Private investors should not assume proceeds from selling shares are on capital account. The Full Federal Court’s recent decision in Greig v Commissioner of Taxation highlights the uncertainty of whether amounts received from an isolated transaction are taxable on revenue or capital account. While the facts of Greig related to shares, the principles apply to other types of property.
Gains from the mere realisation or change of an investment are not ordinary income. However, a profit derived (or loss incurred) by a taxpayer in carrying out a business or profit-making undertaking will be on revenue account. A gain or loss arises from a profit-making undertaking if:
- the taxpayer’s intention or purpose in entering into the transaction was to make a profit or gain; and
- the transaction was entered into in carrying out a ‘business operation or commercial transaction’.
What happened in Greig?
In Greig, the question was whether significant share trading losses were deductible because they were either incurred in carrying out a profit-making undertaking or were necessarily incurred in carrying on a business of dealing in the particular shares.
The taxpayer was a senior executive of a large corporate group. From 2008 to 2014, he spent millions of dollars trading in listed shares, with assistance from a firm of financial advisers. From March 2012 to May 2014, the taxpayer made 64 separate acquisitions of shares in Nexus Energy Limited totalling almost $12 million. The taxpayer stated that these acquisitions were made in line with his ‘profit-making strategy’ of acquiring undervalued stock to sell at a profit within a period of months. His intention was to maximise the amount of cash he would have available upon his planned retirement in 2015.
In the 2015 income year, Nexus went into voluntary administration and the taxpayer’s shares were compulsorily acquired for no value. The taxpayer argued he was entitled to deductions for the loss on the Nexus shares and for his legal expenses in attempting to prevent the compulsory acquisition. The Commissioner argued that those losses were on capital account.
At first instance, the Federal Court found that the losses were on capital account – the taxpayer was not engaged in a business of dealing in the Nexus shares and, although the taxpayer had a profit-making intention when acquiring the shares, they were not acquired in a ‘business operation or commercial transaction’. See this article for further details.
The majority of the Full Federal Court ‘after much hesitation’ allowed the taxpayer’s appeal, finding that the losses were on revenue account.
First condition of a profit-making undertaking: intention
The Full Federal Court accepted that the taxpayer acquired the shares with a profit-making intention.
His plan was to sell the shares at a profit quickly, or at least before he retired, rather than to hold the shares as a long term investment and to receive dividends over time.
The fact it took a longer time to realise the profit (and no profit was in fact made) did not affect the taxpayer’s original and ongoing profit-making intention.
Second condition of a profit-making undertaking: business operation or commercial transaction
The primary judge had earlier found that the shares were not acquired in a ‘business operation or commercial transaction’ – rather, they were acquired as an ordinary private investment.
The majority of the Full Federal Court disagreed. The mere fact a transaction has been undertaken ‘privately’ does not mean that any gain is necessarily on capital account. Had the taxpayer realised a gain from the shares, it would not have been characterised as a windfall, the product of the pursuit of a hobby, or merely a realisation of a capital asset because:
- the profit would have been the result of the implementation of a profit-making purpose that existed at the time of acquisition
- the realisation of profit was part of the taxpayer’s overall sophisticated plan to generate cash profits before his retirement a few years later
- the shares were acquired in a systematic way on 64 occasions
- the taxpayer actively participated in a plan to crystallise what he perceived was the true value of Nexus’ underlying asset
- he used his business knowledge and experience
- he acted as a ‘business person’ would in acquiring the shares to obtain a profit on their sale – he engaged professional help, researched and monitored the value of the shares, used his own business knowledge to acquire more shares, pursued a plan to exploit the unrealised value of Nexus’ underlying asset and took steps to defend the value of his investment in court.
For these reasons, the loss in fact incurred was on revenue account.
In dissent, Derrington J held that the shares were not acquired as part of a business operation or commercial transaction because the taxpayer’s intended strategy did not include undertaking any activity to cause the value of the shares to increase in value. The strategy was nothing more than an investment in shares that he anticipated would increase in value, independently of any action on his behalf.
What does this mean for taxpayers?
This case highlights the difficulties in determining whether a gain from an isolated transaction is taxable on revenue or capital account.
Steward J acknowledged that an ordinary private investor may not have the same knowledge and experience as the taxpayer in this case.
Even so, less sophisticated taxpayers who acquire investments such as shares or property in a systematic and business-like manner are at greater risk of having any gains from the investment taxed on revenue account. The risk is heightened where the shares are expected to be sold for a profit, without any intention of dividend yields or long term capital growth.
Taxpayers and advisers should remember that the mere realisation of an asset to the best advantage does not constitute a profit-making undertaking. In each case, the question is whether the taxpayer had a profit-making intention and whether the taxpayer’s activities were the kinds of things a ‘business person’ would do in acquiring assets to obtain a profit on their sale.