Trifectas, innings and tax on winnings
Tax Telegraph, April 2013
The full-time siren has sounded. In a miracle turn-around, the Dragons have just beaten the Wests Tigers by 6 points. You look at your ticket… and have won $575.00!
As a frequent recreational punter, you revel in the fact this sum is yours to keep, tax-free. That is, unless the ATO determines that you are carrying on a business.
The sports betting industry is one of the fastest growing industries in Australia, experiencing double digit growth in the last five years and expected to turnover in excess of $4.5 billion in the current financial year, according to Merrill Lynch.
Over the years, the Australian culture of the casual Saturday punter has evolved into a much more sophisticated being - one which has access to online betting accounts, the means to analyse odds across various bookies and the ability to place informed bets on almost any game around the world. The rise of sports betting has also seen the development and wide availability of betting software and computer programs designed to calculate odds and variable and identify favourable opportunities for punters.
While punters may have previously put a bet on their favoured team at the finals, or blown their weekly allowance on the hounds, it is now more prevalent for recreational gamblers to access their online betting accounts and regularly trawl for good-value bets. They may also approach their betting in a more systematic way – not purely relying on ‘gut-feeling’- but staying informed with current information, checking previous statistics and finding the best paying odds.
In the last 5 years or so, it has become evident that there exists certain individuals and groups which have managed to generate vast sums of income from sports betting. The operations of these individuals and groups tend to be quite sophisticated and apply a systematic approach to their betting. They may employ staff to run complex algorithms and gambling software from offices around the world. Clearly, individuals and groups such as these are stretching the notion of ‘recreational gambling’- having consistently generated millions in profits, with none being collected in tax.
It is these types of organisations that the Australian Tax Office (ATO) has had their eye on. And in mid last year the ATO struck, with the aim of retrospectively taxing such winnings as assessable income.
The ATO’s strike
The ATO zeroed in on a group called the “Punter’s club” mid last year, which was a syndicate of 19 selected members, including Tasmanian Art collector, David Walsh. The club, with is use of sophisticated gambling software was able to generate billions of dollars during the years of 2004-2006, the years in which the ATO were conducting their audit. According to the Australian Financial Review, Mr Walsh has chosen to dispute in the court the ATO’s attempt to tax him $37.7 million, plus interest for his winnings within these years.
In the Australian Financial review article Mr Walsh stated that he has “always treated the proceeds of gambling as the ATO has told” him, and that “their opinion, sought a number of times, was that gambling winnings aren’t taxable.” However, he states that it is clear that the ATO has changed their mind and decided to come after the profits retrospectively.
Despite the sheer size of their operations, the members of the club claimed that, as with most recreational gamblers, their participation was merely a hobby and their winnings should not be declared as assessable income.
However the ATO is disputing this, stating the club has deliberately withheld information from the tax office to “give the impression it pursued only recreational gambling.”
Recreational hobby not taxable
Under Australian tax legislation, earnings from a recreational hobby are generally not assessable, and losses are not deductible. As such, winnings from betting, gambling including lottery winnings and prizes won are not assessable. However, the exception to this rule is where the taxpayer is carrying on a business of betting or gambling.
This recent move by the ATO highlights the (at times) uncertain distinction between a hobby and what constitutes ‘carrying on a business’. While this is a relatively new issue within the gambling industry, the question has been frequently raised in the horse racing and horse breeding industries and in other areas such as farming, arts and crafts and internet sales.
When does a hobby become a business?
The distinction between a hobby and a business is an important one as each one has different tax, legal and other implications. It is also possible for a hobby to evolve into a business over time, as the nature and scope of activity changes. This may be evidenced by an increase in the scale of the activities, the introduction of business systems and the intention to gain profits.
ATO Taxation Ruling IT 2655 highlights the Commissioner’s opinion on this topic, concluding that “each case will depend on its own facts” but it would be more likely that betting activities are of a business nature if the taxpayer is involved in other activities in the racing industry.
Other indicia of carrying on a business include:
- Whether the betting is conducted in a systematic and organised way
- The scale of the activities
- Whether the gambling is principally for profit of pleasure
- Whether the form of betting rewards skill and judgement or depends purely on chance.
These factors are merely indicators, however, if the “overall or general impression” of the activity indicates a substantial amount of “commercial flavour”, the ATO will not likely find that it is merely the pursuit of a hobby.
As with the case of the Punter’s club, the ATO claimed that their “activities [were] continuous, systematic, enormous in scale and exhibit[ed] a high degree of skill and business acumen”, with betting operations being conducted 24 hours a day. Exhibiting many indicia of a business, the ATO firmly believe that the club is carrying on the business of gambling.
Besides punting on the sports, ‘gambling’ in the financial sector is prevalent in the form of trading in shares, options and more complex instruments such as contracts for difference (CFDs). The difficulty is that it is common for these instruments to be held in large volumes as investments. When considering whether you are merely investing or carrying on a business of share trading, taxpayers should have consideration of the above indicia, being mindful that the intention to make a profit is not, on its own, sufficient to establish that a business is being carried on.
When it comes to CFDs, the ATO holds the view in Tax Ruling 2005/15 that gains from a CFD will be assessable where the transaction is entered into as an ordinary incident or carrying a business, or where the profit was obtained in a business operation or commercial transaction for the purpose of profit making. Accordingly, a loss from CFDs will be an allowable deduction.
Due to the speculative nature of CFDs, the tax ruling highlights that although there has been some debate in the past, speculation of a financial risk can be characterised as being commercial. As such, a gain from an isolated transaction can be assessable if the property generating the profit was acquired in a business operation of commercial transaction for the purpose of profit making.
Although trading in CFDs is seen to be largely commercial, the ATO expresses in Tax Ruling 2005/15 that it is possible that in some cases where CFDs are entered into for purposes other than to make a profit. Where it can be established that a CFD is entered merely for recreational purpose in a manner akin to making a bet in a game of change, the gains or losses will not be assessable or deductible. Although this situation is contemplated in Tax Ruling, we query from a practical perspective whether the ATO would accept that CFDs would be entered into with a recreational purpose without the view to profit. It is recommended that care should be taken for those who wish to rely on the Tax Ruling and argue this point.
Further, the CGT gambling exemption in section 118 of the Income Tax Assessment Act 1997 will apply to disregard capital gains or losses arising out of CFDs where the CGT event is ‘relating directly to…gambling’.
Don’t take the gamble
The ATO has previously warned entrepreneurs to ensure they distinguish their income-earning hobby from a business, or risk paying tax evasion penalties. On the other side of the coin, they have also warned business owners, and in particular hobby farmers, to be sure that they are carrying on a genuine business before claiming deductions or losses, or risk having penalties applied to any resulting adjustments.
If you currently partake in an income-earning hobby, and are unsure whether you running a business, or vice-versa, it is recommended that you seek professional advice to help make the distinction. The tax and legal requirements between a hobby and business are vast and taxpayers will need to consider requirements such as registration for an Australian Business Number (ABN), registration for goods and services tax (GST) as well as meeting superannuation and insurance requirements.
Please contact your local Deloitte Private advisor if you are unsure how these rules may apply to you.
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