Tax question: CFD hedging to lock in profits and receive 50% CGT discount, page-3

reply # 2

your scheme looks complicated & has some implications that will reduce your benefit from the 50% discount:

1. in general, the ATO treats CFD transactions as income losses (rather than CGT) - refer to TR 2005/15

2. however, there is a general principle that where a 'capital protection product' is used to hedge a CGT asset then the capital protection product is treated as a CGT asset. for example, ATO states: The TOFA rules provide for a hedging tax-timing method that allows gains and losses from certain hedging financial arrangements to be characterised and taxed in accordance with the tax treatment of the underlying item being hedged. For example, if a valid hedging tax-timing method election is in effect, gains or losses from a hedging financial arrangement used to hedge against risks associated with a CGT asset will be treated as a capital gain or capital loss on the same basis as the capital gain or capital loss on the underlying CGT asset that is being hedged. http://law.ato.gov.au/atolaw/print....tax~NAT 4151~Part A - About capital gains tax

3. further, section 110-55 prevents interest costs being included in the 3rd element of the 'reduced cost base' of a CGT loss: http://law.ato.gov.au/atolaw/view.h...8&Archived=false&recnum=1&tot=11&pn=ALL:::LEG

4. the potential outcome of the above provisions in relation to your scheme is as follows:

(a) when you calculate your capital gain/loss for the year, you must first reduce your gross capital gains by any capital losses before applying the discount [section 102-5] http://www.austlii.edu.au/au/legis/cth/consol_act/itaa1997240/s102.5.html

(b) therefore, the loss you make from your CFD short will reduce your gross capital gain from the shares before you apply the discount

(c) in addition, you cannot include the interest expenses incurred with your CFD short in its cost base (and you cannot deduct it either under section 8-1 since the interest is capital in nature)

(d) in summary, although your CFD short locks in your gain, you will lose the cost of the interest component.

(e) for example, you buy at $20, short at $50, sell at $70 and the interest costs $5. your net capital gain is $15 (i.e. $50 gain less $20 short loss less $15 discount). at 35% tax rate, the tax discount you receive is $5.25 . however, you lose $5 of that benefit by incurring your unclaimable interest expense

(f) so the amount of interest you incur with the CFD is an important consideration