Part 2 : The Law

The actual law

US Share Trading Tax Rules

US Shares are taxed based on country of residence. 

Being Malaysian Residence we are not taxed in US for purchase and disposal of shares via US Broker. Personally, I think US shares is great because it is high liquidity and high volume. Coupled with this tax policy, it is simply irresistible. 

Malaysia’s Share Trading Rules

To know whether it is taxable or otherwise, we need to first go through the aged old question of “Income vs Capital“.  

Capital Gains Taxed?

It is critical to note that, Malaysian government don’t tax on a capital gain unless it is real property or shares of a real property company. 

Despite at around February 2021 there were lots of rumours flying all over suspecting Malaysia will impose capital gains tax on shares. 

Fortunately, ultimately it was not proposed in Budget 2022.  

How about Income Tax?

This is a more complex part of the story. 

To fall under income tax there are two groups either : 

1. in the “business” of trading shares; or
2. Your “trade” is in shares.  

Yup, it is a legal interpretation. It involves judgment. 

“Business” of trading shares

In plain English, you are helping people to trade shares. 

This category is mainly referring to fund managers. Their business is to receive money from investors and help them manage their brokerage account. We are not in this category.

“Trade” shares

 For retail investors like us, a more technical term will be “adventure in the nature of trade”. 

A “trade” involves doing work only for your benefit. So long as it is a major part of your time and wealth-building activities. 

This area involves judgment and depends on facts and circumstances. 

Tax benefits of being in the “trade”

When you are in the “trade” you get to deduct expenses just like you would if you are in a business. 

The charting software cost, subscription to traders’ group, stock scanner, courses, mentoring programs, the cost of purchasing the computers and that special cool table and chairs for trading. 

If you don’t meet the “trade” criteria, then your expenses are investment expenses. Investment expenses are capital in nature, usually not deductible. 

Four Baskets of share traders

In the retail investor’s world, there are generally four types of trading styles.

Type 1 : Long term investors

Type 2 : Swing Trading

Type 3 : Day Trader 

Type 4: Auto Traders

Long term investors are the warren buffet style. Believe in the capital appreciation of shares. Buy when the shares are undervalued, hold the shares for a prolonged period. This can be weeks, months and even years. Imagine those who bought TESLA from the very beginning. :’)

Swing traders are generally trend followers. Trade the trend and can be in the trade for a matter of minutes, day or longer. As long as the trend is still right. They will remain in the trade. 

Day traders prefer to look at a shorter timeframe. Usually, close out the trade within the day. 

Auto Traders are the ones who rely on robot trading. The use of computer language to specify when to enter and exit trades automatically based on predefined criteria. An area I am currently studying on. It is very very interesting indeed. 

Which type of traders are you? 

We generally call ourselves traders. But being a trader doesn’t mean the same as “being in the trade” in a tax context. 

Criteria to consider to qualify for “trade”

Here’s where the tax advisor’s opinion comes into the picture. The criteria may change as new tax cases emerge. 

Changing case law

The court cases are constantly changing the rules for stock “trade” qualification. Whether qualify for “trade” or otherwise strictly depends on facts and circumstances. 

So be sure your tax advisors research these areas every year. To ensure you qualify for them. 

Why so challenging?

These laws are challenging because it is not specified anywhere in the Income Tax Act. Instead, the court dictates them over the years. 

So it is crucial to work with a tax advisor very closely to determine whether your facts and circumstances make you a trader or to determine what changes in your activities are needed to qualify for the “trade” tax benefits. Also, what are the documentation required to support your position? 

The yardstick

The three key facts : 

1. Volume of trade 
2. Time spent on the trade
3. Impact of your trade

Volume means both the number of trades you make and the Dollar amount of your trades. If you trade constantly throughout the day you have a better chance of arguing than a person who trades only weekly. The amount traded have to be significant dollars too. There is no specific dollar amount that qualifies for this. Those with $1,000,000 traded will have a better chance than those who traded $10,000.

Time spent on trading activities should be a significant part of the day. The amount of time you spend trading. The more time you spend trading, the more your trading looks like your primary income activity. Whether you spend enough time to be a trader is also impacted by the third rule. 

Impact on income from your trading activity must be a significant portion of your income. Is your trading income significant compared to your total income? If trading only represents 10% of your total income, it probably doesn’t matter how much time you spend trading or how many trades you make. 

By definition, a trader is someone very good at trading and who makes a significant portion of their income trading. 

You can’t call someone a professional bricklayer who only does the occasional project in the backyard. Nor would you call someone a professional electrician who does odd jobs for a little extra money. You will not call a person who just started trading, spending most of the time learning the trade and making lots of loss a true professional trader, will you? 

Out of all the factors, time spent is the weakest. To produce the same piece, an experienced wood carving artist may require less time to produce a piece compared to a junior wood craftsman. It just needs to be enough to generate a substantial part of your wealth. 

A true tradesman is someone who is a real professional, constantly working at and making money and spending serious time and effort on trading, then you will likely be considered a trader for tax purposes. You see the factors to qualify for trade is an art, not a science. There is no fixed formula or fixed measurement.

All the factors considered above are there to point to one main point which is “your has the level of skill and ability to do it so well that it resulted in substantial income”. 

Our trading tax regime

The tax regime in the US is more comprehensive. Governments understand tax is a very effective regime to encourage specific trade activities. US attach special tax benefits specific to those who qualify to carry the title of traders in tax sense. There’re different tax benefits for shares, options and commodities. 

In Malaysia trading is not the focal area, it is not a nurtured industry. Our tax system doesn’t tax on capital and doesn’t provide special relief for traders either. The upside is it will make things so much simpler. Not so many tax rules to check and verify. The most complex I think is in determining a trader is “in the trade” or otherwise. 

Unlike US we prefer to fall under capital 

Seriously if given a choice I would prefer my share trading profit to fall under capital. For the simple reason that Malaysia DO NOT TAX capital gain from shares trading (except Real property company).

Naturally, the government would want it to be taxed under income tax. Especially now that foreign-sourced income is no longer exempted. The weight is on retail traders to explain that this sum of money transferred is capital in nature and should not fall under income tax. 

It is not just a battle of facts, it is a battle of evidence. The record of your trading accounts and the timing of the entries will now be of great importance. Also the ability to present your case.