Opinion: Grey areas in share trading and tax

Investing in shares is a little like being at the races.

I don't so much mean the nature of the punt, but rather that people tend to only recount their successes. Any losses seem to disappear into the misty ether of yesterday. Having enjoyed a little win among my more frequent (and mostly uncrystallised) losses, it got me reflecting on the tax consequences of such.

Generally speaking, the gains (or losses) on the sale of shares can hit the tax net in two main ways.

The first is where you have acquired those shares with the intention of selling them. An example of this maybe a situation where you subscribe for shares in one of the Government's privatisation sell downs (e.g. Mighty River Power) with a view that you can ''stag'' them: that is, you hope to sell them quickly for a gain. This could apply to any share, new issue or not.

If you have such an intention, then when you sell them, the sale proceeds will be on revenue account (which is code for taxable). You, of course, can claim a deduction for the cost, which will either generate a taxable profit or a claimable loss.

Where it gets more complicated is when the IRD asks you to prove your intention at the date of acquisition (normally asked with a view to deny a loss or perhaps drag a profit into the tax net). Timing of transactions is indicative of intent (e.g. if you sold within a week, that may indicate an intent to sell) but the best evidence is something more, such as a note in your diary, a file-noted conversation with your broker, or similar.

This applies both ways - demonstrating a long-term intent when, in fact, you sold the share within a short timeframe due to changing circumstances for a gain (and you are arguing it should be tax-free), or trying to claim a loss on a particular share. The onus is on you to prove whatever the IRD believes is incorrect, not on them to prove it is correct, bearing in mind that they always have the benefit of hindsight (including the ability to electronically access details of all share transactions).

The other main reason share transactions fall into the tax net is where that share investment is part of a share trading business/undertaking. In that case, the profit or loss will form part of the overall calculation of the share trading business' income, just like the sale of bread forms part of a corner dairy's income.

The main point of contention in this instance is whether there is a business at all. We have seen many arguments with IRD where it has argued a business exists on what we would consider a relatively few transactions/low time applied where there is an overall profit. Interestingly, in recent years, the IRD has been actively arguing the counter position for some taxpayers, whereby it feels there is no evidence of a business, and thus, losses are not claimable.

In that sense, it seems to apply a much higher standard of ''what is a business'', including, in some instances, carving up the types of shares into smaller groupings (e.g. NZ v overseas shares), so as to demonstrate that, when isolated, neither activity meets the business tests.

Irrespective of the veracity of these types of distinctions, it suggests that in the margins there is still room for debate as to whether those gains/losses on shares should be taxable/claimable, and taxpayers should take care, noting that the IRD is both active in this area (e.g. it habitually examines share trading activities post-floats) and has the dual advantages of hindsight and superior resources.

- Scott Mason is the managing principal of tax advisory for Crowe Horwath NZ.

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