Articles of Interest

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:

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.

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. 

You can read the full ruling here ATO ID 2007/56.

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.

• 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.