when a Explanation 16
Alternative views 46
Detailed contents list 74 What this Ruling is about
1. This Ruling is about the income tax consequences of entering
into financial contracts for differences.
Class of persons/arrangement
2. The Ruling applies to persons who enter into financial
contracts for differences (these are described below). It does not
apply to those products currently marketed in Australia as financial
spread betting transactions and which have different cash flows and a
bigger spread.
Background
3. Contracts for differences are a form of cash-settled derivative
in that they allow investors to take risks on movements in the price of
a subject matter (the ‘underlying’) without ownership of the
underlying.
4. Participants in contracts for differences take a risk that the
price of the underlying will or will not exceed a price for that
underlying at some time in the future.
5. Financial contracts for differences include those relating to
share prices, share price indices, financial product prices, commodity
prices, interest rates and currencies.
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6. All financial contracts for differences will, in substance, have
the following features:
• the provider will quote a buy and a sell price for an
underlying;
• the ‘buy price’ quoted is the price at which the investor
can ‘buy’ the underlying and the ‘sell price’ quoted is
the price at which the investor can ‘sell’ the underlying;
• the provider retains the right to set its own prices and
prices quoted may not necessarily be the market price
for the underlying on the relevant exchange;
• investors will make a gain on closing out their position if:
i) they enter into a contract to ‘buy’ at the buy
price quoted by the provider and later close out
the contract by entering into a contract to ‘sell’
at a higher sell price quoted by the provider; or
ii) they enter into a contract to ‘sell’ at the sell
price quoted by the provider and later close out
the contract by entering into a contract to ‘buy’
at a lower buy price quoted by the provider;
• the buy price quoted by the provider (that is, the price
at which investors can buy the underlying) at any point
in time will always be higher than the sell price quoted
(that is, the price at which investors can sell the
underlying) at the same time. The difference between
the quoted buy and sell prices is commonly known as
the ‘spread’;
• the contract is cash-settled and there is neither the
right to call for nor the right to require the acceptance
of delivery of the underlying. The differences are
settled in cash by the investor and the provider. If the
investor makes a ‘gain’, the provider will pay the
amount of the gain to the investor and if the investor
makes a ‘loss’, the investor will pay the amount of the
loss to the provider; and
• the amount of gain or loss to the investor from price
movement in relation to an underlying will depend on
the level of exposure the investor is subject to for each
point (or each cent) movement.
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7. Retail financial contracts for differences currently available in
the Australian market have the following features:
• commercial practice is that contracts are typically held
for a relatively short period, often a matter of days,
rarely more than a few months;
• commercial practice is that investors are required to
have experience in the financial market prior to being
accepted as a client by the provider;
• commercial practice is that pricing is similar to, or the
same as, pricing on underlying financial markets;
• contracts cannot be assigned and the parties transact
as principals;
• an amount called ‘interest’ is payable by investors on
the value of buy contracts (that is, contracts to buy the
underlying) to the extent they remain open at the end
of each day;
• an amount called ‘interest’ is payable to investors on
the value of sell contracts (that is, contracts to sell the
underlying) to the extent they remain open at the end
of each day;
• for contracts in relation to individual share risk, an
amount is payable by investors equivalent to the cash
dividend declared on the underlying share to the extent
investors have sell contracts that are open prior to the
day the underlying share goes ex dividend and carry
them over to the day the underlying share goes
ex dividend;
• for contracts in relation to individual share risk, an
amount is payable to investors equivalent to the cash
dividend declared on the underlying share to investors
to the extent they have buy contracts that are open
prior to the day the underlying share goes ex dividend
and carry them over to the day the underlying share
goes ex dividend; and
• for contracts in relation to individual share risk, there is
an adjustment for bonus share issues, rights issues
and so on.
8. Other features of financial contracts for differences are:
• some financial contracts for differences are
open-ended contracts; others have a maturity date;
• some financial contracts for differences are closed
daily and new contracts opened in their place; in
others, contracts do not automatically close daily, but
price difference amounts are paid daily;
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• in some financial contract for differences, the contract
is closed out by entering into an equal and opposite
position, with both positions remaining open until the
close of business that day; in others, close out is a
termination of the contract; and
• there may be a commission or a transaction fee based
on the value of the contract. The commission or
transaction fee may be charged each time a contract is
entered into, that is, the fee is chargeable regardless of
whether the contract is entered to create or to close out
a position. The commission or transaction fee is
usually a percentage of the value of the transaction.
9. An investor therefore makes a net gain or loss from a
financial contract for differences resulting from the price movement
(as determined by the provider) of the underlying and the amounts
payable to or by the investor as described in paragraphs 6 to 8.
Date of effect
10. This Ruling applies to years of income commencing both
before and after its date of issue. However, the Ruling does not apply
to taxpayers to the extent that it conflicts with the terms of settlement
of a dispute agreed to before the date of issue of the Ruling (see
paragraphs 21 and 22 of Taxation Ruling TR 92/20).
Ruling
11. A gain from a financial contract for differences will be
assessable income under section 6-5 of the Income Tax Assessment
Act 1997 (ITAA 1997) where the transaction is entered into as an
ordinary incident of carrying on a business, or where the profit was
obtained in a business operation or commercial transaction for the
purpose of profit making.
12. A loss from a financial contract for differences will be an
allowable deduction under section 8-1 of the ITAA 1997 where the
transaction is entered into as an ordinary incident of carrying on a
business or in a business operation or commercial transaction for the
purpose of profit making.
13. A gain from a financial contract for differences will be
assessable income under section 15-15 of the ITAA 1997 where a
taxpayer enters into a financial contract for differences in carrying on
or carrying out a profit-making undertaking or scheme, and the gain
from it is not assessable under section 6-5 of the ITAA 1997.
14. A loss from a financial contract for differences where the gain
would have been assessable under section 15-15 of the ITAA 1997 is
an allowable deduction pursuant to section 25-40 of the ITAA 1997.
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15. A gain or loss from a financial contract for differences entered
into for the purpose of recreation by gambling will not be assessable
income under section 6-5 or section 15-15 of the ITAA 1997 or
deductible under section 8-1 or section 25-40 of the ITAA 1997. A
capital gain or capital loss from a financial contract for differences
entered into for the purpose of recreation by gambling will be
disregarded under paragraph 118-37(1)(c) of the ITAA 1997.
Explanation
Ordinary incident of carrying on a business
16. It is clear that a gain or a loss from a financial contract for
differences will be respectively assessable income under section 6-5,
or an allowable deduction under section 8-1 of the ITAA 1997, where
the transaction is entered into as an ordinary incident of carrying on a
business.
17. Whether there is a business being carried on is a question of
fact and involves an inquiry into matters such as whether the
transactions are entered into in a systematic, organised and
‘businesslike’ way; the repetition or regularity of the transactions; the
scale of the transactions; whether the transactions are related to, or
part of, other activities of a businesslike character; the purpose of the
taxpayer; the degree of skill employed in how the taxpayer engages
in the transactions.
18. Whether gross receipts and gross outgoings are respectively
assessable income and allowable deductions, or whether it is the net
profit or the net loss, will depend on the terms of the contract in each
case. Some contracts create gross but offsetting liabilities; others
provide for a liability for a net amount calculated by reference to
notional gross amounts. However, for most taxpayers there will be no
practical difference whether gross receipts are aggregated as
assessable income and gross outgoings are deducted, or whether the
net profits and net losses are brought to account. The terms of the
contract will also determine the time at which each is assessable
income or an allowable deduction, that is, whether it is daily because
the contract is terminated at the end of each day and a new contract
is opened the next day; or whether it is at the close out of a contract
that is continued from day to day. Again, for most taxpayers there will
be no practical difference, except at the end of the year of income.
Business operation or commercial transaction for the purpose of
profit-making
19. A gain or a loss from a financial contract for differences will be
respectively assessable income under section 6-5 or an allowable
deduction under section 8-1 of the ITAA 1997 where the profit or loss
was made in a business operation or commercial transaction for the
purpose of profit making.
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20. Financial contracts for differences cannot be assigned, are
typically held open for a relatively short period, and do not provide
ownership of an underlying asset.
21. In the sense that there is no ownership of an underlying asset,
financial contracts for differences are essentially contracts of
speculation,1 productive of a gain or a loss:
• a holder will make a gain on a ‘buy’ contract if the
amount received (if the sell price exceeds the buy price
on close out, or as a dividend equivalent amount) is
greater than the amount paid (if the sell price is below
the buy price on close out, or as an ‘interest’ equivalent
amount);
• a holder of a ‘buy’ contract will make a loss if the
amount received is less than the amount paid;
• a holder will make a gain on a ‘sell’ contract if the
amount received (if the buy price is lower than the sell
price on close out, or as an ‘interest’ equivalent
amount) is greater than the amount paid (if the buy
price exceeds the sell price on close out, or as a
dividend equivalent amount); and
• a holder of a ‘sell’ contract will make a loss if the
amount received is less than the amount paid.
22. Financial contracts for differences are productive of a gain or
loss stemming from exposure to typically short term financial risk. The
risks assumed in financial contracts for differences, namely stock
indices, individual shares, currencies, financial products, interest
rates, and commodities are all the basic subject matter of the financial
services industry.
23. Although this has been doubted in the past, speculation on a
financial risk can be characterised as being commercial, in that it
increases the efficiency of the financial markets by adding to the
depth and liquidity of the markets. The commerciality of speculating in
the commodity and financial markets using ‘contracts based upon the
movement of price indices’ was discussed in City Index v. Leslie
[1991] 3 All ER 180; [1992] QB 98 at 104-105 by Lord Donaldson MR:
In the common coin of political life it is not uncommon to encounter
condemnation of ‘City speculators’. It is not for me a judge to join in
that debate, but the day to day working of the markets form part of
the background to this dispute and have to be taken into
consideration.
The commodity and financial markets exist to meet real commercial
needs. Perhaps the simplest illustration can be provided by the
commodity markets. The user of the commodity who is probably a
manufacturer needs to be able to maintain stability in the price of his
1 Compare with: the discussion of an interest rate swap as being speculative in
Hazell v. Hammersmith and Fulham London Borough Council and others
[1992] 2 AC 1; [1991] 1 All ER 545.
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product or at least be able to calculate his costs and therefore his
price for a product which he may not be able to market until some
time in the future. If the producer of the commodity is prepared to
bind himself to supply particular quantities at agreed prices at some
time in the future, there is no problem, but this is a relatively rare
situation. The producer may not know whether his crop will be good
or bad in terms of quality or quantity. He may, and usually will, be
most unwilling to enter into any contracts at the time at which the
consumer needs to be able to fix his costs and prices.
The markets exist to reconcile the apparently irreconcilable needs of
these two groups, the producer of the commodity and the user of it.
It can do this in a number of ways, but in essence those who operate
in the markets back their judgment of how the price will move
between the moment when the user needs to achieve certainty as to
his costs and the moment when the producer is willing to enter into
firm contracts to supply. In its simplest form the dealer in the market
enters into a forward contract with the user and waits to buy from the
producer, hoping that the forward price which he has agreed with the
user will be higher than that which he eventually has to pay the
supplier. In a slightly more sophisticated form, he watches the
market and if at some intermediate stage he thinks that he has
wrongly forecast the movement in price, he finds another dealer who
takes a different view and enters into a buying contract with him,
thus crystallising any profit or avoiding any further loss. In a yet more
sophisticated form dealers who do not wish to be involved in taking a
long term view of how the price of the commodity will move, will
enter into pairs of contracts, one for the notional sale and one for the
notional purchase of a particular quantity of the commodity, the
intention of both parties being that no property in the commodity
shall pass, but that the contracts will be fulfilled by paying sums of
money based upon price differences at different times. This is a
contract for differences of the type considered in Universal Stock
Exchange Limited v. Strachan [1896] AC 166, where the contracts
related to shares rather than commodities, a market in which there is
also a need for a degree of stability and predictability.
From contracts for differences it is but a short step to contracts
based upon the movement of price indices which achieve the same
basic objective.
Clearly this system would not work if all dealers in the market took
the same view as to future movements in prices and equally clearly
the more people there are dealing in the market, the greater the
opportunity for diversity of view. So it comes about that the
intervention of ‘speculators’ from outside the market is not wholly
unwelcome and indeed may in some circumstances contribute
towards the achievement of the real objective of the market,
although in some circumstances they can unsettle a market in no
one’s interests other than their own.
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24. Lockhart J also discusses the value of speculation in Sydney
Futures Exchange Limited v. Australian Stock Exchange Limited and
Another (1995) 56 FCR 236; (1995) 128 ALR 417 at 423-424:
29. A futures market is a market in which people buy and sell
things for future delivery. A futures contract generally involves an
agreement to buy and sell a specified quantity of something at a
specified future delivery date. ... Futures markets perform the
economic function of managing the price risk associated with holding
the underlying commodity or having a future requirement to hold it.
The futures market is a risk transfer mechanism whereby those
exposed to risks shift them to someone else; the other party may be
someone with an opposite physical market risk or a speculator. ... A
small proportion of futures contracts results in the commodity or
financial instrument underlying the contract being in fact sold or
bought by the parties to the contract in satisfaction of their
obligations under that contract. However the economic function of
this delivery mechanism is to ensure that the contract price
converges with that of the physical or cash market at maturity. ...
30. There are basically two types of users of the futures market,
hedgers and speculators. Hedgers typically deal in the physical
commodity and use futures to manage price risks. Hedgers transfer
price risk to speculators. The futures market performs a price setting
function, allowing a hedger to know in advance the price at which he
will buy or sell and to plan for known costs and returns. The futures
market achieves its purpose of setting a price in advance by
providing profits or losses that balance losses and gains in the
physical market respectively.
31. A pithy statement of a futures market was made by
A.L. Valdex in his article ‘Modernising the Regulation of the
Commodity Futures Market’, Harvard Journal on Legislation, vol. 13
No.1, December 1975, 35 in these terms at 40:
‘The primary purpose of futures trading is to enable
producers, dealers, and processors of various commodities
to shift the risk of price fluctuations to speculators through
the process of hedging. Basically, hedging allows producers,
dealers and processors to make contracts in advance for the
sale of their goods and to protect themselves against price
fluctuations by buying or selling futures contracts for an
equal quantity of their product or material of manufacture.
The reduction in risk permits the producer to sell and the
processor to buy at lower prices, which theoretically benefits
the consumer by lowering the price of the finished product.
The speculator is willing to accept the risk of price fluctuation
for the sale (sic) of possible gain.’
32. ... [Speculators] usually do not intend ultimately to buy or
sell the underlying commodities. Speculators are attracted to the
futures market by the principle of leverage, which allows them to
take advantage of price changes on a large amount of a traded
commodity for a small initial outlay. Speculators play an essential
economic role in any futures market by providing trading volume and
liquidity and by taking on the risks which hedgers seek to avoid.
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25. The actual contractual terms in a particular case will
determine when the various amounts and payments, or net profits or
losses, are derived or deductible (see discussion at paragraph 18).
26. If a financial contract for differences is entered into with a
profit-making purpose in a commercial transaction, the gain or loss
made on the contract will be respectively assessable income or an
allowable deduction, even though not an ordinary incident of carrying
on a business. The High Court held in Federal Commissioner of
Taxation v. The Myer Emporium Ltd (Myer) (1987) 163 CLR 199 at
209-210; 18 ATR 693; 87 ATC 4363, that:
The authorities establish that a profit or gain so made [in an isolated
transaction] will constitute income if the property generating the profit
or gain was acquired in a business operation or commercial
transaction for the purpose of profit-making by the means giving rise
to the profit.
Purpose of profit-making
27. The intention or purpose of the taxpayer (of making a profit or
gain) referred to in Myer must be discerned from an objective
consideration of the facts and circumstances of the case. This is
implicit from the judgment of Mason J in Myer at 163 CLR 209-210:
Generally speaking, however, it may be said that if the
circumstances are such as to give rise to the inference that the
taxpayer’s intention or purpose in entering into the transaction was
to make a profit or gain, the profit or gain will be income,
notwithstanding that the transaction was extraordinary judged by
reference to the ordinary course of the taxpayer’s business.
28. One example of where it would be objectively concluded that
there was a commercial transaction for the purpose of profit making is
where a financial contract for differences was used in an arbitrage
transaction. The exploitation of a market imperfection is a commercial
transaction and its purpose is to make a profit.
29. Speculative transactions would also come within the Myer
principle, if there is a profit-making purpose and the transaction is
commercial.
Tax cases on speculating in futures
30. Speculating on the financial market via a financial contract for
differences is very similar to speculating in cash-settled futures. There
is no compelling reason to tax speculative cash-settled futures
differently from speculative deliverable futures when in practice
speculators in the latter almost never expect nor require a delivery of
the underlying in today’s modern world of commerce: see Sydney
Futures Exchange Limited v. Australian Stock Exchange Limited and
Another (1995) 128 ALR 417 at paragraph 67 of Lindgren J’s
judgment for an example of where the practice of non-delivery of the
underlying in futures contracts had been judicially noticed; City Index
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v. Leslie [1992] QB 98 at 104-105 per Lord Donaldson MR. Moreover,
certain types of futures contracts conducted even on the Sydney
Futures Exchange can only be cash-settled without there being any
right to delivery.
31. Speculating in the futures market can be taxable on revenue
account even if those activities are insufficient to constitute the
carrying on of a business, Cooper v. Stubbs (1925) 2 KB 753; [1925]
All ER 643, Townsend v. Grundy (1933) 18 TC 140.
32. The decisions of Cooper v. Stubbs and Townsend v. Grundy
held that speculating in deliverable futures is subject to tax under
Case VI of English tax law (which brings to tax ‘… other annual profits
or gains not charged under Schedules A, B, C or E and not specially
exempted from tax’) even though the taxpayers were not carrying on
a business of speculating in futures contracts. It was also argued by
the taxpayers that the transactions were gambling transactions and
therefore not taxable. On both occasions, the Courts rejected the
gambling argument because the contracts were deliverable and
therefore are not ‘gaming or wagering contracts’. They, however, left
open the question of whether speculating in purely cash-settled
derivatives with no right to call for delivery of the underlying (and
therefore potentially gaming and wagering contracts if parties to the
contracts can either win or lose) are exempted from tax.
33. In Australia, the only decisions on the taxation of speculative
futures contracts are three tribunal decisions, Case Q77 83 ATC 388,
Case X47 90 ATC 382; (1990) 21 ATR 3416 and Case X85 90 ATC
615; (1990) 21 ATR 3728. These decisions support the view that
speculating on futures contracts may be taxable even though the
investor does not carry on a business of speculating in these
contracts. However they do not conclusively determine whether
cash-settled contracts, which are gaming and wagering contracts and
hence gambling transactions, are taxable without a business being
carried on. In Case X85, however, the Tribunal did take the view that
a single cash-settled derivative transaction was within the tax base,
and on revenue account as an allowable deduction, and did so on the
basis of the transaction’s essential commerciality.
Profit from carrying on or carrying out of a profit-making
undertaking or plan: sections 15-15 and 25-40 of the ITAA 1997
34. Where the transaction does not fall within the Myer principle, a
gain will be assessable income under section 15-15 where a taxpayer
enters into a financial contract for differences in carrying on or
carrying out a profit-making undertaking or plan and that gain is not
assessable under section 6-5 of the ITAA 1997.
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35. Similarly, a loss from a contract for differences transaction will
be an allowable deduction2 if there had been a gain, and
section 15-15 would have included it in assessable income under
section 25-40.
36. The case of Antlers Pty Ltd (in liq) v. FC of T 97 ATC 4201;
35 ATR 64, although a decision about the first limb of the former
section 25A of the Income Tax Assessment Act 1936, contains
helpful obiter dicta as to the role of intention and purpose in
section 15-15 as a successor to the second limb of section 25A.
Lockhart J said in this case:
FCT v. Myer Emporium Ltd (1987) 163 CLR 199 is authority for the
proposition that the profit arising from an isolated commercial or
business transaction will constitute income if the taxpayer’s purpose
or intention in entering into the transaction was to make a profit,
notwithstanding that the transaction was not part of the taxpayer’s
daily business activities. ...
The taxpayer’s purpose or intention is usually ascertained from an
objective consideration of the circumstances of the case but his
subjective purpose or intention is also of course relevant and may
sometimes be the determining factor.
It is the intention of the taxpayer that is relevant for section 25A
purposes; it may be gleaned not by mere declarations of intention,
but also by examining all the relevant circumstances, especially the
conduct of the taxpayer in order to discern or ascertain his intention
or purpose.
The purpose in the case of a company is the purpose of those who
direct its affairs: Whitfords Beach.
The determination of the taxpayer’s purpose in acquiring the relevant
property involves an analysis of his state of mind at the time of
purchase and his declarations of intention. However, it is important
to examine carefully, not only the taxpayer’s declarations of
intention, but also the objective facts, especially as they existed at
the time of the purchase, in order to glean the taxpayer’s purpose.3
37. What is important is the taxpayer’s actual purpose,
determined by a consideration of the objective facts. Part of the
objective factual matrix is that the transactions are the purchase of
financial risk – something with a significant commercial flavour – by
means of a contract productive only of a gain or a loss. The
statements of a taxpayer’s subjective intention are also relevant.
2 Note that, pursuant to subsection 25-40(3), a loss under subsection 25-40(1) can be
deducted only if either (a) notice is given to the Commissioner that the taxpayer
acquired the financial contract for differences for the carrying on or carrying out of
any profit-making undertaking or plan or (b) the Commissioner is satisfied the
taxpayer acquired the financial contract for differences for that purpose.
3 Antlers Pty Ltd (in liq) v. FC of T 97 ATC 4201 at 4207; 35 ATR 64 at 71.
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38. The Privy Council in McLelland v. FCT (1970) 120 CLR 487;
70 ATC 4115; 2 ATR 21 (McLelland) read into the predecessor of
section 15-15 a requirement that the profit arise from a ‘business
deal’. The correctness of this may be doubted, FCT v. Whitfords
Beach (1982) 150 CLR 355; 82 ATC 4031; 39 ALR 521. The better
view is that there is some, though limited, scope for section 15-15 to
operate where section 6-5 does not apply.
39. The obiter dicta in McLelland stated that that a ‘successful wager’
and the results of drawing the ‘winning ticket’ in a lottery would not come
within the predecessor of section 15-15 may be accepted as correct, if
confined to the sorts of gambling that will not be assessable income
because of the elements of chance and ‘privateness’ discussed above,
that is, such things as horse racing gambling, gaming at casinos,
lotteries and so on.4 They are not considered to apply to contracts in the
legal form of a bet, where the underlying risk is financial.
No profit making purpose
40. Whilst, as explained in previous paragraphs, gains or losses
are expected most often to be on revenue account, because it is
expected that usually they will be entered into with the purpose of
profit-making, it is possible that in some cases the facts will establish
that a person entered into the contract for differences for purposes
other than to make a profit. In such a case, the gain or loss will not be
on revenue account. The question then arises whether the gain or
loss will be a capital gain or loss.
41. A financial contract for differences is a CGT asset under
section 108-5 of the ITAA 1997. On the closing out of the position
(whether or not by means of entering into an equal and opposite
contract) or on the maturity of the contract, a CGT event C2 happens
under section 104-25 of the ITAA 1997. However, the CGT gambling
exemption in paragraph 118-37(1)(c) of the ITAA 1997 will apply to
disregard capital gains or capital losses arising from financial
contracts for differences where the CGT event is ‘relating directly to ...
gambling’. In the Commissioner’s view, the word ‘gambling’ here
refers to activities involving primarily chance which have a
recreational or sporting character, such as lotteries or games of
chance and betting on horse racing. It is not considered to have the
technical legal meaning of wagering, or the popular meaning of mere
risk-taking. One would not ordinarily expect a financial contract for
differences to be entered into as recreation. However, in those cases
where a financial contract for differences is not entered into with a
purpose of profit-making, it is likely that the purpose with which it is
entered into will be as an unusual form of recreational gambling.
Having regard to the features of a financial contract for differences
outlined at paragraphs 6 to 8 the Commissioner considers that a
financial contract for differences would be entered into with either a
profit making purpose or a recreational purpose, so that the gain or
4 McLelland v. FCT (1970) 120 CLR 487 at 494.
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loss is either on revenue account or properly characterised as the
product of gambling. Although it is not possible to exclude (as a
matter of law) the possibility that a financial contract for differences
will be entered into for some purpose that is neither profit-making nor
recreational, it is (as a matter of fact) considered to be exceedingly
unlikely.
42. If it were established in a particular case that a financial
contract for differences was entered into for merely recreational
purposes in a manner akin to making a bet in a game of chance, no
capital gain or loss will arise.
43. How is the distinction between profit-making and gambling to
be drawn? It is a question of fact in each case. The horse race betting
cases have established that:
• there is a chance-to-skill spectrum and gains which
depend on a significant element of skill are more likely
to have tax consequences than ‘gambling on merely
random events’ (Brajkovich v. Federal Commissioner
of Taxation 89 ATC 5227 at 5233 and 20 ATR 1570 at
1576-77 (Brajkovich)); and
• there is a private/recreational-to-commercial spectrum
and the more closely an activity is identified as
undertaken for recreational purposes, the less likely it
will have tax consequences.
44. In essence, activity which is ultimately considered to be
commercial is different to that activity which is ultimately regarded to
be ‘gambling’, albeit that, as stated in Brajkovich ‘the border between
commerce on the one hand and gambling on the other may seem
uncertain, as to some activities’.5
45. We have indicated above that the terms of the financial contract
for differences are such as to tend to stamp it as an act of commerce.
However, a taxpayer who enters into a financial contract for differences
only once, or very occasionally, who has no expertise in the price of the
underlying by which the gain or loss of the financial contract for
differences will be calculated, does not engage in any income-producing
activities of a character bearing some association or connection with the
financial contract for differences or its underlying, and, in particular, who
gambles in the ordinary recreational way and who has entered into the
financial contract for differences in circumstances such that the financial
contract for differences may be seen to be part of that recreation may
establish that the gain or loss is the product of gambling (and not the
result of a profit-making endeavour.)
5 Brajkovich v. FCT 89 ATC 5227 at 5233; 20 ATR 1570 at 1574.
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Alternative views
46. The alternative view is that the tax treatment of betting,
determined by the line of cases on taxability of betting on horse
racing, should be applied to all transactions classified as gaming and
wagering contracts under the principles outlined in the cases
concerning the enforceability of contracts under the Gaming and
Wagering statutes.6 (Historically, these statutes provided that
contracts of gaming and wagering were unenforceable. As stated
below, financial contracts for differences would have been wagering
contracts under these statutes. The legislation in force in each
Australian jurisdiction as at the date of issue of this Ruling varies. In
some jurisdictions, this historical position continues, in others it is only
in relation to specifically prescribed activities that contracts are
rendered unenforceable or void.)
47. Under this approach, cash-settled financial derivatives would
only give rise to tax consequences where there is the carrying on of a
business. A single arbitrage transaction exploiting a market
imperfection by means of a financial contract for differences would
therefore not have tax consequences, nor would using these
transactions in carrying out a profit-making undertaking or scheme.
Financial contracts for differences are contracts of gaming and
wagering
48. A financial contract for differences is, as stated above, a
gaming and wagering contract under the historical Gaming and
Wagering statutes.7
49. The essential character of such a gaming or wagering contract
was summarised by Hawkins J in Carlill v. The Carbolic Smoke Ball
Company [1892] QBD 484 at 490-491:
… according to my view, a wagering contract is one by which two
persons, professing to hold opposite views touching the issue of a
future uncertain event, mutually agree that, dependent upon the
determination of that event, one shall win from the other, and that
other shall pay or hand over to him, a sum of money or other stake;
neither of the contracting parties having any other interest in that
contract than the sum or stake he will so win or lose, there being no
other real consideration for the making of such contract by either of
the parties. It is essential to a wagering contract that each party may
under it either win or lose, whether he will win or lose being dependent
on the issue of the event, and, therefore, remaining uncertain until that
issue is known. If either of the parties may win but cannot lose, or may
lose but cannot win, it is not a wagering contract.
6 That is: statutes descended from the UK Statute 8 & 9 Vict. c.109. See, for example:
Games, Wagers and Betting Houses Act 1901 (ACT) section 13; Gaming and Betting
(Contracts and Securities) Act 1985 (WA) section 4; Lottery and Gaming Act 1936
(SA) section 50 (‘void’); Racing Act 2002 (Qld) section 341 (‘void’).
7 That is, those where the definition of wagering is not confined to specifically
prescribed activities.
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50. The cases have also established that a contract is not such a
gaming and wagering contract where it provides for the delivery of the
underlying asset. It is the contractual right to delivery that is
determinative, not the expectation of the parties to the contract:
Ironmonger & Co. v. Dyne (1928) 44 TLR 497; Buitenlandsche
Bankvereeniging v. Hildesheim (1903) 19 TLR 641; Premier Swiss
Group (A’asia) Pty Ltd v. Robins Haigh McNeill Pty Ltd (1988)
13 ACLR 547; Morley v. Richardson (1942) 65 CLR 512; [1942]
ALR 161.
51. Financial contracts for differences also do not provide for the
right to the delivery of the underlying asset. They are merely
agreements to exchange cash calculated with reference to the quoted
price of the underlying on settlement and on entry.
52. The fact that other amounts such as transaction fees and so
on outlined in paragraph 6 to 8 may be charged or payable by the
provider does not detract from the position that each party may either
win or lose under each contract as they are entering into the contracts
as principals. This is distinguishable from broker type cases where
the broker can only win (and cannot lose) because the only outcome
from a contract with its client is that it will receive a commission.
Horse racing cases have held that gains from gaming and
wagering are only taxable where there is the carrying on of a
business
53. The horse race betting cases like Evans v. FCT 89 ATC 4540;
20 ATR 922 (Evans), Babka v. FCT 89 ATC 4963; 20 ATR 1251
(Babka) and Brajkovich have held that gains are not taxable unless
the activities constitute the carrying on of a business.
54. Those cases do use general language about ‘betting’. As a
consequence, it has been argued that as financial contracts for
differences are a form of a legal bet, the tax treatment of these
transactions should be similar to horse race betting.
55. It is not considered that the identification of an activity as a bet
or gamble is determinative of the tax consequences of that activity.
56. Rather it is necessary to examine the horse racing cases to
understand the underlying reasons why gambling in the context of
those cases was held not to be taxable unless it constitutes a
business.
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Principles from the horse racing cases
57. The horse race betting cases have established the following
principles:
• that there is a chance-to-skill spectrum and gains
which depend on a significant element of skill are more
likely to have tax consequences than ‘gambling on
merely random events’;8 and
• that there is a private/recreational-to-commercial
spectrum and the more closely an activity is identified
as undertaken for recreational purposes, the less likely
it will have tax consequences.
58. In Evans, Hill J had the following to say about the chance-toskill
and recreational-to-commercial spectra:
While some knowledge of form of the animals and skill in assessing
that form may improve the prospects of winning or at least militate
against the prospect of losing, the fact remains that the element of
chance looms large on betting on the races, be that horse-racing,
greyhound-racing or trotting. While two-up may, if properly played,
be the only game of pure chance (excluding mere lotteries) the
difference between card games and betting on the races is but a
matter of degree. This is not to say that the bookmaker cannot be
said to be carrying on a business: clearly he can. The bookmaker’s
activities are purely commercial and involve all of the indicia of
business referred to above. The element chance, while still present
is, however, greatly reduced by the averaging of bets and the ability
of the bookmaker to lay off part of his risk with others and also
perhaps by his ability at least in part to set the odds which he offers.9
59. In Babka, Hill J again had the following to say about the
chance-to-skill spectrum in considering the argument that mere
punting could never amount to the carrying on of a business:
It would, for example, seem impossible to imagine a taxpayer carrying
on a business of buying lottery tickets. That presumably is because no
matter how systematic a purchaser of lottery tickets may seek to be,
no matter how frequent his bets or how large the sum he gambles, the
odds will always be such that the outcome will predominantly depend
upon chance. Yet the mere fact that the outcome of a particular
activity may be dependent at least in part on chance will not negate a
business activity being carried on. The outcome of a bookmaker’s
business must depend to some degree on chance yet it has always
been regarded as a business. Of the bookmaker’s business it can be
said that the bookmaker has, by laying off his bets and averaging
them in his dealings with the public, by ‘balancing his book’, been able
to reduce his odds to the point where there is sufficient skill to see the
activity as systematic and businesslike being directed to a profit which
it is hoped will eventuate.10
8 Brajkovich v. FCT 89 ATC 5227 at 5233 and 20 ATR 1570 at 1576-77.
9 Evans v. FCT 89 ATC 4540 at 4555; 20 ATR 922 at 939.
10 Babka v. FCT 89 ATC 4963 at 4968; 20 ATR 1251 at 1256.
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60. In relation to the recreational-to-commercial spectrum, Hill J
also said in the context of punting on horse races:
Another factor which tends to work against seeing punting as a
business is that it is an activity which in the main it is normal to
regard as a hobby or a pastime.11
61. In Brajkovich the Full Federal Court said:
On the question of skill and chance, some comment should be
made. Gambling which involves a significant element of skill, for
example, a professional golfer’s betting on himself, is more likely to
have tax consequences than gambling on merely random events.12
62. In that case, one of the reasons the taxpayer was found not to
be carrying on a business was because ‘the evidence shows that he
had from his youth a simple passion for gambling on a large scale; on
the authorities, merely indulging that, without more, is not engaging in
a business’.13 In the course of its judgment the Court also quoted the
High Court cases of Jones v. FC of T (1932) 2 ATD 16 and Martin v.
FC of T (1953) 90 CLR 470; (1953) ALR 755 in relation to the private
and recreational nature of gambling on horse racing:
[In Jones,] Evatt J. found that ‘the element of sport, excitement and
amusement was the main attraction’ . . . [In Martin], the Court, at
p.481, thought the evidence illustrated ‘the normal and usual
activities and nothing more of persons who derive pleasure from
betting on the racecourse and racing under their own colours.14
63. Also relevant is the observation made by Rowlatt J in the
United Kingdom decision, Graham v. Green (Inspector of Taxes)
(1925) 2 KB 37 at 41:
The trade or vocation which has to do with difference in prices may be
popularly spoken of as gambling, because there is no intention to
accept or deliver the thing bought and sold. But the operations in
those cases are operations in relation to the difference of prices of
commodities, and there is an element of fecundity in them, and indeed
those operations form the subject matter of a great deal of trade.
64. The point that horse race betting occupies on each of the
spectra led the Courts in those cases to establish a very high
threshold, namely, a taxpayer’s activities must be capable of being
characterised as carrying on a business before those activities are
taxable. Put in another way, as the activities of betting on horse races
involve a higher element of chance and are so strongly associated
with the element of recreation, the activities carried on by a taxpayer
must exhibit those of a business before a court can expel any doubt
that it is not a windfall gain or carried out for recreational purposes.
As a result, courts generally consider that an isolated bet, in the
context of betting on horse races, will not be taxable if it does not
constitute a business.
11 Babka v. FCT 89 ATC 4963 at 4969; 20 ATR 1251 at 1257.
12 Brajkovich v. FCT 89 ATC 5227 at 5233; 20 ATR 1570 at 1576-77.
13 Brajkovich v. FCT 89 ATC 5227 at 5233-34; 20 ATR 1570 at 1577.
14 Brajkovich v. FCT 89 ATC 5227 at 5231; 20 ATR 1570 at 1574.
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Applying the principles in the horse racing cases to financial
contracts for differences
65. It is therefore necessary to determine the degree to which
transacting with financial contracts for differences is commercial and
involves skill, and to compare it with betting on horse races.
66. The Tax Office view is that financial contract for differences
transactions and horse race betting are different in character. In
particular, transacting with a financial contract for differences is closer
to the skill end of the chance-to-skill spectrum and the commercial
end of the private/recreation-to-commercial spectrum than a bet on
horse racing.
67. Transacting with financial contracts for differences is
essentially a commercial activity of investing in a cash-settled
derivative, albeit in the legal form of a contract of gaming and
wagering, in relation to an underlying financial risk. The action of
purchasing financial risk is essentially commercial. In contrast,
although there are elements of the horse racing industry which are
essentially commercial – for example, the businesses of breeding and
training horses, the action of purchasing risk on horse races is
essentially recreational, and only could become commercial through
the carrying on of a business.
68. Section 1101I of the Corporations Act 2001 makes a contract
that is a financial product valid and enforceable. Financial contracts
for differences are thus valid and enforceable contracts in Australia
despite in some jurisdictions being contracts of gaming and wagering
under the Gaming and Wagering statutes15 in those jurisdictions. The
validity of such contracts being found in the Corporations Act 2001 as
opposed to gaming legislation indicates the parliament’s intention that
they, as a branch of human activity, belong to an order entirely
different from gaming or gambling, that is, they are true commercial
activities: see Brajkovich16 where the Full Federal Court referred to
comments by McTiernan J in R v. Connare Ex parte Wawn (1939)
61 CLR 596 at 631 about gambling belonging to an entirely separate
branch of human activity because ‘gaming is a mode of transferring
property without producing any intermediate good whereas trade
gives employment to numbers and so provides immediate good’.
15 That is, statutes descended from the UK Statute 8 & 9 Vict. c.109. See, for
example: Games, Wagers and Betting Houses Act 1901 (ACT) section 13;
Gaming and Betting (Contracts and Securities) Act 1985 (WA) section 4; Lottery
and Gaming Act 1936 (SA) section 50 (‘void’); Racing Act 2002 (Qld) section 341
(‘void’).
16 Brajkovich v. FCT 89 ATC 5227 at 5232; 20 ATR 1570 at 1575.
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69. Other matters that point to the commerciality of such contracts
include the following:
• the providers’ authority to provide these arrangements
and other financial products comes from holding
Australian Financial Services Licences issued by
Australian Securities and Investment Commission
under the Corporations Act 2001 for the conduct of
investment businesses;
• these contracts provide another means of access to
the financial markets and are potentially substitutes for
other financial instruments;
• these contracts are marketed as an investment;
• the financial experience of the investors;
• the providers of such contracts will resolve any
disputes in accordance with market practice on similar
commercial transactions; and
• the pricing of the contracts being similar to or the same
as prices on underlying financial markets.
70. The degree of control that investors have in determining when
to close out a transaction also contributes to distinguishing financial
contracts for differences from recreational gambling since it allows
skill and judgment to be exercised right up to the termination time.
71. As Hill J pointed out in Babka:
A punter, particularly one betting upon the on-course totalizator or
the TAB cannot affect the outcome of the race nor can he dictate the
odds which he will receive. While it is true that to some extent a
trader in futures cannot affect the outcome which is related to the
price of a particular commodity and which may be affected by
matters totally outside the control of the trader, at least the trader in
futures has some impact on the profit to be derived in the sense of
the price upon which he enters into the contract.17
72. Similarly, in Evans, Hill J in deciding that the taxpayer was not
carrying on the business of punting considered the following factors to
be significant:
[T]hat his betting was predominantly with the TAB or on-course
totalizator (rather than with bookmakers) where the odds given are
unknown at the time the bet is placed and the dividend will be unable
to be precisely calculated until it is announced 10 minutes or so after
the race is concluded where it is dependent upon the total TAB and
on-course totalizator betting upon the race less betting tax.18
73. The alternative view is not considered to be correct.
17 Babka v. FCT 89 ATC 4963 at 4968; 20 ATR 1251 at 1257.
18 Evans v. FCT 89 ATC 4540 at 4558; 20 ATR 922 at 942-943.
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Detailed contents list
74. Below is a detailed contents list for this Taxation Ruling:
Paragraph
What this Ruling is about 1
Class of persons/arrangement 2
Background 3
Date of effect 10
Ruling 11
Explanation 16
Ordinary incident of carrying on a business 16
Business operation or commercial transaction for the
purpose of profit-making 19
Purpose of profit-making 27
Tax cases on speculating in futures 30
Profit from carrying on or carrying out of a profit-making
undertaking or plan: sections 15-15 and 25-40 of the ITAA 1997 34
No profit making purpose 40
Alternative views 46
Financial contracts for differences are contracts of gaming
and wagering 48
Horse racing cases have held that gains from gaming
and wagering are only taxable where there is the carrying
on of a business 53
Principles from the horse racing cases 57
Applying the principles in the horse racing cases to financial
contracts for differences 65
Detailed contents list 74
Commissioner of Taxation
31 August 2005
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Previous draft:
TR 2004/D17
Related Rulings/Determinations:
TR 92/1; TR 92/20; TR 97/16
Subject references:
- carrying on a business
- cash-settled derivatives
- financial derivatives
- futures
- gambling
- gaming and wagering
- profit-making undertaking or plan
Legislative references:
- Corporations Act 2001
- Corporations Act 2001 1101I
- ITAA 1936 25A
- ITAA 1997 6-5
- ITAA 1997 8-1
- ITAA 1997 15-15
- ITAA 1997 25-40
- ITAA 1997 25-40(1)
- ITAA 1997 25-40(3)
- ITAA 1997 104-25
- ITAA 1997 108-5
- ITAA 1997 118-37(1)(c)
- TAA 1953 Pt IVAAA
- Games, Wagers and Betting
Houses Act 1901 (ACT) 13
- Gaming and Betting (Contracts and
Securities) Act 1985 (WA) 4
- Lottery and Gaming Act 1936
(SA) 50
- Racing Act 2002 (Qld) 341
Case references:
- Antlers Pty Ltd (in liq) v. FC of T
97 ATC 4201; 35 ATR 64
- Babka v. FCT 89 ATC 4963; 20
ATR 1251
- Brajkovich v. FCT 89 ATC 5227;
20 ATR 1570
- Buitenlandsche Bankvereeniging
v. Hildesheim (1903) 19 TLR 641
- Carlill v. The Carbolic Smoke Ball
Company [1892] QBD 484
- Case Q77 83 ATC 388
- Case X47 90 ATC 382; (1990) 21
ATR 3416
- Case X85 90 ATC 615; (1990) 21
ATR 3728
- City Index v. Leslie [1991] 3 All
ER 180; [1992] QB 98
- Cooper v. Stubbs (1925) 2 KB
753; [1925] All ER 643
- Evans v. FCT 89 ATC 4540; 20
ATR 922
- FCT v. The Myer Emporium Ltd
(1987) 163 CLR 199; 87 ATC 4363;
18 ATR 693
- FCT v. Whitfords Beach (1982)
150 CLR 355; 82 ATC 4031; 39
ALR 521
- Graham v. Green (Inspector of
Taxes) (1925) 2 KB 37
- Hazell v. Hammersmith and
Fulham London Borough Council
and others [1992] 2 AC 1; [1991] 1
All ER 545
- Ironmonger & Co. v. Dyne (1928)
44 TLR 497
- Jones v. FC of T (1932) 2 ATD 16
- McLelland v. FCT (1970) 120 CLR
487; 70 ATC 4115; 2 ATR 21
- Martin v. FC of T (1953) 90 CLR
470; (1953) ALR 755
- Morley v. Richardson (1942) 65
CLR 512; [1942] ALR 161
- Premier Swiss Group (A’asia) Pty
Ltd v. Robins Haigh McNeill Pty Ltd
(1988) 13 ACLR 547
- R v. Connare Ex parte Wawn
(1939) 61 CLR 596
- Sydney Futures Exchange Limited
v. Australian Stock Exchange
Limited and Another (1995) 56 FCR
236; (1995) 128 ALR 417
- Townsend v. Grundy (1933) 18
TC 140
- Universal Stock Exchange Limited
v. Strachan [1896] AC 166
Other references:
- Valdex, AL ‘Modernising the
Regulation of the Commodity
Futures Market’, Harvard Journal of
Legislation, December 1975, vol.
13, No. 1
ATO references
NO: 2003/14584
ISSN: 1039-0731
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ATOlaw topic: Income Tax ~~ Assessable income ~~ business and
professional income - Australian sourced
Income Tax ~~ Assessable income ~~ carrying on a
business
Income Tax ~~ Deductions ~~ isolated transactions
Income Tax ~~ Deductions ~~ other business and
professional expenses
Income Tax ~~ Deductions ~~ other investment related
expenses