A Contract for Difference (CFD) is a derivative that allows you to speculate on the price movement of underlying securities like shares, indices and commodities over which the CFD is based without the need to own the instrument.
In simple terms a Contract for Difference is a short term agreement between the buyer of the Contract for difference 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 improve or decrease in value. CFDs are settled by way 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 end result be negative, the holder of the CFD must pay the difference to the CFD provider, and the holder will incur a loss. As CFDs don’t 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’re carrying on a business (or entering into commercial transactions) of buying and selling CFDs for the purpose of profit making, any gains made will be regarded as assessable income and any losses incurred are going to be an allowable deduction. The deciding factor here is whether you happen to be in fact carrying on a business (or entering into a commercial transaction) the key tests to determine this are outlined below:
* The quantity of transactions you enter into each year (e.g. on a weekly or monthly basis);
* The size and scale of your operations;
* Whether you could be carrying on your activities in a systematic, organised and businesslike approach for the aim of profit making; and
* The degree of skill employed in performing these actions.
If you determine that you’re 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 considered a CGT-asset, any capital gains are dealt with as assessable earnings and capital losses are usually deducted from any present or future capital gain.
Because the ATO views Contracts for Difference as contracts of speculation, in that you’re effectively betting that the underlying equity or instrument will either increase or reduce in value, it would appear from the ruling that the aforementioned many not apply to CFD transactions. If this is the case, any capital gain or capital loss you make ‘from a financial Contract for Difference entered into for the purpose of recreation by gambling’ will likely 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 convince the ATO the deal was entered into for the purpose of recreation by gambling, you will 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 existing or future capital gains that you may have.
Because the ATO views that Contracts for Difference are predominantly entered into for a profit making or gambling 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 check with 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.
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