There are two constants in life – death and taxes. We do not propose to disagree with the almighty, but we might have something to say about currency trading tax! Successful traders will know we always encourage how to trade successfully whilst keeping losses and costs low. Yet one area which deserves a visit is the tax advantageous nature of Forex trading. It often gets people’s attention that Forex trading is, depending on the tools used, tax free!
Spread betting is not allowed in the US but is available to customers who reside in the UK or Ireland. From a Forex perspective, spread betting is when a trader takes a position in a currency, betting it will rise or fall. As Forex Trading is so volatile, with gains and losses several times a day for day traders, the tax man has preferred to leave it untaxed. Essentially the government treats financial spread betting a bit like placing bets on horse racing. You don’t pay anything on gains, but you cannot offset your losses against tax.
When looking to trade successfully, lower costs are important and the lack of currency trading tax, such as stamp duty on spread betting makes it attractive for day traders. If you are having to pay stamp duty on each trade you open and close each day then it rapidly gets expensive! The lack of stamp duty is due to spread betting being a derivative of a security, as you don’t actually own the underlying security.
CFDs are a little more complicated despite being available to customers globally. For starters the U.S. deems CFDs to be swap contracts. This makes it less clear how they should be treated from a tax perspective. Best to consult with a US tax accountant – the IRS is not a foe anyone wants!
In the UK, CFDs, like spread betting are not liable either for stamp duty or income tax. Unfortunately, CFDs are liable for capital gains tax but this means any losses can be used to offset gains, meaning you can profit from losing trades. It’s not all doom and gloom, as in the UK capital gains has an attractive tax-free allowance. Capital gains tax is also lower than income tax. So it is better to be taxed on capital gains than on income earned. This is where the attraction of spread betting and CFDs lie.
So far in this article we have examined the case of using spread betting and CFDs as a second source of income. If Forex business becomes your main source of income the currency trading tax ramifications are different. Once your main source of income is spread betting then you will be liable for income tax. Trading CFDs as your main source of income will also mean you are liable for income tax. Yet losses can be declared for tax relief purposes. This makes CFD trading tax efficient if it is your main source of income.
The complexity of working out what each person owes in currency trading tax means the government prefers to find other ways of taxing winnings. It is easier to tax the betting company directly. In the end the government feels it can earn far more by taxing companies than individuals. Otherwise it would be the other way around!
Governments regularly changes tax laws as they find new and innovative ways to earn income from you. Spread betting is currently not liable for capital gains tax but it’s not beyond doubt that this could change. CFDs are liable to capital gains tax. Usefully there is a tax-free allowance of £11,700 per year for UK based investors. This CGT allowance usually increases each year.
For capital gains, you will need to fill out a Capital Gains Tax Return. It is easier to fill out online. For income tax, you will need to fill out an annual Self-Assessment Tax Return, which is also easier done online. HMRC can be contacted for both returns with any questions on currency trading tax.
There will rarely be a day when something is tax free. Currency trading tax is advantageous in the current climate whether it is secondary income or your main source of income. Knowing which option to use, be it spread betting or CFDs, will mean being able to maximise the advantage of currency trading tax. In turn you will be able to increase your winnings as there will be no tax related drain! What are you waiting for to earn tax-free income?