Gambling is a winner on taxes but the losses can hit you hard

I am in touch with an FX trader in the UK. He trades on different FX markets. I invested €15,000 with him, on which he pays me a monthly 3 per cent return. So each month I get approximately €420 paid into my bank account. Sometimes it’s a bit more – that’s an approximate figure.

This comes under the spread-betting sphere he assures me from which income generated is not taxable in the UK or Ireland.

I started doing this six months ago. I am wondering are there any other tax implications for this income, or can I just keep on reviewing?

Mr D.L., email

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Trading currencies can be a volatile business; spread betting only increases that volatility risk. It does sound like that is what your UK-based trader is up to. I hope you know what you’re doing. And I certainly hope you have placed a “stop” to limit losses should your trader’s bets turn sour.

Basically, in spread-betting you are gambling on the future price direction of the underlying asset. In the case of foreign exchange trading, your trader is betting that one currency will strengthen (or weaken) compared to another currency. If you think it'll weaken, you go "short"; if your view is that it will strengthen, you go "long".

You bet a certain amount on each point that a bet moves in either direction. If you bet €5 a point “long” on the dollar against sterling and the dollar advances against the British currency, you win. But, if sterling firms relative to the dollar, you are out of the money and it could prove costly.

For currencies, which I gather are generally quoted out to four decimal places, the “point” is that fourth decimal place.

So if, for example, the dollar is trading at $1.3401 against sterling when you buy and moves to $1.3521 when you close the bet, your €5/point bet has made you €600 – (€5 x 120 points).

Of course, if the dollar weakens to, say, $1.3240, you will be on the hook for €805 – (€5 x 161) – and if you don’t close the bet those losses could keep mounting.

The real peril in spread-betting is margin. You only have to put up a fraction of the potential stake on the bet. That’s makes it very accessible for investors with modest stakes. But it means that both winnings and losses can be magnified.

That’s fine on the winnings side but if the bet runs against you, the potential loss is open-ended – unless you have placed an instruction to close the bet and accept your losses at a certain financial point. With spread-betting, chasing losses in the hope a bet will “come good” is generally a one-way ticket to the poorhouse.

Taxation

But what about the tax?

This is one of the major attractions of spread betting. In both Britain and Ireland, spread betting is not subject either to capital gains tax or, with one significant caveat, to income tax.

The exemption to capital gains tax (CGT) is fairly logical. CGT is assessed on gains from the sale of physical assets, but with a spread bet, you never actually own anything: you’re simply betting on the movement of an underlying asset.

It’s not beyond governments to change their view on this – as budgetary needs or a view on the proliferation of such untaxed income emerges – but it would need legislation so there would be plenty of advance warning. And there’s absolutely no suggestion of anything like that at the moment.

On the income tax side, betting wins generally are not seen as subject to taxation. This applies to lotteries and sports betting, and the same principles apply to spread betting.

But, it’s not entirely a blank cheque. The issue is whether the betting (and winnings) are incidental, or whether they can be seen as part of your trade. If the latter, then yes, the Revenue Commissioners would argue, they are taxable.

The real question is, if this activity forms a regular part of your activity, how do you determine whether it’s a trade? Revenue says it looks at it on a case-by-case basis; legal analysts think it would need to be very much part of your working business for Revenue to be able to enforce taxation if challenged.

I’d imagine Revenue will look both at what share of your income is accounted for by spread-betting earnings and also what other employment earnings you have and in what type of business.

The bottom line is that, in your case, I doubt Revenue will consider these winnings taxable.

The flip side, of course, is that if you get a losing bet, you cannot offset those losses against other taxable gains under CGT rules in the same way that you could if you owned and sold a physical asset, such as a share, at a loss.

To be perfectly honest, my view is that if you did not have a very clear understanding on spread betting – including the tax implications – then you probably shouldn’t be playing that game, but that’s your call.

Please send your queries to Dominic Coyle, Q&A, The Irish Times, 24-28 Tara Street, Dublin 2, or by email to dcoyle@irishtimes.com. This column is a reader service and is not intended to replace professional advice.