If you’ve disposed of shares or any other form of investment and you know you’ve made a capital gain, it makes sense to take a look at your investment portfolio and consider disposing of any assets which you own which you know are sitting at a loss.
The resulting capital losses can be offset against the capital gain to reduce your overall tax burden.
As we approach the end of the financial year, this strategy is commonly used by investors looking to clear out their loss-making shares in a tax-effective way.
Be careful, though, if you sell shares sitting at a loss and then buy them back in the new tax year. The ATO takes a hard line against so-called 'wash sales'. This refers to the sale of an asset before the year-end and the purchase of a substantially identical asset immediately after the year-end.
The fine print
In 2008, the Australian Tax Office (ATO) issued a tax ruling TR 2008/1, which specifically disallows arrangements where “...in substance, there is no significant change in the taxpayer’s economic exposure to, or interest in, the asset, or where that exposure or interest may be reinstated by the taxpayer”.
In other words, the ATO regard the purchase and the sale as effectively the same asset and they can apply the anti-avoidance provisions to cancel any tax benefits and apply penalties.
So, look out for planning that involves:
- Entering into an arrangement to sell and re-purchase an asset at substantially the same price, or just before or at the time of the sale of an asset; or
- purchasing financial instruments that deliver the same financial benefits that arise from the previous direct ownership.
Let's talk timeframes
Exactly what is the timeframe that the ATO is concerned with here? If you sell shares at a loss now, but buy a similar parcel of the same shares in – say – six months' time, should you be concerned about the ATO applying the ‘wash sale’ provisions?
Well, there is no statutory timeframe to avoid a 'wash sale'; you simply have to look at the specific arrangement and whether the transaction had a dominant purpose of deriving a tax benefit.
If, for example, there is an agreement in place now for you to rebuy the shares when the share price reaches a certain level, this could be an indication that there is planning in place to crystalise a tax benefit.
Any agreement which links the sale of the shares and their subsequent repurchase is leaving yourself open to challenge.
The following are important considerations when selling and repurchasing shares in a publicly-traded company:
- The length of time between disposal and acquisition;
- can a repurchase be attributable to commercial changes (such as a change in market value of the asset);
- the nature of the shares being traded. If the shares are in a stable company with little likelihood of significant change in market value over a short period, the sale/acquisition is less likely to be referrable to commercial purposes and more likely to be tax-driven. If the share price is volatile, then short-term trading is more likely to be commercially driven; and
- the quantity and price of shares repurchased (is the asset substantially the same as that sold?).
So, if you do indeed have shares sitting at a loss that you intend to sell in order to shelter other capital gains which have arisen during the year, make sure the sale is genuine and that there is no intention to buy back the stock in the new financial year.
Mark Chapman is the director of tax communications at H&R Block (NYSE:HRB). As well as operating his own private practice, Mark spent seven years as a Senior Director with the Australian Taxation Office. Mark is a Chartered Accountant, CPA and Chartered Tax Adviser and holds a Masters of Tax Law from the University of New South Wales.