A common question that many people ask is 'can my trust fund invest in CFDs?'. A typical misconception amongst traders and investors is that trust accounts are treated in a different way by their CFD provider to individual and corporate accounts. Actually trust accounts are treated in the exact same way as any other account, the only difference is the tax treatment of gains when the trustee chooses to distribute them to the beneficiaries of the trust.
Traders and investors commonly use trusts for investing in CFDs for the following reasons:
for members of their family or 'family group' to benefit from their CFD trading profits;
tax benefits, providing the trust passes the family control test and makes distributions of trust earnings only to beneficiaries of the trust who are members of the 'family group';
protecting the assets of the family group's from the liabilities of one or more of the members of the family (for instance, in the event of a family member's bankruptcy or insolvency);
offer a mechanism to pass family assets on to future generations;
accessing favorable taxation treatment through the use of income tax "tax-free thresholds" of members of the family; and
avoiding issues including challenges to the will following the event of the death of a member of the family.
The Benefits of using a trust to invest in CFDs
The major benefit of a family trust is that the trustee is able to disperse income earned from investments made by the trust in any way they see fit, providing the distributions are made to the beneficiaries of the trust. Trustees do not have to make trust distributions in any particular percentage or in the same proportion.
A trust is not required to pay income tax on profits that are distributed to the beneficiaries, but does need to pay tax on undistributed earnings. Trustees can distribute trust income to several beneficiaries, and in proportions that take advantage of those beneficiaries' personal tax rates. The beneficiaries then pay the tax on distributions made to them.
For example, should an adult beneficiary of the trust only receive income from the trust and benefit from the tax-free threshold (currently $6,000) for that year, the trustee would be able to distribute a part of the family trust's revenue to this person. The result would be that the beneficiary will receive some income but may not need to pay tax if that amount is less than $6,000. If the distribution to the beneficiary exceeds their tax-free threshold, the surplus amount is going to be taxed at the beneficiary's personal tax rate.
Distributions received from a trust are not considered a special type of income, but instead form part of a beneficiary's assessable income. If the beneficiary receives income from other sources along with distributions through the trust, all of their income is taxed together.
If the beneficiary's earnings exceed the tax-free threshold for a particular year, the rate of tax applied to the total amount of the surplus earnings over the tax-free threshold may be lower than that for other beneficiaries due to total income that these other beneficiaries already receive.
Undistributed income is taxed in the hands of the trustee at the top marginal tax rate giving a strong incentive for family trusts to completely allocate the trust's income before the end of every financial year.
The trustee should also take care in relation to which beneficiaries are chosen to receive distributions, as penalty tax rates can apply to distributions made to minors.
Income Distributions
One important aspect of a family trust that has got to be kept in mind is to whom the distributions are made.
First, all distributions have to be made only to individuals who are eligible under the terms of the trust deed to be beneficiaries of the trust.
Secondly, for trusts that have made a family trust election, the distributions may only be made to beneficiaries who are within 'the family group'. In relation to this the ATO states on its website:
"A consequence of making a family trust election is that any distributions (broadly defined) outside the family group of the family trust by the trust will be taxed at the top marginal rate applying to individuals plus the Medicare levy."
In other words, if a family trust makes a family trust election after which it pays out to someone not a member of the family group, they are taxed at the maximum rate possible.
Trust Buzz Words Trust deed - This set out the terms and conditions under which a family trust is established and maintained. The trust is established by the trust's settlor and trustee (or trustees) signing the trust deed, and the settlor giving the trust property (the "settled sum") to the trustee.
The settler - The settlor's function is to offer the assets to the trustee to hold for the benefit of the trust's beneficiaries on the terms and conditions set out within the trust deed. The settlor executes the trust deed and then will normally, have no further involvement in the trust.
The trustee - The trustee is responsible for the trust and its assets. The trustee has broad powers to execute the trust, and manage its assets. In a family trust, the trustees are usually Mum and Dad (or a company of which Mum and Dad are the shareholders and directors). Their children and any other dependants tend to be listed as beneficiaries.
The trust information here should be considered general in nature, and by no means interpreted as legal advice.
You can find out more about trading CFDs in your trust account in our free CFD Guide.
Benefits of trading CFDs CFDs are derivative products that offer distinct benefits including:
Liquidity
Traded on margin
Traded long or short
Traded online
Low transaction cost
Access to international markets
Benefits from dividends
Liquidity CFD prices are obtained directly from the underlying market. This means CFDs give you access to the liquidity in the underlying market, plus liquidity offered by the CFD provider. Most of the time there is much more liquidity in the CFD market than in the underlying or physical market due to the higher number of participants including private and institutional traders.
Trade on margin CFDs are traded on margin, typically from 5-10% to for shares and 1% for indices. This means a more efficient use of your capital as you only need to allocate a small percentage of your funds to secure a trade. This also enables you to magnify the returns on your investment with a much smaller capital outlay.
Trade long and short Before CFDs, going short a stock could only be done through a traditional broker that would charge hefty fees on top of the normal brokerage. With CFDs traders can now go short any position or market without any extra cost. Going short is as easy as going long with CFDs. Going short also provides another benefit that was not available before. Your CFD provider will pay you interest on a short CFD position. This is similar to earning interest on your bank account balance.
Trade on-line With an estimated 13.4 million Australians with Internet access online share trading has also been on the increase, giving traders more control and constant access to their positions. Most CFD providers offer free software and CFD trading platforms that allow traders to place orders online even outside normal trading hours.
Low transaction cost Trading CFDs can cost you as low as $10 each way compared to traditional stock brokerage rates of around $25-30. Although transaction costs are a small portion of your overall trading cost, they have an impact on your bottom line once the volume of your transactions increases.
Access to international markets CFDs open up a wide range of trading instruments. Most CFD providers offer CFDs on Australian and International shares, indices, sectors, commodities, foreign exchange and treasuries. Most of these markets were not available or accessible to private traders before due to the complex nature or complicated set up of traditional brokerage accounts.
Receive benefits of dividends and stock splits As CFDs reflect the price and movement of the underlying physical share, they also mirror any corporate actions that take place in the underlying share. This means, if you are a holder of a share CFD, you will also receive dividends and stock split benefits once they become due. However, you are not entitled to any voting rights or franking credits. On the same vein, when you are short a share CFD and the underlying stock goes ex-dividend, you have to pay the dividend amount as you would if you were short the physical share.
To find more helpful CFD trading tips you can download our free CFD Guide.
Contract for difference traders are not just competing with each other in the market. They are competing with themselves. Traders can be emotional and irrational, and that can make them their own worst enemies.
Feelings and Instincts can bring trading successes, but they are more likely to result in trading losses unless we learn to be in control of them. This is why appreciating trading psychology is vital.
Many CFD traders would like to disconnect themselves from their feelings. Unfortunately, this is not possible, and some feelings may even add to their trading successes. Therefore, it is more useful to learn to understand yourself as a trader, recognizing your own strengths and weakness, so that you can decide on a trading style that suits you best.
In this section, you will learn about four psychological biases that may adversely change your trading results, and you will understand what you can do to overcome them. The biases are:
1. Overconfidence
2. Anchoring
3. Confirmation
4. Loss aversion
1. Overconfidence Bias
Overconfidence bias is an magnified belief in your competence as a trader. Any trader who finds themselves thinking that they know the business inside-out and that they have nothing more to learn and that profits are theirs for the taking, may well suffer from an overconfidence bias.
Dangers of Overconfidence
Overconfident traders tend to get themselves into trouble by trading too frequently or by placing tremendously large trades with the plan of making a killing. It's not inevitable, but an overconfident investor invites misfortune.
Are You Overconfident?
If you want to identify whether you have a tendency to be overconfident, ask yourself, “Have I ever delayed or reversed a decision because I couldn't accept that I was wrong?” Likewise, you could ask yourself, “Have I ever placed more on a trade than what I know is really sensible?”
Overcoming Overconfidence
One way to overcome an overconfidence bias is to stick to a strict set of risk management rules. These rules should limit the number of markets you invest in, the number of Contracts for difference you trade at one time, how much you are willing to risk on any one trade and how much of your account are you willing to lose before you take a break from trading and re-evaluate your trading strategy.
2. Anchoring Bias
Anchoring bias is a perception that the future is going to look very similar to the present. When you anchor yourself too closely to the present, you may fail to notice dramatic changes in the offing.
Dangers of Anchoring
Anchored traders tend to get themselves into trouble because they wrongly believe that current trends will never end or that companies they've always followed will never let them down. Because they are emotionally attached to a Contract for difference, they continue to make investments in a way which is not optimal in changed circumstances. With each trade, they lose more money because they are bucking the trend.
Are You Anchoring?
If you want to know if you have any anchoring tendencies then ask yourself, “Have I ever lost money because I couldn't accept that a trend had ended?” If you have done this, you need to be aware of that tendency.
Overcoming Anchoring
One way to overcome anchoring is to seek a new perspective. Look at different time-frames on your charts. If you usually rely on hourly charts for data, look instead at the daily and weekly charts to examine long-term trends as well as levels of support and resistance. You could also examine shorter-term charts to see if trends are reversing.
Broadening your standpoint in this way will help you to avoid anchoring yourself to any one point.
3. Confirmation Bias
Confirmation bias is the habit of only looking for information that supports your beliefs. If you anticipate the price of BHP Billiton (BHP) is going to rise, for example, you will only really take in news and data that support your belief.
Dangers of Seeking Confirmation
Traders who pursue confirmation of their beliefs tend to miss warning signs that would otherwise protect them from preventable losses. Ultimately, this can only lead to losing money because decisions to buy or sell, or even to do nothing, are being made on false premises.
Do You Seek Confirmation?
To know if you have any confirmation bias tendencies, ask yourself, “How often do I look for signs that I may be wrong in my analysis?” If your answer is rarely or never, you may be a confirmation seeker and you need to actively work to ensure that such a bias never influence your better judgment.
Overcoming Confirmation Bias
One way to overcome confirmation bias is to find an individual or group with whom you can discuss your trading. You don't need somebody who will simply flatter you or perpetually agree with you. Traders with different views and thoughts will help you to be more vigilant. Sometimes your convictions will only be reinforced by talking with other traders, but at other times, they may force a total and timely rethink.
4. Loss Aversion Bias
Loss aversion bias is based on the theory that losing $1,000 will have a larger impact on you emotionally than gaining $1,000 will. In other words, fear is a more influential motivator than greed.
Dangers of Loss Aversion
Ironically traders who fear losses are much more likely to hold onto losing positions than traders who are able to accept short-term losses and exit their trades. A reluctance to give up a losing position will not only cause you to incur larger losses but also stop you from finding better trades.
Do You Fear Losses?
If you want to know if you have any loss aversion tendencies, ask yourself, “Have I ever held onto a losing position, beyond the point where I knew I should have quit, because I hoped the trend would reverse and wipe out my losses?” If you have, then you need to be aware of that tendency.
Overcoming Loss Aversion
One way to overcome a loss aversion bias is to trade with automatic stop-loss orders. Many traders trade with just a mental stop-loss that, when it comes to the crunch, they fail to honor. They let their emotions interfere with their better judgment as they try to justify irrational decisions that prevent them from quitting and cutting their losses.
In summary, as soon as you buy a CFD you should set your stop-loss order. It should be physically set, operate automatically, and you should respect it.
If you would like to understand more about the psychology of CFD trading you can download our free CFD Guide.
Some CFD providers only offer one type of CFD others offer both. The most common type of CFD is the market made variety, typically this type of CFD is offered by CFD providers that also offer spread betting and originate in the United Kingdom where spread betting is popular.
All CFD traders or potential CFD traders should understand the differences between the mechanics of both types of CFDs and the fee structures associated with them.
Direct Market Access (DMA) CFDs
Direct Market Access (DMA) CFDs mirror the price and liquidity of the underlying instrument on which the CFD is based. DMA CFDs are the most fair and transparent type of CFD available. When trading DMA CFDs the trader is a "price maker". DMA CFD traders can enter and see an equal order flow onto the underlying exchange, this guarantees that at all times they receive true market prices on every trade. DMA CFDs offer traders real time execution, guaranteed market prices and participation in the order book and opening and closing phases of the market this provides a significant advantage for scalpers.
DMA CFD providers do not profit directly from performance of the CFD trader, as all CFD positions are 100% hedged. This means that if you buy the CFD, the provider will instantly buy the underlying equity as their hedge trade.
Points to note
• The quoted price of DMA CFDs is the same as the price quoted on the underlying exchange;
• DMA CFD orders flow directly onto the underlying exchange;
• DMA CFD traders can be a price takers or makers and participate in the market depth on the exchange, and;
• DMA CFD traders can participate in opening and closing market auctions.
Market Maker (MM) CFDs
A Market Made CFD does not mirror the price on the underlying market. Market Makers that offer Market Made CFDs derive their CFD prices from the underlying instrument on which the CFD is based rather than quoting the exact exchange price of the instrument like DMA CFD providers. Market Makers act as an intermediary to the CFD trade and have the ability to alter the price of the CFD, price alterations often occur in their favor, often resulting in stop orders being triggered and slippage which can add a significant cost to the trade.
Market Makers do not hedge 100% of their CFD positions, typically they hedge only the resulting amount after their clients long and short positions net each other off, however in many cases they do not hedge at all and often directly profit from their client’s losses. When trading Market Made CFDs trades do not flow directly onto the exchange, they are at the discretion of a dealer as a result orders are filled slower and at inferior prices.
Points to note
• MM CFD traders do not receive the same prices as those quoted on the exchange;
• MM CFD spreads are often widened and orders re-quoted;
• Market Makers are price takers not price makers, this means MM CFD traders cannot participate in the underlying order book;
• MM CFD traders cannot participate in the opening and closing market auctions and;
• Some Market Makers profit from the performance of their clients positions.
Market Made CFDs do have some benefits over DMA CFDs in that they are generally offered over a larger range of stocks and indices. Market Makers are also able to offer additionally liquidity in larger stocks, the reason for this is because they have positions on their internal order book which they would like to clear.
Market Makers often re-quote clients when they attempt to buy or sell a CFDs, re-quotes occur as a result of the Market Marker adjusting their internal order book to compensate for a lack of liquidity at a particular price level on the underlying exchange.
So which type of CFD should you choose: When comparing the two types of CFDs you should consider whether you’re trading style and the instruments that you trade suit either a Market Made or Direct Market Access model. Typically scalpers and active traders choose DMA CFDs over MM CFDs as there are no re-quotes and the trader can be a “price maker” through participating in the underlying order book of the stock which they are trading. Market Made CFDs are popular with longer term traders and those that prefer to trade indices and forex. The reason for this is than often Market Markers offer both indices and forex commission free. Often DMA CFD providers do not offer indices and forex on a DMA basis as by their very nature they are a market made product and cannot be traded on an exchange.
Before choosing a CFD provider you should analyse your trading strategy and choose the type of CFD that suits you best. If you are unsure of your trading strategy or would like save the hastle of having multiple CFDs account with multiple providers you should choose a CFD provider that is able to offer you both Market Made CFDs and DMA CFDs.
Other types of CFDs
It is also worth noting that there is a third type of CFD, these are exchange traded or ASX CFDs and are offered by the Australian Stock Exchange. ASX CFDs are not popular amongst traders or investors due to their lack of liquidity and wide spreads. ASX CFDs are only offered over a small range of securities, indices and foreign exchange pairs. ASX CFDs do have the benefit of being cleared and traded on an exchange however as there are no significant advantages of this type of CFD traders prefer either the Market Made or Direct Markets Access CFDs.
With some CFD providers you can trade either Market Made CFDs or Direct Market Acess CFDs.
To find more helpful information on CFD trading you can download our free CFD Guide.
Pairs trading is the action of a trader buying one CFD and simultaneously selling another. As the trader is long one CFD and short the other they are not affected by broader market movements instead they are subject to the price movements of pair of securities which they are trading. As long as the trader buys the outperforming security or sells the underperforming security they will make money.
Most traders buy CFDs with the expectation that the market will rise, few traders take short positions with the view the market will fall. Pairs traders are indifferent to market direction and don’t mind which way the market moves so long as they choose a strong pair of related securities.
Pairs trading has become popular since the introduction of CFDs, prior to this it was difficult for a trader to short sell. CFDs have made pairs trading simple accessible to the everyday investor.
Most traders adopt pairs trading strategies when there is uncertainty as to the direction of the market. The reason for this is that it removes the market risk, rather whether the trade makes money will depend on whether you buy a CFD that will outperform or sell a CFD that will underperform. A typical example of this would be buying Commonwealth Bank (CBA) and selling ANZ Bank (ANZ), because you expect that CBA will outperform ANZ. Should both stocks rise or fall you will be indifferent, however should CBA rise and ANZ fall as you expected, you will make money. If CBA falls less than ANZ you will make money likewise if CBA rises more than ANZ you will also make money.
There are a number of benefits of using CFDs in your pairs trading strategy. One of the main benefits is the financing offset that will be achieved when you earn a financing income on your short position. Take the above example for instance, when you open your long CFD position on CBA you will pay a small financing charge however when you go short the ANZ CFD you will receive financing income. Although the offset is not 100% it will most certainly reduce the cost of the trade. In many ways pairs trading as a short to medium term strategy and can be much cheaper and less risky than simply opening a naked long or short position.
Pairs trading is not only commonly used when trading share CFDs but has also become very popular for use with indices. When using CFDs over indices traders can take the view that one index will outperform the other. An example of this may be the US market versus the Australian market. In this example you would buy the ASX 200 index CFD and sell the S&P 500 index CFD with the view that the Australian market will outperform the US market.
Pairs traders adopt a number of strategies, one of the more common strategies used is to choose pairs that are correlated, for example Stockland against Mirvac or Rio Tinto against BHP Billiton. It is also common for traders to use sector CFDs in their strategy such as the healthcare sector versus the materials sector or energy sector versus the ASX 200 index.
An example of sector trading would be the resources sector versus the ASX 200 index. You might be of the view that the resources sector is overvalued relative to the market and will underperform the market, you would short the resources sector and buy the ASX 200 index. Alternatively you may feel that the market will retreat and money will move back into the defensive stocks, in this case you would buy the healthcare sector and short the energy sector. When choosing sectors you should consider their weighting within the overall index as this will help you determine the sectors correlation to the overall market.
Pairs trading can be done on just about anything except currencies which by their very nature are already a pair’s trade. A common pairs trading example is illustrated below.
You have the view that ANZ is undervalued and trading on much lower earnings multiples than CBA, and will therefore outperform CBA. The pairs trade is go long ANZ and short CBA.
You buy a $10,000 worth of CFDs over ANZ and sell $10,000 worth of CBA CFDs. The margin on each position is $1,000 or 10% of the value of the contract.
ANZ CFDs are trading at $22, your $10,000 investment gets you 454 CFDs. CBA CFDs are trading at $52, your $10,000 investment gets you 192 CFDs.
Your pairs trade would be ‘buy’ 454 ANZ CFDs and at the same time ‘sell’ 192 CBA CFDs.
Typically CFD commission rates are $10 or 0.10%, your trade will cost you $10. As the trade consists of four trades (buying and selling) your total commission would be $40 ($10 x 4).
Let’s assume that ANZ rises to $30 and CBA rises to $55. In this scenario you would make a profit on your ANZ position and a loss on you CBA position.
Your positions would now look like this:
Long 454 ANZ shares @ $30 = $13,620
Short 192 CBA shares @ $55 = $10,560
The leverage CFDs offer makes day trading attractive, however, before commencing a day trading strategy you should asses the benefits and downside to using CFDs.
Below are some of the benefits of using CFDs in your day trading strategy:
Low Commission
The commission rates on share CFDs are much less than on traditional shares, this means that you can trade more actively for smaller price movements making CFDs extremely cost effective for day traders.
No financing charges If you do not hold your CFD position open overnight you will not incur any financing charges
Risk minimisation
You are not exposing yourself to the risk of a stock or share CFD gapping up or down overnight as a result of global market movements.
Free cash flow As you are only holding your positions for a short time frame you are not locking up you cash, this means that when you see a trading opportunity you will have sufficient funds in your account to place the trade.
Although there are many advantages of using CFDs in your day trading strategy there are also some downsides, these are listed below:
Time
As all of your trading will occur during market hours over short time frames you need to monitor your trading screen on a regular basis, this process can be time consuming.
Decision making
As time is of the essence in day trading it is important to have a very good idea about your trading system as you will have to make quick decisions about your trades.
Capital outlay Day traders focus on profiting from smaller price movements, therefore in order to make large amount of money, it is necessary to start off with a bigger float or use more leverage.
If you have the time, a good intraday strategy and can afford to start trading with a larger float, then day trading may be the right trading style for you. Before rushing out, opening a CFD account and becoming a day trader you should consider the following tips:
Trading CFDs is very much like running your own business, however, as CFDs are leveraged, there is a chance of losing more than your actual deposit, using stop loss orders and having a good money management plan will minimize this risk.
Before starting to trading, ensure that you understand and stick to your trading strategy. You should start by practicing your trading system in a demo account.
All traders will have both winning and losing trades. Trading a profitable trading system is the most important factor in making profits overall. It is likely that when you start out trading you will have some loosing trades. However, despite the fact that the number of losing trades is often more than the number of winning trades, the size of the winners are generally considerably larger than the losers. In order to make consistent long term profits, you need to properly back test and understand your trading system.
Measure the performance of your trading system, you need to look at its profits as a percentage of your initial cash float, the maximum historical drawdown as a percentage of your initial cash float, the steadiness of returns, and the profit-loss ratio combined with the win-loss ratio.
Choose your CFD provider carefully. Each CFD provider offers a different number of CFDs some of which are short sellable and others not. The trading platform each provider uses determines the type of orders that you can use in your trading strategy. You will need to consider all of these issues as they may have an impact when back testing your trading system.
To find more helpful information about day trading CFDs you can download our free CFD Guide.
It is becoming increasingly popular for trustees of self managed superannuation funds (SMSF) to use leverage in order to magnify returns by investing in derivatives such as Contracts for Difference (CFDs). The Australian Taxation Office (ATO) defines CFDs as “synthetic financial products that enable investors to access the price movement in shares and other instruments such as stock indices, stock options, currencies and futures contracts without owning the underlying product.”
The ATO sates that a SMSF should only enter into derivatives transactions, if the purpose is to hedge and not speculate; and the SMSF has a risk management strategy (RMS) in place.
The ATO Interpretive decisions released on 29th March 2007 tries to distinguish between the two types of CFD transactions which are available in the market. One type requires the investor to place an amount on deposit with the CFD provider, and the other type requires the investor to pledge other assets of the investor.
Both types of CFD transactions are explained in detail below.
Type 1
The ATO’s interpretative decision 2007/56 states that where the purpose of the investment is for hedging only and there is no pledging of other assets of the investor, investing in CFD’s by a SMSF will be considered within the rules of SIS Act.
The ATO states their reasoning for this as because there is no loan between the CFD provider and the SMSF trustee and therefore no contravention of the prohibition on borrowing by trustees in section 67 of the SISA. The requirement to pay a deposit and meet margin calls does not represent borrowing; they are rather contractual liabilities to make payments if and when required and are not repayments. The obligations in relation to CFDs are distinguished from margin lending through a broker's margin account in relation to the purchase of shares by an SMSF, which does represent a prohibited borrowing under the SIS Act.
The operation of the CFD bank account and the obligation to pay deposits and margins does not create a charge over any assets of the fund. The parties are relying on the contract and not on any security interest to be created by the contract. Under the CFD, the monies in the CFD bank account are the property of the CFD provider and the fund (investor) has no beneficial interest in the account. (Trustees need to examine individual product disclosure statements and contracts to ensure that there is no charge made over an asset as prohibited in regulation 13.14 of the SISR and that all requirements of the SISR and SISA are adhered to.)
The investment is in accordance with the fund's investment strategy as required under paragraph 52(2)(f) of the SIS Act and regulation 4.09 of the SIS Regulations. “
Type 2
The ATO’s interpretative decision 2007/57 states that immaterial of the fact that hedging may be the sole purpose for investing in CFD’s, if the CFD provider requires the investor to pledge other assets of the investor then investing in CFDs by a SMSF will be considered outside the rules of SIS Act. Should this occur the trustee of a SMSF has contravened subsection 34(1) of the SIS Act and has breached the prohibition against trustees giving a charge over, or in relation to, fund assets. The interpretative decision is outlined here ATO ID 2007/57.
ATO’s reasoning for this decision is:
“However the trustee and the CFD provider entered into a separate written agreement under which fund assets were deposited with the CFD provider in fulfillment of the fund's obligation to pay margins. Regulation 13.14 of the SISR prohibits trustees from giving a charge over, or in relation to, an asset of the fund. This regulation is an operating standard for regulated superannuation funds under section 31 of the SISA. Subsection 34(1) of the SISA requires that the operating standards are complied with at all times. The terms of the agreement stated the circumstances in which the fund's assets would be realised, and showed an intention to create a charge over the assets. By entering into the agreement with the CFD provider the trustee has contravened subsection 34(1) of the SIS Act.
Regulation 13.15A of the SIS Regulation, which allows trustees to give a charge over fund assets in relation to options and futures contracts in accordance with the rules of an approved body, and in accordance with the fund's derivatives risk statement, does not apply. A CFD is not an options contract or a futures contract, and the charge was not given in relation to the rules of an approved body.
The trustee has therefore contravened regulation 13.14 of the SIS Regulations and consequently subsection 34(1) of the SIS Act.
In Conclusion As a trustee of a SMSF prior to making an investment in CFDs the trustee must consider the following:
1. Does the trust deed allow for investment in derivatives (CFD's);
2. If derivative investments are acceptable the trustee must only deposit cash as margin; and
3. There must be a Derivative Risk Management Strategy (RMS) in place.
If it is found that your SMSF is not complying with the rules your auditor may lodge a contravention report meaning that your fund may become a non-complying fund in an ATO audit.
For more helpful information on CFDs and Superfunds you can download our free CFD Guide.
A CFD or Contract for Difference is a type of derivative contract taken out between two different parties, the buyer and seller. The seller has an obligation to pay the difference between current price of a specific share or other instrument over which the CFD is based and the price at the time of selling the contract to the buyer. Should the difference be negative (a loss), it works the other way round where the buyer pays the negative difference to the seller.
CFD trading began in London in the 1990s. It was only in 2001 that investors realized that Contracts for Difference had advantages over traditional share trading, the main advantage being the avoidance of stamp duty.
CFDs have a number of advantages in that no CFD contract expires and the owner of a CFD is required to only maintain minimum margin meaning a low capital outlay is required, this is very different to traditional share trading where the full value of the position is required upfront. It is essential that CFD traders calculate their risk tolerance and study market trends on regular basis to avoid margin calls which can occur should the CFD position move against them. CFD traders can also go short and use stop loss orders enabling allowing them to minimize losses.
There are many types of financial instruments available allowing investors to outlay a relatively small amount of money in trade. Depending on the level of knowledge an investor has they will choose the relevant financial product to suit their needs. If we compare all types of financial instruments Contract for Difference trading is most similar to futures trading with the added benefit of liquidity and leverage.
Below are four of the main benefits of CFDs:
1. Financing Rates
CFDs incur a financing rate when you hold a position overnight. The financing for long positions is typically the Reserve Bank rate or cash rate plus a premium. So if the Reserve Bank rate (RBA) is 4.25% then you pay 6.25% per year calculated daily as the CFD provider will typically add a 2% haircut on top of the RBA rate. The financing rate for CFDs is typically much less that that charged by margin lenders.
2. Leverage Leverage is one of the main reasons CFDs have become so popular. Leverage works like this, imagine you had $5,000 in a share trading account you could only trade up to $5,000 and a 5% move on $5,000 would only be $250. If you took that same $5,000 and used it to trade CFDs you could open a $20,000 position, that same 5% move now equates to $1,000. Using the CFD you can have potentially made another $750 with no additional outlay.
3. Liquidity One of the most important aspects of CFDs is liquidity. Unlike other derivative products such as options, CFDs directly mirror the liquidity in the underlying market. When trading with a CFD provider using a Direct Market Access (DMA) model you can see the exact volume available in each stock at each price level in the market depth, you are also able to participate.
4. Low Commissions
The most significant advantage of CFDs are their low commission rates, some of the CFD products such as index CFDs are even commission free. Typically CFD brokers charge a minimum of $10 or 0.1% for share CFDs.
You can learn more about CFDs and their benefits in our free CFD Guide.
A Contract for Difference (CFD) is a derivative that allows you to speculate on the price movement of underlying securities such as shares, indices and commodities over which the CFD is based without the need to own the instrument.
In simple terms a Contract for Difference is a short term contract between the buyer of the CFD and the CFD provider, with both parties taking an opposite view as to whether the value of the underlying security or instrument over which the CFD is based will increase or decrease in value. CFDs are settled in the form of a cash payment which is calculated as the difference between the opening and closing value of the underlying security or instrument. If the difference is positive the CFD provider pays the difference, and the holder of the CFD will profit. Should the outcome be negative, the holder of the CFD must pay the difference to the CFD provider, and the holder will incur a loss. As CFDs do not have an expiry date CFD positions can be held open indefinitely.
The Australian Taxation Office (ATO) has published a Tax Ruling TR-2005/15‘Income tax - tax consequences of financial contracts for differences’, relating to the tax treatment of financial Contracts for Difference.
The Tax Ruling states that if you are carrying on a business (or entering into commercial transactions) of buying and selling CFDs for the purpose of profit making, any gains made will be regarded as assessable income and any losses incurred will be an allowable deduction. The deciding factor here is whether you are in fact carrying on a business (or entering into a commercial transaction) the main tests to determine this are outlined below:
The number of transactions you enter into each year (e.g. on a weekly or monthly basis);
The size and scale of your operations;
Whether you are carrying on your activities in a systematic, organised and businesslike manner for the purpose of profit making; and
The degree of skill employed in performing these activities.
If you determine that you are not carrying on a business (or entering into commercial transactions), any gain or loss you would normally make would fall under the Capital Gains Tax (CGT) provisions. As CFDs are regarded as a CGT-asset, any capital gains are treated as assessable income and capital losses can be deducted from any current or future capital gain.
As the ATO views Contracts for Difference as contracts of speculation, in that you are effectively betting that the underlying security or instrument will either increase or decrease in value, it would seem from the ruling that the aforementioned many not apply to CFD transactions. If this is the case, any capital gain or capital loss you make ‘from a financial Contract for Difference entered into for the purpose of recreation by gambling’ will be disregarded under the CGT gambling exemption provision.
What this all means is that if you have made a $1,000,000 capital gain from a CFD trade and you can persuade the ATO the transaction was entered into for the purpose of recreation by gambling, you will be laughing all the way to the bank. However, if the outcome were a $1,000,000 capital loss, you would lose the ability to offset the capital loss from any current or future capital gains that you may have.
As the ATO views that Contracts for Difference are predominantly entered into for a profit making or gambling purpose, it will would difficult for you to claim a capital loss if you could not prove that you are carrying on a business or entering into commercial transactions.
To find more helpful information on CFDs and tax you can download our free CFD Guide.
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