Contract for Difference (CFD) Company Tax
In straightforward terms a Contract for Difference can be described as short term contract between the buyer of the CFD and the CFD broker, with both parties taking an opposite view as to whether the value of the underlying security or instrument on which the CFD relies will increase or decline in price. CFDs are settled in the form of a cash settlement that is calculated as the difference between the opening and closing price of the underlying share or instrument. If the difference is positive the CFD broker pays the difference, and the holder of the CFD will benefit. Should the outcome be negative, the holder of the CFD is obliged to pay the difference to the CFD broker, and the holder will incur a loss. As CFDs do not have an expiry date CFD positions can even be held open forever.
The Australian Taxation Office (ATO) has published a Tax Ruling TR-2005/15 'Income tax - tax consequences of financial contracts for differences', regarding the tax treatment of financial Contracts for Difference.
The Tax Ruling states that if you are carrying on a business (or entering into commercial transactions) of buying and selling CFDs for the purpose of profit making, any gains made are going to be regarded as assessable earnings and any losses incurred will be an allowable deduction. The determining issue here is whether or not you happen to be in fact carrying on a business (or entering into a commercial transaction) the principle tests to work out this are outlined below:
- The number of transactions you enter into each year (e.g. on a weekly or monthly basis);
- The size and scale of your operations;
- Whether or not you're carrying on your activities in a systematic, organised and professional approach for the purpose of profit making; and
- The degree of skill employed in performing these activities.
If you determine that you are not carrying on a business (or entering into commercial transactions), any gain or loss you'd usually make would fall under the Capital Gains Tax (CGT) provisions. As CFDs are regarded as a CGT asset, any capital gains are dealt with as assessable earnings and capital losses are usually deducted from any current or future capital gain.
As the ATO views Contracts for Difference as contracts of speculation, in that you are effectively betting of the fact that underlying security or instrument will either increase or reduce in value, it would seem from the ruling that the aforementioned many not apply to CFD transactions. If so, any capital gain or capital loss you make 'from a financial Contract for Difference entered into for the aim of recreation by gambling' is going to be disregarded under the CGT gambling exemption provision.
What this all means is that if you have made a $1,000,000 capital gain from your CFD trade and you can persuade the ATO the transaction was entered into for the purpose of recreation by gambling, you might be laughing all the way to the bank. However, if the outcome were a $1,000,000 capital loss, you'd lose the ability to offset the capital loss from any existing or future capital gains that you may have.
As the ATO views that Contracts for Difference are predominantly entered into for an income making or gaming purpose, it would difficult for you to claim a capital loss if you could not prove that you are carrying on a business or entering into money-making transactions.
For more information on CFD tax rulings in Australia, you should seek advice from your CFD provider or ask your accountant. You will find basic tax guidance in the PDS issued by your CFD broker, you would have received this document before you start trading CFDs online.