At what point does a Investor become a Trader from a tax perspective?

[lou]

Some food for thought for the weekend. At what point does a Investor become a Trader from a tax perspective? Obivously when you become a trader the IRD will tax you on your gains/loss from your share trades.

I know it comes back to intention however there can be a grey line between the two categories.

It would be good to get peoples perspective, anecdotes, and advice on the subject.

[777]

I would say if your intention was to invest but you happened to trade numerous shares many times a year then you would have trouble convincing the IRD you are not a trader. How many is "many" though is the tricky question. Length of time of each holding would come into it as well.

[lou]

I would say if your intention was to invest but you happened to trade numerous shares many times a year then you would have trouble convincing the IRD you are not a trader. How many is "many" though is the tricky question.

Agreed. The IRD look at intention but they also look at practice. You can't intend to be an investor then go around trading willy nilly.

Then question becomes when does this occur?

Length of time of each holding would come into it as well.

This would be a telling factor however a trader/investor may have a range of time frames. Some for a month or less, others may go a year or longer.

[fungus pudding]

I would say if your intention was to invest but you happened to trade numerous shares many times a year then you would have trouble convincing the IRD you are not a trader. How many is "many" though is the tricky question. Length of time of each holding would come into it as well.

As does use of the money realised. What % of income does the investment represent? - was it spent on upgrading a car, or reinvested in a higher yielding stock or other income producing asset? Was the stock you sold showing a good return on purchase - or was it bought for capital gain? History of purchasing/selling. Will reinvesting raise or lower your taxable income? None of these form hard and fast rules but are the sort of thing IRD can look at if doing an assesment. Funnily enough, they don't always believe the intention bit, so use the above test - and more - to paint their own picture of what the investmment was intended to do. e.g. it's hard to believe a low yielding stock was bought for any other reason thain cap. gain, whereas as high yielding stock (whether the investor pays tax directly or indirectly such as a PIE) is far more likely to have been acquired just for income. Then again, if an investor accumulates heaps with little on no ttrading then has a clearance sale and 'retires' from that market permanently or for a few years - he/she is probably in a better position. See how easy it is to know!

[Lizard]

At what point does a Investor become a Trader from a tax perspective?

At about the point they appear to make enough money from capital gains to be worth sending someone around to check through their paperwork?

Although I've taken steps I believe make me tax compliant, I agree that it is still unclear exactly what view IRD would choose to take. It would be interesting to hear of any cases where IRD have actually applied the rules to challenge tax paid.

[fungus pudding]

At about the point they appear to make enough money from capital gains to be worth sending someone around to check through their paperwork?

Although I've taken steps I believe make me tax compliant, I agree that it is still unclear exactly what view IRD would choose to take. It would be interesting to hear of any cases where IRD have actually applied the rules to challenge tax paid.

It would be interesting also to hear of any circumstances where interest claimed for share purchase has been disallowed. Normally interest on money raised to further income is deductible, naturally enough, but what if dividend doesn't cover interest? I know of a case where a commercial property was purchased - rent was showing a loss over interest paid - and rent review was long term off. IRD looked at it and disallowed interest claim as the purchaser should have known his taxable income would not increase in the foreseeable future.
Damned if I know how they even noticed it, although it was one of the AMP properties leased to Woolworths. There were heaps of them through Australasia (all AMP to Woolworths) with 40 year leases signed around 1960 and no rent reviews (obviously AMP hadn't heard of inflation back then: after all what would an insurance company know about investing?) . AMP bailed out of them all at give-away prices. So whether they went through the lot disallowing interest claims, I do not know.

[lou]

At about the point they appear to make enough money from capital gains to be worth sending someone around to check through their paperwork?

Sad but true.

Although I've taken steps I believe make me tax compliant, I agree that it is still unclear exactly what view IRD would choose to take. It would be interesting to hear of any cases where IRD have actually applied the rules to challenge tax paid.

Lizard how do you describe your investing/trading style?

What steps do you take to make you tax compliant?

[Lizard]

Lizard how do you describe your investing/trading style?

My general style is contrarian/value based investing. I like to run a diversified, balanced portfolio of mostly dividend-producing stocks with some growth stocks. I also enjoy ferreting out super-cheap "up-and-coming" spec stocks, which I tend to put very small amounts into while I decide if I like them. Sometimes I will take a quick profit or loss - probably typically 10 small trades a year of less than 12 months - but otherwise typical holding period is probably around 3 years.

What steps do you take to make you tax compliant?

I have a portfolio in my own name and one estate trust for which I am trustee. My intention when I started out was to educate myself as an investor. As I sought out the "best way to invest" and accumulated more funds, I tried many different things - began to make more money and found myself making more transactions. I wanted to hold lots of investments to learn as fast as possible, so only tended to invest the minimum in each one. At the point where I added up my transactions and found I'd done 35-40 in each portfolio for the year, I decided my behaviour was starting to resemble trading. At that point, I did not think that actually trading shares was going to make me the 50% more in returns that I would have needed to make at the time to be worth classing myself as a trader. Nor did I consider it appropriate for the Estate to be trading. So I sat down and wrote a couple of documents, outlining goals, strategy, and method.

I also split my own portfolio into a large investment pile and a smaller trading pile and tried to separate the two by using different brokers at time of purchase to show my intention. I started a hand-written trading log to record trades - if kept up to date, it should be a reliable record of my purchase intention. I also wrote a letter to IRD asking them to confirm that it would be acceptable to separate the portfolios in this way - to which of course I received an "it's acceptable, but would still be down to the circumstances..." type response.

For my investing portfolio, my procedures state that I re-balance once every 3 months and outline the procedure to be used in decision making on buying and selling. Since I wrote it 5 years ago, it is probably about time I pulled the documents out and updated and checked them. I now tend to do a lot less transactions in the Estate portfolio and mostly driven by re-balancing.

Obviously, I also keep spreadsheet records as I go of all trading transactions to record appropriately for tax. These days, the majority of trades occur in FIF regime shares, but it is not clean cut - I have FIF shares in my investment portfolio and some exempt shares in trading where I pay tax on profits... however, I think I would be reluctant to ever claim a loss from this trading while making money on investment shares - it would seem provocative!

I think other things that people could consider doing would be to use a professional accountant and/or Sharesight service to make sure they are seen to be more likely to be paying correct tax. Other things I think IRD consider are the extent to which a person is spending time on trading versus working at another job and the extent to which they are living on profits from the sale of shares... so something to bear in mind when considering retiring early. Right now, I am not working and our family is at one of the more expensive stages - if I do not get back into work shortly, I may need to look closely at what I am withdrawing money from the market for and ensure it is not investment gains that are paying the grocery bills. Or move more funds into Trading and pay tax accordingly.

Having written all this, I have no idea of the odds of me being audited either now or in the future and therefore the extent to which this may seem a waste of effort to some. Nor do I know what stance IRD would choose to take. All my precautions are based on making my best effort to pay tax fairly while not over-paying or under-managing my investments.

[BIRMANBOY]

One faced with this situation might be advised to consider opening separate a/c's for the purposes of separating all trading activities as opposed to investment. We have 3 sep a/c with DB for example (all dif GST registrations). So one is my personal a/c which I was going to use for some trading but have not gotten around to, one investment using my Ltd Company and the last as a partnership with my partner for some joint investments. The benefit as long as you dont "muddy" the waters is that its readily apparent which is doing what. Its quite simple to register as a company and the only down side is that running a company does have more accounting stuff to be done at the end of year etc. I guess you also might consider the "reasonableness" re IRD of balancing upwards all the time in an investment portfolio..the occasional balancing "downwards" would make your position much stronger in any questionable trades/sorry rebalances.

DISCLAIMER and edit...what I need to mention is that as a Company there is no such thing as NON taxable cap gains which of course you can utilize as an individual if its for investment as opposed to trading. As a company, cap gains are booked into a separate a/c which is separated from other trading activities. If your company is specifically set up as a share and bond vehicle then the cap gains are treated as regular trading profit or loss as the case may be. If you add your share stuff into your pre-existing co (like me) then the cap gains from shares are booked but not realized until either you wind up company or presumably decide to add them in to yearly a/c. In any case please talk to your accountant as to benefits /downside etc.

[CJ]

A couple of points:
- unlike property, there is no tainting. Just because you hold one share for trading, does mean the hold portfolio (or all associated portfolios) are tainted.
- it is on a share by share basis.

As such, diferent portfolios is not needed but is good practice.

The thing I struggle with as a buy and hold investor, is how can I buy a share like Xero or DIL (both small parts of my portfolio at purchase price), Obviously growth, not dividend stocks. However, they do form part of a diversified portfolio. And I fully expect them to become good dividends stocks at some stage - DIL in the next year or so and Xero in about 3-5 years.

Or how about RYM - dividend yeild is pathetic but combine with Growth, a good stock as part of a diversified portfolio. Even some of the utilities I own pay less than the interest rate on my margin account.

I am obviously not buying for a quick, or even mid term trade but if you look at the yield I get, potentially you could argue at least 50% are not bought solely for yield.