I’m sure I filed that somewhere...

Mistake 20: avoiding the paperwork

Nothing is particularly hard if you divide it into small jobs.

Henry Ford

In addition to the daily activities associated with trading—scanning and analysing the market, entering and exiting trades, monitoring open positions, researching new ideas and systems—comes all the associated paperwork and record keeping. In many ways, this is the boring stuff. It is easy to delay it, avoid it, do other jobs and run away from it using any excuse you can find. However, it is an essential component of any trading business and one that must be completed on a regular basis. The more active your trading activities, the more work will be required to record results. Active short-term traders will obviously generate more paperwork, and have much more information to record and monitor than longer term traders.

Trader or investor

While tax laws will vary from country to country, most apply different tax treatment and legislation to traders than to investors. Tax laws and their interpretation can be complex. The ideas and concepts covered here are general in nature and should not be taken as specific advice. Individual traders and investors must seek out their own advice and opinion from tax professionals.

Don’t be an ostrich

Having quantified that you are a trader, the importance of keeping adequate records of your trading activities then becomes a very important aspect of your daily, monthly, quarterly and yearly responsibilities. As well as for taxation purposes, the keeping of accurate records allows you to closely monitor the performance of your trading. It will enable you to calculate the important numbers discussed throughout this book. This allows you to determine the probabilities of your chosen trading system or strategy, and hence your ’ edge’ in the markets. Without understanding these numbers you will have no idea as to how you (or your system) are performing. You will also have no basis for comparison. If crunching these numbers is left too long or not done on a regular basis, then your trading business is either nothing more than a hobby or doomed to failure.

Sticking your head in the sand and avoiding the paperwork and record keeping associated with trading is not an option. You can only avoid doing it for so long until your broker lets you know you have depleted your trading capital to such an extent that you can no longer trade, your accountant starts screaming at you for paperwork to enable preparation of your tax return, or the relevant tax authorities come knocking on your door.

Jason Cunningham, a Certified Practicing Accountant (CPA) and founding member of Australian-based accountancy business, The Practice, offers some advice on the importance of keeping accurate records of all your trading activities.

The importance of good record keeping cannot be emphasised strongly enough. The right system of record keeping will aid in controlling trading finances. Without it, traders will not know how well or how poorly their business is performing. These records will provide important information on trading activities and assist with the preparation of income tax returns, business activity statements (BAS) and financial statements. From my experience, the five most common reasons traders avoid the paperwork are:

1. It’s boring and monotonous; there is nothing exciting about it. It’s easy to put it off for another day, and find other jobs to do rather than fill in another spreadsheet or form.

2. Some people think it’s not relevant — trading is what they do so they don’t want to spend time doing the menial tasks.

3. It may uncover the ‘hidden truth’ — that their trading is not profitable. So they avoid the paperwork to avoid the facts.

4. Some people don’t know how or where to start — they are daunted by the scale of what they need to do, particularly if they have put it off for some time.

5. One might have to pay tax if a profit has been made, so it’s avoided it in an attempt to delay the inevitable.

I’ve seen a situation where a client had a GST audit undertaken by the tax office on a BAS statement they had prepared where they expected to receive a GST refund. Because the client was unable to produce the appropriate paperwork (tax invoices) to substantiate their claim, the refund was knocked back and they were hit with a 25 per cent penalty.

Another guy got made redundant, rolled his super into a self managed superannuation fund (SMSF) and lost $200 000 in one year ‘trading’. Perhaps if he had been more diligent with his paperwork he would have been more aware or accountable for the trading losses while they were still small and he may not have lost so much money.

Spreadsheets and computer programs

There are really no excuses for poor or inadequate record keeping. The ease with which information can be recorded in a spreadsheet (using software programs such as Microsoft Excel) makes it possible for anyone to be able to efficiently record all their trade results. There are also a number of purpose-built software programs available. All of these will allow you to record all aspects of all of your trades, including entry date and price, exit date and price, number of shares or contracts bought and sold, brokerage charges and profit or loss ensuing from the trade. More complex calculations to calculate win-to-loss ratios, average win versus average loss, and profit and payout ratios can also be undertaken. In short, every aspect of your trading business can be easily documented and recorded. These figures will provide you with all the information you need to determine the success or otherwise of your trading business. For share traders and investors, dividends received, share splits and mergers, and rights and bonus issues can also be recorded. In addition to the benefits of recording all this information for yourself it makes your accountant or tax agent’s job in preparing your quarterly and annual tax returns much easier, and hence much more cost-efficient for you.

Making the recording of your transactions a daily activity is a great habit to get into. It is much easier to do it every day than to leave it to build up over a week or a month (or even longer). This is particularly important for more active traders who may have several trades to enter each day. Left to build up over a week, the task becomes daunting and keeps getting put into the too-hard basket, until it becomes an almost unmanageable job. It is a bit like the old ‘a stitch in time saves nine’ mantra that your grandma chanted all those years ago!

Online record keeping

For those using an online trading platform or a reputable vendor-supplied trading program, the job of recording all your trades and related information is made even easier. The majority will have an inbuilt function for recording all trades. Some of these online systems may be fully automated to the extent that the information is recorded automatically into this portfolio manager as trades are executed. Information on the overall performance of the system is continually calculated and available at the click of a mouse.

Backing up

The ever-present threat of computer malfunctions and ’ bugs’ makes it essential to back up all your information on a regular basis. As good as your spreadsheets and portfolio management software may be, it will all be of little use if your computer crashes and the information is lost. It is another good habit to ensure that you back up this information on a regular basis to an external source. This may be an external hard drive, memory stick, or CD ROM. It may also be an idea to send the information to your accountant or tax agent on a regular basis, as another way to ensure these records are kept offsite.

Pay a bookkeeper

If your trading system is short term, highly interactive and mentally demanding, then perhaps the last thing you want to consider at the end of the trading day is recording all the information from your day’s trading activities. For those trading automated systems, this may not be an issue as you will have the time available to do it. If not, then a viable option may be to employ the services of a bookkeeper or data-entry person who can undertake this task for you. This is a relatively inexpensive option that will also ensure that the paperwork is done on a regular basis and in a timely manner. It may also act as another checking mechanism, as the bookkeeper will no doubt have questions and be checking all the relevant details. This will help ensure that any errors or discrepancies can be queried and sorted out early, rather than leaving them until it is too late or they have been forgotten about. Most brokers require you to check your trading statements within 24 hours to alert them to any discrepancies, incorrect fills or trades, or mistakes. Having an external third-party check through your trading records on a daily basis may well assist you in ensuring that these errors are identified and corrected early, before they become a larger problem.

Defining your activities — an Australian perspective

The following information provided by Jason is specific to the Australian regulatory environment. The definitions and rules will be different depending on your country or tax jurisdiction. Please take the time to thoroughly research and understand the tax implications for your trading or investing activities for the country in which you reside or trade. They will vary.

Share traders are subject to income tax legislation. Investors’ activities are governed by the capital gains tax (CGT) provisions of the Income Tax Assessment Act 1997.

The main issue here is to determine whether your share trading activity can entitle you to be classified, according to the Australian Tax Office (ATO), as ‘being in business’ and therefore seen as deriving assessable income as opposed to generating ‘capital gains’.

If you are eligible to be classified as a business, you will be entitled to reduce your income tax commitments in three ways:

The situation differs if you were treated as deriving capital gains because:

To prove that you are in the business of trading you can either ensure you follow the ATO’s guidelines and you self-assess, or you apply for a private binding ruling.

When self-assessing, the question of whether a person is a share trader or a share investor is determined on a case-by-case basis. The ATO will consider the following factors that have been used in various court cases:

Note that the ATO has issued a fact sheet called ‘Carrying on a business of share trading’, which provides further explanation.

As the impact of this can be detrimental to your overall tax position, it is strongly recommended you seek the assistance of experienced professionals to assist you in determining whether you are a trader or an investor. Do not take a flippant approach.

If your situation is a bit doubtful, you have the option of applying for a private binding ruling. This process involves:

Part of proving that you are in business is to register as a business. This is done by applying to the ATO for an Australian business number (ABN). An ABN is an 11-digit number that identifies you to the ATO and makes it simpler when dealing with most government bodies. It is at the discretion of the business owner as to whether they register for GST.

It is our experience that when trading, you are in business, and you should treat it like a business. The tax office rightly stipulates the guidelines for trading in a businesslike manner with a view to earning a profit.

Under the CGT regime, expenses cannot be deducted against capital gains. You can only offset capital losses against capital gains. However, this varies if you hold shares to derive dividend income, in which case certain expenses may be deducted against the dividends paid by those shares (for example, interest on a margin loan).

On the other hand, if you are classified as a share trader (or business), then basically all expenses incurred in deriving that income are deductible. The ATO’s requirement is there must be a direct nexus or connection between the expense and the income. Therefore, deductible expenses can include the following:

Essentially, these are the traditional expenses available to someone running a typical business.

To reiterate, due to the complexity of the taxation issues surrounding traders and investors, it is strongly recommended that you seek the assistance of an experienced professional to guide you through the myriad issues.

Shoes in a shoebox, records on a spreadsheet

With the technology and range of options available for record keeping, it is no longer acceptable or realistic to rock up to your accountant or tax agent at the end of the financial year with a box full of papers and expect them to miraculously produce a meaningful tax return for you. It is not even in your best interests. By constantly recording all your trading information and data on a regular basis you can constantly monitor your trading performance and have a firsthand knowledge of your performance. It also saves a significant amount on the cost of preparing tax returns and financial statements.

If you just turn up to your accountant with records in a shoebox, not only will you be charged an arm and a leg for the work, but chances are it won’t be accurate. Plus, if you’ve registered for GST, you have to lodge a quarterly business activity statement (BAS), so it makes sense to prepare your records quarterly.

The other thing I’d like to stress is the importance of seeing an accountant to not only assist with your compliance obligations (such as tax return preparation), but to also get some proactive advice (such as tax planning and structure advice). It’s also important to discuss these issues with accountants who understand trading and investing.

JaSOn Cunningham is a qualified CPA and financial planner with his own financial planning licence. In 1997, Jason co-founded an accounting firm called The Practice (<www.thepractice.com.au>), which provides accounting, taxation, business consulting, financial planning and finance solutions to a wide range of clients. In this chapter, Jason gave his valuable tips on how to stay organised—and profitable — when it comes to keeping records on your trading activities.

Jason has extensive experience in helping a wide range of clients grow and manage their financial affairs. A crucial part of his role—and the area he is most passionate about—is to help his clients identify and understand their needs and objectives, and give them the tools to reach their goals. Jason’s specialty is the complex world of trading and tax. He has run numerous workshops and seminars for various share and option trading groups. Jason has a weekly radio gig tackling financial matters for callers. He is the author of Where’s My Money?, a book packed with practical tools and real-life examples to help you take charge of your financial future and make your dreams a reality. This 10-step, plain-English guide has something for everyone—whether you earn $35k or $350k.