Possible way to minimise effects of tax?

[Cutten]

Assume you have accumulated profits going back a few years. If you make profits on a trade, they will be taxed at 40% in the UK (actually 41% now, but I'll keep things simple). So can't you just trade positions 2/3 as large as normal, and have the same returns as a tax-free trader would enjoy?

My reasoning is that if you have a loss, you can offset it against your previous year's gains e.g. you made 100k last year, and this year you lose 20k. You offset this against 20k of the profits you made last year, so you get a 40% tax refund i.e. an 8k credit, reducing your after-tax cash loss to 12k.

Equally, on the upside your position is taxed at 40%, so a 20k gain translates to a 12k after-tax gain.

So effectively your position, either losing or making 20k before tax, was in reality only risking or making 60% of that amount, after tax. Tax has cut your position size by 40%, not only on the upside but also on the downside. So can't you effectively replicate tax free returns just by increasing your size to compensate?

Just increase your position size by 2/3 (60% multiplied by 1 and 2/3 = 100%), and you should get identical results to someone living in Monaco or the Bahamas.

The only risk I can see is if you suffer losses in excess of previously accumulated profits that you can offset against. Another problem is if increasing your size would affect your returns (as can happen for some scalpers in less liquid markets). You will also pay more commissions. But I can't think of any other objections.

Am I missing something here, or is this potentially away to achieve identical gains to a tax free trader? Any thoughts?

 

[bonsai]

Looks like pure sophistry to me.

lol

I would be interested to know how you think you can keep some of the issues under control

when you increase/decrease your position size (on opening the trade) how do you know it is going to be a profitable or losing trade ?

 

[oatman]

I'd just worry about making £100,000 a year consistently and then consider tax issues.

 

[Cutten]

Looks like pure sophistry to me.

lol

I would be interested to know how you think you can keep some of the issues under control

when you increase/decrease your position size (on opening the trade) how do you know it is going to be a profitable or losing trade ?

You don't need to know - you just take all trades at 166.6% of the usual size. At the end of the year you have a profit or loss 66.6% higher than you would have otherwise. You then either get taxed at 40%, or rebated at 40%, bringing your profit or loss down to what it would be if you paid zero tax.

 

[mmillar]

Cutten,

I can't follow the logic of what you are saying but...

If you earn £100k in Year 1 and lose £20k in Year 2 then you will have a total gain of £80k which you need to pay 40% tax on = £32k.

If, instead, you increased your stake by 66% you would have made £166k in Year 1 and lost £33.2k in Year 2, making a total gain of £132.8k, and then 40% tax would be £53.12k

How is that not paying any tax?

 

[wysinawyg]

You do pay tax, he's just saying that you'd end up with £80k at the end in the second example (which is the same as if you hadn't paid tax in the first example).

[aside, I don't know if the rules on reclaim of tax are as described, but assuming they are...]

It doesn't work from a risk management point of view though. If you lose £30k in a year you'd get £12k tax back so only lose £18k overall. If you'd lost £50k you'd get £20k tax back and would actually lose £30k. To safely lose £30k you need an account 166% the size of one that can safely lose £18k.

wysi

 

[bonsai]

Cutten
I dont think you have cottoned on
(no half pun intended)

go through it year by year
and at the beginning of each year, tell me what you are going to do.

so in year , you have made 100,000 at size 1.
now, what next?

 

[Cutten]

Cutten
I dont think you have cottoned on
(no half pun intended)

go through it year by year
and at the beginning of each year, tell me what you are going to do.

so in year , you have made 100,000 at size 1.
now, what next?

I'm suggesting you should trade size 1.667.

Let's say you either make or lose 20% on a 100k account by trading at size 1. Trader A, with no accumulated profits, would do this (I am assuming a 40% flat tax rate for simplicity):

Starting capital £100k

Winning year Losing year

Gross P&L £20k -£20k
Tax 40% 0%
Post-tax P&L £12k -£20k
End capital £112k £80k

Trader B, with 100k accumulated profits, trading at size 1, would do the same on the profit side (i.e. make £20k pre-tax, giving £12k after tax). However, in a losing year his return would look like this:

Loss £20k
Tax -40% (tax rebate against prior profits)
Post-tax P&L -£12k
End capital £88k

Thus his risk on a losing year is only 60% of the risk (-£12k vs -£20k) faced by the trader who does not have accumulated profits.

So, I am suggesting that Trader B, with accumulated profits, can increase his size by 2/3, to 1 2/3, yet still only face the same risk as Trader A. Thus, at size 1.667, Trader B looks like this:

Winning year Losing year

Start capital £100k
P&L=£20k x 1.667=£33.33k -£20k x 1.667=-£33.33k
Tax 40% (rebate) = -40%
Post-tax P&L £20k -£20k
End capital £120k £80k

So compare the risk/reward of Trader A, with no accumulated profit, with Trader B, who has 100k accumulated profit against which to offset future losses.

Trader A (size 1) Trader B (size 1.667)
Winning Year net P&L £12k £20k
Losing Year net P&L -£20k -20k


Now compare trader B, trading size 1.667, with Trader C, who pays no tax, trading size 1

Winning year Losing Year
Trader B Trader C Trader B Trader C
Gross P&L £33.33k £20k -£33.33k -£20k
Tax 40% 0% -40% 0%
Post-tax P&L £20k £20k -£20k -£20k
End capital £120k £120k £80k £80k

So, by trading 2/3 more size, Trader B with a 40% tax rate achieves an identical post-tax return - whether he wins or loses, to tax-free Trader C.


Does this explain it? Let me know if you see any flaws with the analysis.

 

[oatman]

Tell me how you're going to make £100k pa and I'll pay for your tax consultant

 

[Cutten]

It doesn't work from a risk management point of view though. If you lose £30k in a year you'd get £12k tax back so only lose £18k overall. If you'd lost £50k you'd get £20k tax back and would actually lose £30k. To safely lose £30k you need an account 166% the size of one that can safely lose £18k.

wysi

Whilst that is true, how is it an objection? I am not talking about two traders with a rebatable £100k each. I'm talking about one with a rebatable profit of £100k, and one with no rebatable profit.

Take £100k that can't be rebated. If you lose £18k trading size 1, then you have £82k left.

Now take £100k that can be rebated. You can trade size 166%, and if you lose £30k, then after the rebate you still have £82k left. So you can trade 166% the size of the non-rebatable account without having any more risk (after tax).

Once you have accumulated profit from the prior year, the tax rebate effectively means that both your profits *and* losses are reduced in size by 40%. Thus you are effectively trading 60% positions rather than 100% positions.

So, if you increase your position size by 166%, you reach an identical position to someone who didn't have to pay any tax in the first place.

E.g.

Tax-free man starts with 100k. He makes 20%, 20%, -20% over three years. At the end he has made 15.2% (1.2*1.2*0.8), for a £15,200 profit, leaving £115,200.

40% tax-man starts with £100k rebatable profit. He trades 166% the size, so he makes 33.3% year one, gets taxed 40%, for a net profit of 20%. Year two he makes 33.3% again, net profit 20%. So now he was £144k. Year three he loses 33.3%, gets a rebate, leaving a post-tax loss of 20%, for a cash loss of £28.8k on the year. Total capital = 144-28.8 = £115,200.

So he has achieved identical results to a tax-free trader, both on the upside *and* during down years, just by upping his size.


P.S. I've noted my previous post has lost some space formatting that I used to try and do columns - sorry if it is a bit hard to read as a result!

 

[wysinawyg]

Kind of seeing where you're coming from now.

The problem of course is if you can't get the rebates. e.g. if worse came to worse and you never made a profit you would have dropped 166% of the money that the tax free guy did. Now there is a chance of that, so it definitely is an increase in the risk.

wysi