Tax deduction of margin interest for retail traders
Written by Ray Coman
Improved access to capital markets have given rise to retail traders in shares, fx, crypto and other investments. The burgeoning of self-management of funds has been facilitated by deregulation and improved online connectivity.
For many traders and short term investors, managing capital to bring a profit is the primary challenge. However, for those that are consistently profitable, the issue of tax presents itself as a new hurdle to maximising returns.
Margin Interest Deductibility
Where self-managing of funds is treated as investment activity, it is not possible to deduct margin interest from taxable gains.
An individual’s liability to capital gains tax is mainly regulated by the TCGA1992. Section 38 explains:
“Except as provided by section 40, no payment of interest shall be allowable under this section.”
Section 40 of the same act explains the exception which relates to capitalisation of interest by property developers. This exception will not present any tax savings opportunity to traders in online instruments.
If the activity is treated as trading, however interest payments can be deducted in full from taxable profits. The determination of trading versus investment activity is established by badges of trade: https://comanandco.co.uk/badges-of-trade
In practice, individual investing activity using own funds usually results in capital gains rather than taxable profit. Trading activities are usually subject to tax at a higher rate than capital gains. Moreover, the investor has an annual exemption to deduct from any taxable gain.
It is matter of fact as to whether or not an individual is trading.
Traders whose activities are developing from investment to trading would be particularly interest in the tax impact of that transition. As explained above, tax could be saved on margin interest payable as a trader. In business, taxable income will be lower than the equivalent taxable gains. Thus, even though the rates of tax are usually higher on income than on gains, if the rate is applied to a lower value, any eventual tax would be less.
Coman & Co can compare different scenarios and advise on related tax matters.