ATO ID 2009/55: Deductibility of premiums payable on the acquisition of options
Date of decision: 30 June 2009
Year of income: Year ending 31 December 2004 Year ending 31 December 2005
Business line: Public Groups and International

Issue
When are premiums payable on options acquired by a commodity producer for the purpose of hedging commodity price risk allowable deductions under section 8-1 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Decision
Premiums payable on the options acquired to hedge commodity price risk are allowable deductions under section 8-1 of the ITAA 1997 in the income year in which they are due and payable.

Facts
The taxpayer, a commodity producer, is exposed to fluctuating prices on the sale of its commodities. In order to offset the risk of fluctuating prices the taxpayer adopts various hedging strategies designed to ensure its commodity sales revenue, together with any gains or losses on its hedging transactions, is within an acceptable range. These strategies involve the sale and/or the acquisition of options, or the use of option transactions in combination with other derivatives. On acquiring the options the taxpayer becomes liable to pay a premium to the seller which represents a non-refundable payment for the rights conveyed by the option. Each premium is paid two days after the acquisition of the option.

Reasons for decision
Summary: The options acquired by the taxpayer as part of its hedging strategies are an integral part of its business, designed to protect its revenue in the event of a fall in the price of the commodity it produces for sale. Section 8-1 of the ITAA 1997 allows a deduction for losses or outgoings to the extent they are incurred in gaining or producing assessable income or are necessarily incurred in carrying on a business for the purpose of gaining or producing assessable income, provided the losses or outgoings are not capital, private or domestic in nature. Taxation Ruling TR 97/7 provides broadly that a taxpayer incurs an outgoing at the time a present money debt is owed that cannot be escaped. The term incurred also covers losses or outgoings to which a taxpayer is 'definitively committed' or is 'completely subjected'. There has to be a presently existing liability which must be more than 'impending, threatened or expected' ( New Zealand Flax Investments Ltd v. Federal Commissioner of Taxation (1938) 61 CLR 179; (1938) 5 ATD 36; (1938) 1 AITR 366; Federal Commissioner of Taxation v. James Flood Pty Ltd (1953) 88 CLR 492; (1953) 5 AITR 579; (1953) 10 ATD 240; Nilsen Development Laboratories Pty Ltd v. Federal Commissioner of Taxation (1981) 144 CLR 616; (1981) 81 ATC 4031; (1981) 11 ATR 505. The premiums payable on options acquired to hedge the taxpayer's revenue stream are a necessary outgoing made in the normal course of the maintenance of the taxpayer's business of selling commodities. The premiums payable are necessarily incurred in carrying on a business for the purposes of producing assessable income. They are not capital or of a capital nature and are deductible under section 8-1 of the ITAA 1997. The taxpayer incurs a liability to pay a premium to the seller at the time of acquiring the option. It is at this time that a presently existing liability is created and the outgoing is incurred for the purposes of section 8-1 of the ITAA 1997.

Legislative references: Income Tax Assessment Act 1997 section 8-1
Case references: New Zealand Flax Investments Ltd v. Federal Commissioner of Taxation (1938) 61 CLR 179 (1938) 5 ATD 36 (1938) 1 AITR 366
Related public rulings and determinations: Taxation Ruling TR 97/7
Related ATO interpretative decisions: ATO ID 2009/53 | ATO ID 2009/54 | ATO ID 2009/56
Subject references: Call options Commodity transactions Deductions & expenses Financial derivatives Financial instruments Hedging Incurred Put options