Share trading and investing are two popular avenues for Australians looking to grow their wealth. While both involve buying and selling assets, there are significant differences, especially regarding tax implications. Understanding these differences is crucial for maximising returns and minimising tax liabilities.
Understanding the Difference Between Share Trading and Investing
Share trading involves buying and selling stocks within relatively short time frames, often capitalising on market fluctuations to generate quick profits. In Australia, gains derived from share trading are typically treated as assessable income and subject to taxation at the individual’s marginal tax rate.
Investing, on the other hand, entails purchasing assets with the intention of holding them for extended periods, allowing wealth to accumulate over time through capital appreciation, dividends, and compound interest.
Difference between the two:
Difference in Approach
Share trading requires a more hands-on approach, with traders closely monitoring market movements and reacting swiftly to changes. In contrast, investing takes a more passive approach, focusing on long-term growth rather than short-term gains.
Time Horizon
Share trading often has a shorter time horizon, with traders looking to capitalise on short-term price movements. Investing, however, has a longer time horizon, with investors holding assets for years or even decades.
Tax treatment
First, let’s consider the tax treatment of holding shares as a trader and an investor.
If you are a trader, the treatment of your profits or losses will be as follows:
- The gains are treated like ordinary income
- The shares are considered trading stock in a business
- The losses, as well as the costs, are deductible expenses in the year of incurring them
On the other hand, if you are an investor, the following will be the treatment of your profits and losses:
- Since the shares are considered assets, they are subject to CGT (capital gains tax) when sold
- If a capital loss is incurred, it can be used to offset capital gains but not to offset income from other sources
- The costs are taken into account when the shares are sold
- The income is earned from dividends, and the same receipts
It is worth noting that if an individual goes from an investor to a trader (or vice versa), how their profits and losses treated also changes.
Key Considerations in Tax Treatment
Profit and Loss Treatment:
For Share Investors:
- Profit from Sale: Subject to capital gains tax.
- Loss from Sale: Used to offset capital gains or carried forward for future use.
- Dividend income: Included in assessable income.
- Purchase Price: Considered when calculating capital gain or loss.
- Transaction Costs: Factored in when shares are sold.
For Share Traders:
- Profit from Sale: Assessable as ordinary income.
- Loss from Sale: Deductible against income.
- Dividend income: Included in assessable income.
- Purchase Price and Transaction Costs: Deductible in the year incurred.
Determining Share Trader Status:
Identifying whether you qualify as a share trader involves assessing various factors, including:
- Nature and purpose of activities.
- Repetition, volume, and regularity of transactions.
- Organisational structure and record-keeping practices.
- Capital investment in shares.
Nature of Activity and Profit Intent:
Merely intending to profit isn’t sufficient to establish a business. Share traders engage in buying and selling shares for income generation, while investors focus on earning dividends.
Repetition, Volume, and Regularity:
Frequent transactions and a high volume of share dealings indicate a trading business rather than a passive investment.
Organisational Structure and Record-Keeping:
A business-like approach involving market analysis, expert advice, and meticulous record-keeping signifies share trading activities.
Capital Investment:
While capital investment matters, it’s not the sole determinant of trader status.
Transitioning Between Roles
Changing from an investor to a trader, or vice versa, necessitates a shift in how you manage your shareholdings and report income. Here’s what you need to know:
From Investor to Trader:
- Shares transition from CGT assets to trading stock.
- Choose between original cost or market value at the time of change.
- Unused capital losses remain as such and cannot be converted into revenue losses.
From Trader to Investor:
- Shares cease being trading stock.
- Treat shares as if sold at cost and immediately repurchased at the same amount.
Conclusion
Understanding the key differences between share trading and investing is crucial for making informed financial decisions. While both avenues offer opportunities for wealth creation, their tax implications vary significantly.
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