Currency Trading Tax in UK or Forex gains or binary options

what is Forex or Currency Trading

Forex or foreign exchange is a decentralised international market where the whole world's currencies trade. Even if the whole world’s stock markets are brought together, it won’t match the Forex market. The Forex market is the largest, most liquid market in the world with an average daily trading capacity beyond $5 trillion. It is also called FX or currency trading. A closer look at Forex trading can help you find some great trading prospects not offered by other investments.

Forex dealings: Exchange is the key

If you travel to a foreign country, you need to make Forex transactions. For example, if you visit France, you will have to exchange your pounds into euros. The number of euros that you get for your pounds is determined by the Forex exchange rate between the two currencies —based on supply and demand. Moreover, the exchange rate keeps fluctuating all the time.

Buying and selling currency in UK

All Forex trades require two currencies because betting is done on the value of a currency against another. Take the example of EUR/USD, the world’s most-traded currency pair. EUR, the pair’s first currency is the base, and the second one i.e. USD is the counter. The price quoted on your platform is the value of one euro in US dollars. There are always two prices – the buy price and the sell price. The variance between the two is the spread. When you click buy or sell, you are buying or selling the pair’s first currency.

Suppose you expect the euro to rise in value against the US dollar. Your pair is EUR/USD. As the euro is first, and you feel it will rise, you buy EUR/USD. If you believe the euro will go down in value against the US dollar, you sell EUR/USD.

If the EUR/USD buy price is 0.70644 and the sell price is 0.70640, then the variance is 0.4 pips. If the trade goes in your favour (or against you), then, as soon as you address the difference, you may make a profit (or loss) on your trade.

Currency Trading on the margins:

While trading Forex, how can you see any considerable return on your investment if prices are quoted to the hundredths of cents? This can be done by trading with leverage.

When you trade Forex, you are in effect making use of the first currency in the pair to buy or sell the second currency. With a market worth 5 trillion US dollars a day, the liquidity is so profound that liquidity providers like the large banks, basically, agree to let you trade with leverage. In order to trade with leverage, you just reserve the necessary margin for your trade size. This helps you get much more experience, while keeping your capital expenditure low.

However, leverage not only raises your profit prospects, it can also add to your losses, which can go beyond deposited funds. When you are not familiar with Forex, it would be wise to begin trading small with lower leverage ratios, until you feel well-established in the market.

Currency trading tax in UK on Forex, CFD trading and Spread Betting

Those who have a funded trading account and are making trades may have to pay tax on Forex trading profits. They may also be permitted to claim tax exemption on any trading losses.

Are CFD trading profits taxable?

Profits from CFD (Contract for Difference) trading must be reported to HMRC and any other tax regulatory bodies. No stamp duty or income tax is applicable on CFD trading, but it is liable for Capital Gains Tax. There can be a higher tax-free allowance and a lower tax rate than income tax on capital gains, which is another benefit of trading for a living instead of paying income tax through employment or self-employment.

Declaring income and paying CGT:

You will have to file an annual Capital Gains Tax (CGT) return, which can be best done online. To find out more details, you can contact HMRC.

Point to remember: If trading is your main source of income and depending on how much you are making, CFD trading can be the most tax-efficient way to trade. It can be far more tax-efficient than traditional Forex trading (trading through an ECN broker). Another benefit of CFD trading is that losses can be declared with the purpose of claiming tax relief.

Are Spread Betting profits taxable?

Spread Betting is tax-free as long as it does not become your principal source of income. When Spread Betting becomes the main income, all profits will be taxable. As a secondary income, Spread Betting is the most tax-efficient way of trading. However, in case of Spread Betting being your primary income, CFD trading will be much more tax-efficient. Moreover, no tax relief can be claimed for losses from Spread Betting as it is categorised as gambling.

Declaring income and paying tax: In order to declare your income and pay taxes as applicable, you must file an annual self-assessment tax return with HMRC. The return can be filed online and for further details, you can contact HMRC.

Point to remember: Contrary to popular belief, Spread Betting is not completely tax-free. It is tax-free only as long as it is not your primary source of income. This law is applicable to all gambling related activities.

Are Forex trading profits taxable?

Not only Capital Gains Tax, but stamp duty and possibly other charges are also applicable on Forex trading through a true ECN broker.

Declaring income and paying tax on Forex profits :

It is advisable to seek the help of a professional tax accountant as understanding the system of taxation on true Forex trading profits can be quite difficult.

Point to remember: If you are not familiar with trading and/or have an account of a smaller size (below £50,000), opening an account with a CFD or Spread Betting Provider would be most suitable.

Binary options and UK tax position

Are profits from binary options trading liable for Income Tax and/or Capital Gains Tax? Is there a need to declare income from your binary option trades on your tax return? Many such questions bother not only beginners, but experienced traders, too. Here we bring to you a clear and the latest picture of binary options trading and its tax implications in the UK. This can help you evaluate your trading activity.

The Fundamental of Currency Trading with Binary Option

HMRC considers all relevant conditions in order to determine tax liability. Here we summarise the position on how the tax authorities are likely to look upon binary options. Nevertheless, it is essential to keep in mind that the proper treatment of any financial transaction or investment depends on a number of facts as explained here: what is the true nature of the activity; who is doing it; what is the intention behind it; and what model of activity does it belong to?

A suitable example of this contextual approach is a deal with a spread betting firm, i.e. wondering whether an asset will go up or go down. In most cases, HMRC is likely to regard this activity as betting, which implies that any profits made from it will be beyond the range of both Income Tax and Capital Gains Tax. But if that same transaction is made for commercial uses; (for example, if it is carried out tactically as a technique to make up for the risks associated with direct investment in a security), any gains coming from it might be considered part of a wider pattern of activity drawing tax liability.

Tackling tax - common terms, specific meanings:

HMRC will not consider you a ‘trader’ even if you regard yourself as one if the activity you are engaged in comprises only speculative transactions. The outcome of entirely speculative, gambling or betting activity is that profits from it are usually not taxable. But the possible drawback of this is that no tax relief can be claimed on losses from this type of activity.

HMRC would also disagree strongly with the description of ‘binary options’ as ‘options’ in the proper sense. According to HMRC, an option is an established right to buy or sell an underlying asset at a particular price within a particular timeframe. It is likely to have an innate value in itself (which carries CGT implications). If you notice any mention of tax treatment of ‘options’, remember that it is not suggestive of binary options.

Tips on: How To Reduce Currency Trading Taxes?

The foreign exchange market, or Forex, as it is widely known as, is the largest market in the world with more than $4 trillion changing owners every single day. To explain it more accurately and objectively, it is 12 times larger than the normal earnings on a daily basis on the worldwide equity markets and over 50 times bigger than the standard daily turnover on the NYSE. With a market of this size, it is quite normal that most traders and tax professionals still find it difficult to understand the taxation system of Forex.

The fundamentals: The provisions covering Section 988 transactions are introduced in the Tax Reform Act of 1986. Section 988 transaction, the default system of taxation for currency traders, treats the gains or the losses from Forex transactions as usual gains or usual losses. If you have Forex gains, they are taxable as regular income, depending on whichever tax range you fall within. Following is an example:

Jane’s salary is $100,000 a year. She has a profitable year trading Forex, making $50,000 for the year. Jane comes in the 25 per cent tax bracket, which makes her tax due on her Forex gain $12,500 ($50,000 X 25 per cent).

Forex losses: Monetary losses incurred in Forex trading are treated as ordinary losses, and can be used to counterbalance any other income on your tax return. Here’s an example:

Rather than making a profit of $50,000, Jane loses $50,000 in Forex trading. The $50,000 loss can be taken against her W-2 income, making her assessable income $50,000 ($100,000 - $50,000). If her Forex loss was treated as a capital loss and not an ordinary loss, Jane would only be able to take $3,000 off of her taxes, making her taxable income $97,000. The outstanding $47,000 loss would have to be kept for spending in future years.

Now the question is: what type of a Forex trader gains from Section 988 tax treatment? If a trader is not again and again profitable and has other earned income on their tax return, they should stay under the Section 988 taxation to be able to make the most of any losses from Forex trading. If you are not consistently gainful in your Forex trading and you have no other earned income, you should think about doing what money-making Forex traders should do: withdraw from Section 988 tax treatment.

IRC Section 988(a) (1) (B) offers Forex traders a way to withdraw from the usual gain/loss tax treatment. Excluding what is allowed for in regulations, a taxpayer may choose to treat any foreign currency gain or loss as a capital gain or loss (depending on the specific case) if she/he makes such a choice and recognises such transaction before the close of the day on which such transaction is performed.

This exemption gives Forex traders the choice to pull out of usual gain/loss treatment; making your Forex trades taxed in the similar way as Section 1256 contracts. Section 1256 contracts are taxed at a more advantageous rate of 60/40. Sixty per cent is taxed at long-term capital gains rates and 40 per cent is assessed at short-term capital gains rates. While the highest tax rate on regular income at present is 39.6 per cent, the highest tax rate on Section 1256 contracts by contrast is 28 per cent, nearly a 30 per cent decrease in taxation on the profits.

Using the instance mentioned above, if Jane had pulled out of the Section 988 tax treatment, her tax rate on her $50,000 Forex profit at a 60/40 rate would go down 24 per cent (19 per cent vs. 25 per cent), saving him $3,000 in taxes that year.

Here’s an assessment of normal tax rates versus the 60/40 tax rate using 2013 tax brackets:

The Internal Revenue Service (IRS) wants a trader to make the choice of pulling out of Section 988 tax treatment internally, i.e. you state your decision to withdraw in your own company books or records. The IRS need not be informed beforehand, as you do if you were making the mark to market election. It would be wise to have your decision to pull out authenticated, which would help strengthen your claim of a well-timed election if you got scrutinised.

Conclusion:

Withdrawing from Section 988 tax treatment for Forex traders is an easy decision for profitable traders due to the tax savings. On the other hand, it would be a sensible decision for those traders too who do not always make profits yet do not have any earned income on their tax returns. If a trader has an ordinary loss and no earned income to counterbalance it, the ordinary loss finishes off being exhausted as it cannot be kept for future tax years. If you withdraw and elect Section 1256 tax treatment, the loss can be carried forward for use against future capital gains.

If you still have doubts about whether to opt out or not, you must look for the advice of a well-informed trader tax specialists to help you with this decision.

About the author

Sumit Agarwal
Sumit Agarwal (ACMA ACA India), the Managing partner of dns accountants is a highly respected accountant with expertise in helping owner-managed businesses.