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UK Forex gains – a taxing time ? !

One of the areas of Forex trading that I find novices are somewhat confused about is the tax treatment of gains or losses made from trading Forex or futures.

As with all areas of UK tax this can be really quite complex and you should always consult your accountant or financial adviser for the full information. However to keep it simple the rules are more or less as follows:

For individual traders it is close to impossible to have trading gains or losses treated in the same way as self-employed profits and losses are (i.e. under schedule D). The reason for this is that under schedule D people could set off losses from one trade against profits made from another trade. So let us assume you are a dentist making £100,000 a year from pulling teeth and also an unsuccessful  part-time trader. Last year lost £70,000 ! . If  the Inland Revenue allowed you to be taxed under schedule D for your trading profits and losses the £70,000 loss could be set against the £100,000 profit from Dentistry  and you would pay tax on only the net figure of just £30,000. As more people lose money from trading than make money from trading this would not be a good deal for the Inland Revenue – so they don’t allow it !

It does not make any difference if trading is your full-time source of income and is, if you like, your genuine self-employment –  they will still not allow it to be taxed as self-employed or schedule D.

Trading profits  are therefore pretty well always taxed as capital gains.

With capital gains tax the first £11,100  (2015/2016) you are in any tax year is completely free of tax. If you are a couple and trading in both names this figure would double to £22,200. After that gains are taxed at two different rates. Those that pay income tax at the basic rate will be charged capital gains tax at 18% and those that are paying income tax at high rates will pay capital gains at 28%.

These rates are what is known as top sliced. This  means that If you are a basic rate taxpayer by virtue of your income, but have made large enough taxable capital gains to push you over the threshold above which income tax is levied at 40% (£31,765 taxable income in 2015-16, £31,865 in 2014-15), you will pay the higher rate of CGT on the portion of gains that takes you over the threshold .   Ie in effect your capital gains are added to your taxable income to calculate what proportion of your gains are taxed at which of the two rates for capital gains.

If your trading gains for any tax year are in  excess of the £11,100 limit then you should declare the gains on your tax return. If your gains are less than £11,100 then you do not need to.

Although by this stage most people are groaning that they may have to pay tax at all the rates are actually quite good compared to income tax rates especially once you start earning substantial sums of money because your highest rate of capital gains tax is alqys just 28%.

Now the good news: Gains made from betting or lottery winnings are free of all capital gains tax. If you trade through a spread betting company, as the name implies, you are in the eyes of our good friends the Inland Revenue actually betting rather than trading. This means that all profits made through spread betting companies (IG index for instance)  are completely free of any tax. Whereas gains made from exactly the same trades but  put  through a Forex broker (say FXCM) are subject to capital gains tax.

The reason for this difference in treatment is in the way that those companies are taxed themselves.

So why would anybody in the UK put trades through Forex or futures brokers when if they put the same trades through a spread betting company they would pay no tax on the gains.?

There are several reasons for this but suffice it to say  because of the way those companies are taxed themselves this differing tax treatment has to be reflected in the quotes and prices they quote or fill at. So it is the case that you will get better prices from a  real futures broker  than for instance a spread betting company. Notice also that I said  futures broker and not Forex broker. This question of the spreads and fills becomes especially important when trading short-term because  a very large proportion of profits can easily be swallowed up by a bad spread or poor fill.

Normally I recommend people ignore the tax implications until they are lucky enough to be making over £11,100 profit a year then at that stage reconsider whether they want to put some of their trades through a broker rather than for instance a spread betting company or indeed vice versa.

In my own trading I have accounts with both.

It is beyond the  scope of this article but some of you may already be thinking of the possible arbitrage opportunities  between brokers brought about by the differing tax treatments ? And yes you would be right there are such opportunities !