Are “Wash Sales” A Capital Idea? The ATO Doesn’t Think So

Let us share with you an old, but still compelling, short story.

Back in 1998, a taxpayer (Mr. X) thought it was a capital idea to transfer a parcel of shares, which had significantly dropped in value, from one family trust to another trust both of which he controlled. By doing so, the idea was that the capital loss that was made on those shares by the first trust could be offset against capital gains that had also been made by the same trust on other share sales.

Unfortunately for Mr. X, the ATO thought otherwise and disallowed the loss using the general anti-avoidance rules. Problem was, the loss shares were, in effect, still within Mr. X’s economic group.

Not to be out-done, Mr. X took his case through the courts…and lost!

Some years later, the ATO issued a Ruling warning that it was on the look-out for arrangements of this kind. It sets out an inexhaustive list of the kinds of arrangements it will investigate to cancel a tax benefit from a loss where there is no significant change in an economic exposure to, or interest in, an asset that is still controlled by the same group.

So, simply moving an asset from one related party (individual, company, trust or superannuation fund) to another related party to generate a loss will be within the scope of the anti-avoidance rule.

Other arrangements, for example, where that interest in an asset is sold to an unrelated party but later reinstated by re-acquisition, are also open to review.

If, for example, 1000 shares in a listed company are sold on market for a loss and the same number of shares are purchased after year-end the anti-avoidance rules could apply.

But how does the ATO find out about these transactions?

Data-matching is one of the tools that the ATO now uses very effectively to obtain information from sources other than the taxpayer. Transfers of shares listed on the ASX are now reported to the ATO as part of this program, and so it is relatively easy for the ATO to identify transactions that require a closer look.

High wealth reviews are another way for the ATO to identify transactions that require close inspection.

When the share market is high, it can be tempting to move loss-making assets between entities within a related party group, or to even sell them before year-end and then buy them back again early in the next financial year, to offset gains made on the more successful investments.

But if the ATO sees this as a “wash sale” and denies the loss, thus leaving other realized gains as fully assessable, the transaction may not be such a capital idea. Penalties will only add to the problem.

Mr. X’s experience, therefore, should be at the forefront of mind!

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Disclaimer: This information is general in nature and should not be relied on as advice. It does not take into account the objectives, financial situation or needs of any particular person. You need to consider your financial situation and needs and seek professional advice before making any decisions based on this information.