SMSFs running businesses have always been a tricky affair. In fact, for many years it was thought that it wasn’t allowed.
Sometimes an investor might want their super fund to own a typical small to medium enterprise such as a retail or manufacturing business. The preference for using a super fund to own these common SMEs might simply be for capital management or tax planning purposes.
Business or pleasure
A more sophisticated reason is to have your super fund deemed by the Tax Office to be running an investment business, such as a share trading business with your shares defined as trading stock. In order to gain this status your super fund would have to demonstrate that it was a highly active trader of shares or some other financial market.
The advantage of running a share trading business is that all gains will be taxed at normal rates (that is, no allowance for CGT discounts) and, more importantly, all losses will be tax deductible.
In truth most super funds have never bothered to be classed as running a share trading business. However the Global Financial Crisis encouraged many funds with substantial losses to consider applying to the Tax Office for share trader status so they could immediately claim their capital losses as a tax deduction. In many cases these super funds had been happy to use the normal capital gains tax rules for years but the size of losses forced them to look for another solution.
Government reaction
The Government was so concerned about this situation – and its potential revenue impact – that they banned all super funds from being able to class a range of investments as trading stock. This range of investments includes company shares, units in a unit trust and rights or options over the list of items that can no longer be trading stock.
This ban applied from 7:30pm (Canberra time) on 10 May 2011. But as the saying goes, there is more than one way to skin a cat.
Just recently the Tax Office published a Private Binding Ruling (No. 1012450094901). In this ruling, the taxpaying super fund told the ATO that they were a regular trader in Contracts for Difference – CFDs. During the 2012 financial year the super fund had made trading profits of more than $100,000 and trading losses of more than $200,000.
CFDs are an interesting investment structure. In the Private Binding Ruling (PBR), the Tax Office defined these products concisely as, “a form of cash-settled derivative in that they allow investors to take risks on movements in the price of a subject matter (the ‘underlying’) without ownership of the underlying”. Financial CFD’s include those relating to share prices, share price indices, financial product prices, commodity prices, interest rates and currencies.
“Unlike share trading, the non-margin amount of a CFD position is merely a deposit. When a transaction is made, the deposit is not included in the calculation of gross receipts.”
Care required
Importantly the SMSF in question had a process for investing in CFDs which formed part of a business plan that was reflected in the fund’s investment strategy.
The fund held one third of its assets directly in ASX listed shares, another third in CFDs (mostly covering Australian and international equity indices and commodities) and the final third in cash deposits. The super fund used borrowing when they purchased their CFDs but this had been done in such a way that only one third of the fund’s total assets were at risk from adverse market movements.
In the PBR, the Tax Office noted the following – “in the year ended 30 June 2012, the factors that gave the overall impression that you [ie the super fund] were in business are:
- “You traded regularly, you opened and closed many CFD positions. Some positions remained open at 30 June 2012; and
- “Turnover was high; you made gains from profitable trades of over one hundred thousand and made losses from losing trades of over two hundred thousand.
- “You operate in a business-like manner and your trading has a degree of sophistication.”
As a result of its deliberation the ATO deemed that in the 2012 financial year the super fund was carrying on a share trading CFD business, which means that the losses became a tax deduction.
This is a very significant ruling and one that other SMSF investors might like to consider for their own super fund in some select instances, while remaining fully aware of the inherent risks of using complex instruments like CFDs.
Important: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. Consider the appropriateness of the information in regards to your circumstances.
Also in the Switzer Super Report
- Peter Switzer: Getting in doesn’t mean I got out [1]
- Greg Fraser: Stock in focus – the Cinderella story of new News Corp [2]
- Paul Rickard: Which Bank – NAB or ANZ? [3]
- Rudi Filapek-Vandyck: ANZ upgraded – pegged to benefit from QE tapering [4]
- Penny Pryor: Property market the place to be [5]