Options trading and australian tax
There is a growing trade in options in Australian listed shares. This paper examines the income tax and Part IIIA consequences of buying and selling put and call options. It finds options trading and australian tax certainty, and some uncertainty. So that readers will be familiar with how we are using some of those terms, we shall set out some definitions for the purposes of this paper.
When a taxpayer buys a call option, the taxpayer has the right, but not the obligation, to buy a fixed number of shares at a specified price at any time up to the expiry of the option. Conversely, where a taxpayer buys a put option, the taxpayer has the right, but not the obligation, to sell a fixed number of shares at a specified price at any time up to the expiry of the option [The Law of OptionsD.
Farrands, Law Book Company, Australia, at 4, states that the true nature of an option has not as yet been comprehensively determined by the courts. It is stated that the controversy is whether an option is: Those rights and obligations create a code when dealing in options trading and australian tax traded options. An exception to this general rule is where a Twenty Leaders of the Australian Stock Exchange Index option is purchased.
The Twenty Leaders Index option is options trading and australian tax cash settlement only. Basically, the taxation consequences of buying a call or put option depend upon whether the taxpayer trades in options, is merely speculating in options or is hedging against a particular exposure.
Notwithstanding this, care must be taken, as a particular option transaction may have elements of more than one of the categories of trading, speculating or hedging or there may be other considerations which are relevant in determining the taxation consequences of dealing in a particular option. A trader options trading and australian tax options will be a person who routinely and systematically buys and writes options in the expectation of profit.
Factors which are relevant in determining whether or not a taxpayer is a trader, include: Whether or not a complying superannuation fund satisfies the above criteria, Section of the Income Tax Assessment Act would effectively tax the fund as if the transactions were on capital account.
Specifically, Section states that Part IIIA of the Income Tax Assessment Act applies in respect of options trading and australian tax disposal of an asset option to the exclusion of the ordinary income tax provisions.
The difference between a speculator and options trading and australian tax trader is somewhat blurred. A speculator may, for example, take an occasional position in the expectation of a profit. A hedger would use an option to reduce the risk relevant to his or her underlying share portfolio. Where an option is used to hedge an underlying transaction which is on revenue account, the option would similarly be treated as being on revenue account.
An example of an option transaction on revenue account would be a sharetrader who uses Exchange Traded Options ETOs to hedge against rising options trading and australian tax prices. Where an option is used to hedge an underlying transaction which is on capital account, the option would similarly be treated as being on capital account.
An example of an option transaction on capital account would be a share investor who uses ETOs to hedge against rising share prices in a particular company he or she is interested in investing in.
A trader who buys an option will generally be able to claim a tax deduction at the time when the premium becomes due and payable [As far back atthe Deputy Commissioner of Taxation, in a letter written to a firm of option brokers, stated that: Also see the comments by Mr. Thompson in Case G27 75 ATC at where he states that taxpayers who are share traders may be allowed a deduction for the cost of an option at the time of payment.
If the option lapses, there will be no further tax effect. As most ETOs are limited to a maximum of nine months duration, those provisions generally do not have any practical relevance. However, options trading and australian tax are options on selected stocks which have expiry terms of two and three years. Traders will be assessable on any income derived from trading in options.
However, income accruing to the purchaser of an option because, for example, the option increases in intrinsic value will not be derived for tax purposes until the option contract is closed out.
That is, the income options trading and australian tax closing out an option position will not be derived until the receipt from writing an equal but opposite position becomes due and receivable. If an option is exercised, the gain in relation to the option will ultimately be reflected in a lower cost of shares if the option is a call option or in higher share sale prices if the option is a put option.
This in turn will be reflected in higher share trading profits, or lower losses, as the case may be. As with most matters relating to taxation, there is another view on what is the correct taxation treatment of options [See, for example, A. The alternative view is that the net profit or loss on the overall option transaction is assessable or deductible when the option contract is either closed out, exercised or expires similar to how a trader in physical goods treats trading stock.
This approach effectively requires an analysis of the entire set of transactions in determining whether a taxable profit or loss has arisen. As the Twenty Leaders Index is a cash settled option, in our view, the appropriate tax accounting treatment is the net profits approach. However, as yet, there are no tax rulings on the tax treatment of buying an ETO [There is, however, a House of Lords decision: It was held in that case that, although an option right disappeared on the acquisition of shares the subject of the optionno trading profit or loss arose until the shares were sold.
There is, however, a technical CGT problem in a taxpayer adopting the net profits approach where an option contract is closed out. If the option fee only forms part of the calculation of the overall options trading and australian tax or loss, then Section ZA 4 of the Income Tax Assessment Act may not fully protect the taxpayer from unfair taxation.
Section ZA 4 reduces the amount of a capital gain of a taxpayer on a transaction by the options trading and australian tax included as ordinary income from that transaction. Where an option contract is closed out and, say, no overall profit is included as ordinary income because none was made, or a loss was madethe receipt from closing out the transaction will not, strictly speaking, be included in assessable income [Presumably Section ZZC options trading and australian tax of the ITAA would still apply to the written position to close out the open option position.
Options trading and australian tax taxpayers in this position would be required to argue a substance approach that is, rely upon what the Options trading and australian tax legislation is allegedly trying to achieve or that a options trading and australian tax loss also arose on close-out. However, there are timing difficulties with these arguments, which will be explained later.
However, there are important timing issues where open option contracts straddle year end. Also see the Australian Options Market Dealing in Options - an explanatory booklet on Exchange Traded Call Optionsregarding the rights and obligations of persons dealing in options. To "realise" a gain, a trader would close out their position by entering the market again and taking an equal but opposite position.
The Income Tax Assessment Act defines "trading stock" as including "anything produced, manufactured, acquired or purchased for purposes of manufacture, sale or exchange, In our view, the ordinary meaning of "trading stock" is something which is acquired by a trader and held for resale that is, the nature of the business is to buy and sell commodities.
It seems to us that buying and subsequently writing opposite ETOs does not fall within the ordinary meaning of "trading stock". However, the Income Tax Assessment Act expands the ordinary meaning of "trading stock" to include other activities for example, exchange. Notwithstanding, it still appears that buying and options trading and australian tax ETOs does not fall within the expanded definition of trading stock. It is possible that where a trader in shares buys a call option, and subsequently exercises the option and receives shares which become trading stock, the trader may have the tax deduction for the option premium deferred until the tax year options trading and australian tax which the shares first become trading stock [Section 51 2A of the ITAA.
For example, if a share trader buys an "in the money" call option on 30 June, and subsequently exercises the option and acquires shares which become trading stock, then the deduction for the call option may be deferred until the year when the option is exercised. Assume on dayABC shares are sold.
Day ABC shares sold. If a net loss resulted instead of a net profit, that loss would be deductible, provided the taxpayer notifies the Tax Commissioner no later than the date upon which he or she lodges his or her first income tax return after acquiring the option [ Section 52 of the ITAA.
Conversely, a deduction may be available to a speculator who undertakes an isolated option transaction if: If the loss is not allowed as an immediate deduction, the CGT provisions would apply. The tax consequences of the CGT provisions are discussed below, when dealing with taxpayers who use options to hedge capital exposures. Normally, the premium paid by a taxpayer who is hedging a transaction which is on revenue account would be allowed a deduction when the premium is due and payable [See earlier comments on the timing of deductions options trading and australian tax to traders, especially Footnote 3 above.
If the option is subsequently closed out, the income would be assessable. However, if the option is a Twenty Leaders Index option or a LEPO, the net profit or loss would be assessable or deductible when the option contract is either closed out, exercised or expires. The premium paid by a taxpayer who is hedging a transaction which is on capital account would generally be dealt with under the CGT provisions of the Income Tax Assessment Act. It is doubtful whether an immediate income tax deduction would be available to the taxpayer when hedging a transaction on capital account.
The ATO would be unlikely to accept the decision in Australian National Hotels v FC of T 88 ATCas authority for the proposition that option premiums hedging a capital transaction are analogous to insurance premiums. A buyer who acquires an option which is on capital account will realise a capital loss that is, basically the amount of the premium paid at the time the option expires [Section M 3 b of the ITAA states that, in respect of a chose in action, a change in ownership options trading and australian tax be taken to have occurred on options trading and australian tax.
As there is no consideration for the expiry of the option, the market value rules of Section ZD 2 potentially apply. Further, as the disposal would be otherwise than to another person, Section ZD 2 would normally require the market value of the option to be determined as if the disposal did not occur.
Accordingly, a capital loss should arise equal to the amount of the option premium paid. Capital losses can only be offset against capital gains. Alternatively, where a buyer exercises a call option, the premium paid in respect of the option, together with the consideration paid for the underlying shares purchased, would form part of the cost base in respect of the acquisition of the underlying shares [Section ZZC 8 of the ITAA.
Where a buyer exercises a call option, the premium paid in respect of the option is potentially subject to indexation if the underlying shares acquired on exercise are held for at least 12 months. Indexation commences from the quarter that the liability to pay the option premium arises [See Tax Determination TD Investor acquired the shares on 1 January Investor exercises the option on 31 December As Investor would have owned the shares in ABC for 2 years, the option premium is indexed from the June quarter.
When an option contract is closed out, the option holder ceases to be a party to such an option [See the Australian Options Market Options - The Versatile Investment page 6 on options trading and australian tax discharge of obligations resulting from closing out an open position. Logically, any amount subject to CGT would be the overall gain, after taking into account indexation if appropriate. Notwithstanding the above, there is perhaps an argument that options trading and australian tax option fee is not assessable until the year in which the option expires or is otherwise dealt with.
Arthur Murray NSW Pty Limited v FC of T CLR provides some support for the proposition that while there is a continuing obligation on the writer to perform under the option contract, the income has not yet fully come home to the writer.
However, in the case of all standard options, the option fee is never refundable. It has therefore, come home to the grantor of the option and is income.
See the dicta in Arthur Murray at This will almost always be the same as a cash basis because premiums are usually paid simultaneously with the grant of an option. If the premium is received as part of an isolated transaction by an individual, it is assessable on a cash basis. If the option lapses, there will be no further tax effect because premiums are never returnable.
Deposits and options trading and australian tax calls lodged by options trading and australian tax of options are not immediately deductible. In fact, only that part of the deposit or margin call which is not refunded to the seller would ultimately be deductible. If the option is exercised, the loss in relation to the option will ultimately be reflected in lower share sale prices if a call option was sold or in a higher cost of shares if a put option was sold.
This in options trading and australian tax, will be reflected in lower share trading profits, or higher losses, as the case may be. If the option is a Twenty Leaders Index option or a LEPO, options trading and australian tax resulting from the overall transaction should only be taken into account when the options are closed out, exercised or expire. The premium received by a taxpayer who is hedging a transaction which is on revenue account would be assessable income to the writer on a due and receivable basis, or if the premium is received as part of an isolated transaction by an individual, on a cash basis.
Other taxation issues which arise to the seller of an option who is options trading and australian tax a revenue exposure are essentially the same as those applicable to traders or speculators who sell options. Where a taxpayer is hedging a transaction which is on capital account, the grant of an option will be a deemed disposal of the option at the time the option is granted [ Section ZZC 3 of the ITAA. The consideration for the deemed disposal of the option is the premium received.