A Contract for Difference (CFD) is a derivative that allows you to speculate on the price movement of underlying securities including shares, indices and commodities on which the CFD is based without the need to own the instrument.
In simple terms a Contract for Difference is really a temporary agreement between the buyer of the CFD and the CFD broker, with both parties taking an opposite view to whether the value of the underlying security or instrument on which the CFD is based will improve or decrease in value. CFDs are settled in the form of a cash payment 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 provider pays the difference, and the holder of the CFD will profit. Should the end result be negative, the holder of the CFD must 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 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 happen to be carrying on a business (or entering into commercial transactions) of buying and selling CFDs for the aim of profit making, any gains made are going to be regarded as assessable income and any losses incurred will be an allowable deduction. The determining issue here is whether you happen to be in fact carrying on a business (or entering into a commercial transaction) the key tests to work out this are outlined below:
* The quantity of transactions you enter into every year (e.g. on a weekly or monthly basis);
* The size and scale of your operations;
* Whether you are carrying on your activities in a systematic, organised and businesslike manner for the aim of profit making; and
* The amount of skill employed in performing these activities.
If you determine that you’re not carrying on a business (or entering into commercial dealings), any gain or loss you would 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’re effectively betting of the fact that underlying share or instrument will either increase or decrease in price, it would appear from the ruling that the aforementioned many not be relevant to CFD dealings. If so, any capital gain or capital loss you make ‘from a financial Contract for Difference entered into for the purpose of recreation by gambling’ will 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 a CFD trade and you can persuade the ATO the deal 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 would lose the ability to offset the capital loss from any present or future capital gains that you have.
Because the ATO views that Contracts for Difference are predominantly entered into for an income making or gaming purpose, it would tricky for you to declare a capital loss if you could not prove that you are carrying on a business or entering into commercial transactions.
For more information on Contract for Difference tax rulings in Australia, you should seek advice from your CFD provider or ask your accountant. You will find straightforward tax guidance in the PDS issued by your CFD broker, you would have received this document before you start trading CFDs online.
