ATO ID 2009/59: Shares acquired and disposed of in an options trading business: trading stock
Date of decision: 30 June 2009
Year of income: Year ended 30 June 2006 Year ended 30 June 2007 Year ended 30 June 2008
Business line: Private Groups and High Wealth Individuals

Issue
Where an individual taxpayer carries on the business of trading in exchange traded options (ETOs), are shares acquired and disposed of as part of that activity trading stock for the purposes of section 70-10 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Decision
Yes. Where an individual taxpayer carries on the business of trading in ETOs, shares acquired and disposed of as part of that activity are trading stock for the purposes of section 70-10 of the ITAA 1997.

Facts
The taxpayer is an individual who carries on the business of trading in ETOs over listed shares on the Australian Securities Exchange's (ASX) Options Market. The taxpayer routinely and systematically takes (buys) and writes (sells) ETOs with the expectation of profit. The taxpayer uses a broker to trade in ETOs. The taxpayer sold a put option contract over a listed share. At a later date the taxpayer purchased a put option contract over the same contract series but did not request the broker to treat the purchase as a closing transaction. The taxpayer was exercised against on the sold put option which resulted in the taxpayer acquiring the underlying shares. After acquiring the shares the taxpayer exercised its bought put option to sell the shares to another party.

Reasons for decision
Summary: Section 70-10 of the ITAA 1997 defines trading stock to include anything produced, manufactured or acquired which is held for the purposes of manufacture, sale or exchange in the ordinary course of business. In Federal Commissioner of Taxation v. Sutton Motors (Chullora) Wholesale Pty Ltd (1985) 157 CLR 277; 85 ATC 4398; (1985) 16 ATR 567 the meaning of the term 'trading stock' was considered. Making reference to its 'traditional and narrower denotation' the Court said, CLR at 281-282; ATC at 4400; ATR at 570: That denotation is of goods held by a trader in such goods for sale or exchange in the ordinary course of his trade. When used in relation to 'a business', as the term is used in the Act generally (see section 28) and in subsection 82D(1) in particular, that central meaning comprehends the goods held on hand in the business for the purpose of sale or exchange in the ordinary course of trade. In Patcorp Investments Ltd v. Federal Commissioner of Taxation (1976) 140 CLR 247; 76 ATC 4225; (1976) 6 ATR 420 Gibbs J said, 'the expression "trading stock" is defined in s 6(1) of the Act to include anything purchased for the purposes of sale'. Shares may not always be trading stock in the hands of their owner, even where their owner may be considered a share trader. Whether a particular parcel of shares constitute trading stock will be determined by the circumstances in which they are held ( Investment and Merchant Finance Corporation Ltd v. Federal Commissioner of Taxation (1971) 125 CLR 249; 71 ATC 4140; (1971) 2 ATR 361 ( IMFC )). In considering whether an item is trading stock, it is also relevant to consider whether the person acquiring the item would be engaged in trading in that item. A further relevant issue is not the nature of the business carried on but whether the person was a trader in the goods ( John v. Federal Commissioner of Taxation (1989) 166 CLR 417; 89 ATC 4101; (1989) 20 ATR 1). In IMFC , Walsh J said: But when shares are bought by a dealer in shares and it is intended that they are to be resold and that this will probably occur in the not distant future, I do not think they are to be denied the description of trading stock, either because the trader expects or intends that they will be sold at less than their cost price or because he seeks to obtain a commercial advantage from the transaction . . . As part of the more general conduct of carrying on the taxpayer's business of trading in options, shares are acquired in situations where a sold put option is exercised. In this instance, the shares are held for the purpose of sale and such sale takes place shortly after acquisition. The shares are not purchased for investment and are not held on capital account. Having regard to the above it is considered that the shares acquired in conducting the taxpayer's options trading business, being those shares acquired under the sold put option which were disposed of on exercise of the bought put option, are trading stock for the purposes of Division 70 of the ITAA 1997.

Legislative references: Income Tax Assessment Act 1997 section 70-10 Division 70
Case references: Federal Commissioner of Taxation v Sutton Motors (Chullora) Wholesale Pty Ltd (1985) 157 CLR 277 85 ATC 4398 (1985) 16 ATR 567
Related public rulings and determinations: Taxation Ruling TR 98/7
Related ATO interpretative decisions: ATO ID 2009/57 | ATO ID 2009/58
Subject references: Acquisition of shares Carrying on a business Disposal of shares Income Shares Trading stock