A Contract for Difference (CFD) can be described as derivative that allows you to speculate on the price movement of underlying securities like 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 short term contract between the buyer of the Contract for difference 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 increase or decline in price. CFDs are settled in the form of a cash settlement which 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 provider, and the holder will incur a loss. As CFDs do not have an expiry date CFD positions can be held open indefinitely.
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 purpose 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 aspect here is whether 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 quantity of transactions you enter into every 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 actions.
If you determine that you are not carrying on a business (or entering into commercial transactions), any gain or loss you would usually make would fall under the Capital Gains Tax (CGT) provisions. As CFDs are considered a CGT-asset, any capital gains are treated as assessable earnings and capital losses can be deducted from any present or future capital gain.
As the ATO views Contracts for Difference as contracts of speculation, in that you are effectively betting that the underlying equity or instrument will either increase or decrease in value, it would appear from the ruling that the aforementioned many not be relevant to CFD dealings. If this is the case, any capital gain or capital loss you make ‘from a financial Contract for Difference entered into for the aim 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 convince the ATO the transaction was entered into for the aim of recreation by gambling, you may 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 a profit making or betting 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 money-making transactions.
For more information on Contract for Difference tax rulings in Australia, you should seek advice from your CFD broker 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.
