ATO ID 2006/313: Share option trading
Date of decision: 10 November 2006
Year of income: Year ended 30 June 2006
Business line: Private Groups and High Wealth Individuals

Issue
Can a taxpayer carrying on the business of trading in exchange-traded options (ETOs) deduct from assessable income under section 8-1 of the Income Tax Assessment Act 1997 (ITAA 1997) the market value of sold ETO positions that remain open at the end of the taxpayer's income year?

Decision
No. A taxpayer carrying on the business of trading in ETOs is not entitled to deduct from assessable income the market value of sold ETO positions that remain open at the end of their income year.

Facts
The taxpayer carries on the business of transacting in ETOs on the Australian Securities Exchange (ASX) options market by selling (writing) ETOs in the expectation they will expire unexercised. The taxpayer sells an ETO to establish a position in the options market. This is referred to in the market as having an open sold position. The position remains open until one of the following occurs: When the taxpayer sells an ETO, they are entitled to receive a premium in return for writing the option at the time the option is written. The taxpayer returns the premium as assessable income under section 6-5 of the ITAA 1997 at the time the ETO is written. At the end of the taxpayer's income year, the taxpayer has ETOs that remain in the open position as they have not been exercised, closed out, or expired.

Reasons for decision
Summary: Section 8-1 of the ITAA 1997 allows a deduction for losses or outgoings to the extent that 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 that the losses or outgoings are not capital, private or domestic in nature. Taxation Ruling TR 97/7 provides (at paragraph 5) that, as a broad guide, you incur an outgoing at the time you owe a present money debt that you cannot escape. Taxation Ruling TR 94/26 provides guidance on the meaning of the term 'incurred'. In particular, paragraph 3 states: In most cases where a loss has not been realised or an outgoing has not been made, a presently existing pecuniary liability, at the end of the relevant income year, will be a necessary prerequisite to an expense being 'incurred' for the purposes of subsection 51(1) ( Coles Myer Finance 93 ATC 4220; 25 ATR 95; Nilsen Development Laboratories Pty Ltd & Ors v. FC of T 81 ATC 4031; 11 ATR 505)... The market value of the taxpayer's open sold ETO positions represents the cost to the taxpayer to acquire offsetting ETOs in the same contract series. Effectively it is the cost to the taxpayer to close out the positions. At the end of the income year the taxpayer is not under any obligation to close out their open sold ETO positions. The market value of the taxpayer's open sold ETO positions is not a loss or outgoing incurred by the taxpayer as there is no presently existing liability to pay an amount to close out the ETOs. It is possible that the ETOs will never be closed out as they may be exercised by the buyer or expire unexercised. The taxpayer only incurs a loss or outgoing for the purposes of section 8-1 of the ITAA 1997 when they close-out their open positions by buying identical ETOs to those that they originally sold.

Legislative references: Income Tax Assessment Act 1997 Section 8-1 Section 6-5
Related public rulings and determinations: Taxation Ruling TR 97/7 | Taxation Ruling TR 94/26
Related ATO interpretative decisions: ATO ID 2004/526
Subject references: Call options Deductions & expenses Producing assessable income Put options