No need to speculate, in South Africa, there are indeed tax implications on the trading of derivatives. However, the characterisation of monies earned on the trading of derivatives is typically the cause of great uncertainty for trading taxpayers, resulting in the submission of erroneous tax returns.
In terms of section 1(1) of the Income Tax Act No. 58 of 1962 (the Act), the broadly defined “gross income” provides for a specific exclusion for any receipts or accruals which are capital in nature. In various jurisdictions, the tax regulations on the trading of derivatives are favourable to taxpayers in this particular respect, with profits derived from the trading of derivatives being taxed as capital receipts which are typically subject to more favourable tax rates.
In the South African context, the question of whether income derived is revenue or capital in nature is a factual enquiry of the taxpayer’s circumstances, with key consideration being given to the taxpayer’s intention.
The case of CIR v Pick ’n Pay Employee Share Purchase Trust (1992 4 SA 39 (A), 54 SATC 271 put forward the test of the taxpayer’s intention on the disposal of assets. Summarily, stating that in the case where transactions are carried out in a manner which suggests the existence of business operations, the taxpayer’s intention can be determined to be that of profit-making with income derived therefrom constituting revenue.
When exactly is trading considered a trade?
Over the course of the years, the courts have extensively considered factors which are typically, objectively, indicative of a trade being carried out by a taxpayer, including:
- the genuine intention to turn profits;
- the expending of resources;
- the carrying out of active operations, rather than merely watching over investments;
- and the volume or frequency of transactions.
If it trades like a trade, it is likely a trade!
While the profits turned on the trading of derivatives may be quite attractive, traders incur expenses some of which may be significant and tax deductible. Important to remember for traders is that section 11(a) of the Act restricts the deduction of deductible expenses incurred to the year of incurrence. It is therefore important for traders to be cognisant of what constitutes a tax-deductible expense and when exactly it is incurred.
For instance, during the term a trader holds securities, some of the traded entities may realise an increase in profits resulting in the declaration of dividends. The trader will be liable to pay over the dividends to the brokerage firm as the lender of the securities, such dividends are commonly known as “manufactured dividends” and are an expense deductible for tax purposes in terms of section 11(a) read with section 23(g) of the Act.
Other common tax-deductible expenses incurred by traders are typically lending fees, manufactured interest, equipment depreciation and internet expenses.
Johnny Hindsight; the best trader in town.
While most things are clearer in hindsight, the sudden realisation is sometimes unwelcomed. For many taxpayers trading in derivatives, this comes in the form of becoming privy to the tax implications of one’s trading activities and the subsequent fear of retribution on erroneous tax returns previously submitted.
If you are a trader reading this article in incognito mode,. worried that the taxman may come knocking on your door to collect what is rightfully his plus penalties, recourse may be available to you by way of the Voluntary Disclosure Programme (VDP).
The permanent programme was introduced, in terms of the Tax Administration Act No. 28 of 2011 (the TAA), in 2012 with the primary objective being to encourage defaulting taxpayers to get their affairs in order to ensure optimal revenue collection. The objective is achieved by providing protection against criminal prosecution and/or the imposition of penalties to said taxpayers where defaults are successfully declared under the VDP.
In terms of section 227 of the TAA, a defaulting taxpayer may be eligible for VDP if the disclosure in their application meets the following criteria:
- the disclosure is voluntary;
- the disclosure involves a default not similar to any default disclosed within the past five years;
- the default stems from a behaviour listed in the understatement penalty percentage table – as per section 223 of the TAA;
- the disclosure is full and complete;
- the disclosure does not result in a refund being payable by SARS; and
- the disclosure is made in the prescribed manner and form.
Comment
Whilst the trading of derivatives is a notably fast-emerging market in South Africa, tax legislation fails to keep up and make specific provision for such. It is therefore advisable that traders engage the services of tax experts for assistance with the interpretation and application of existing laws to the facts surrounding the taxpayer’s circumstances. This nugget of wisdom further applies to the submission of applications under VDP whilst the requirements may seem straightforward achieving favourable results takes skill and expertise.
