Private ruling: Am I carrying on a business of writing call options?
Published: June 2012
Ruling period: Year ended 30 June 2011.
Date scheme commenced: 1 July 2010.

Ruling: Q1: For the year ended 30 June 2011, were you carrying on a business of writing call options? | A1: No. | Q2: For the year ended 30 June 2011, are the gains or losses you made from writing call options treated as profits or losses made from an undertaking or scheme, and assessed under sections 15-15 and 25-40 of the Income Tax Assessment Act 1997 (ITAA 1997)? | A2: Yes.



Reasons for decision: Summary: Whether or not a person is carrying on a business is a question of fact, not a question of law. The determination of whether or not a business is being carried on is generally a process of weighing up all of the relevant indicators within the context of a given situation. No one indicator determines whether or not a business is being carried on. Taxation Ruling TR 97/11 income tax: am I carrying on a business of primary production? (TR 97/11) lists the following indicators as relevant in determining if a business is being carried on: · Whether the activity has a significant commercial purpose or character, · Whether the taxpayer has more than an intention to engage in business, · Whether the taxpayer has a purpose of profit as well as a prospect of profit from the activity, · Whether there is repetition and regularity of the activity, · Whether the activity is of the same kind that is carried on in a similar manner to that of the ordinary trade in that line of business, · Whether the activity is planned, organised and carried out in a business like manner, · The size, scale and permanency of the activity, · Whether the activity is better described as a hobby, a form of recreation or a sporting activity. In your case you are carrying on an activity of writing call options in one particular commodity. | Detailed Reasoning - Whether the activity has a significant commercial purpose or character: The activity of option trading is a commercial activity, particularly where there is no ownership of any underlying asset. However, given the relatively low level of your transactions it would be considered that your activities lack a significant commercial purpose or character. | Detailed Reasoning - Whether the taxpayer has more than an intention to engage in business: You had more than an intention to engage in your activities, and did in fact write approximately 20 call options for which you received premiums. | Detailed Reasoning - Whether the taxpayer has a purpose of profit as well as a prospect of profit: You had both a profit purpose as well as a prospect of profit. | Detailed Reasoning - Whether there is repetition and regularity of the activity: You wrote approximately 20 call options for the minimum quantity of your commodity that could be traded over a five month period. The average number of call options was then approximately four per month. This amount of repetition would not be considered to be at a level that would indicate that a business was being carried on. | Detailed Reasoning - Whether the business is of the same kind that is being carried on in a similar manner to that of the ordinary trade in that line of business: It would be expected that in carrying on a business of writing call options or trading in derivatives a trader would take steps to protect their capital and to mitigate risk, and to maximise their profit. Strategies for this might include a contingency plan to purchase offsetting put options should the price of a commodity move in an unfavourable direction, diversification into other commodities to spread risk, having an exit strategy or stop loss plan in place, trading in large quantities over the short term to take advantage of small changes in prices to maximise a return. You would not be considered to be conducting your activity of writing call options for your commodity in a manner that is similar to the ordinary trade of that business. Although you were undertaking a very risky strategy of writing call options when you did not already own the underlying asset, you did not have a strategy in place should the price of your commodity not remain fairly constant as it had done in the past. You were encouraged by your investment advisor to roll over your positions, and you relied on their advice rather than using your own judgement. You did not diversify into other writing call options on other commodities that may have spread your risk. Although your transactions are of a reasonably high dollar value, they were also for the minimum amount of your commodity that could be traded. The value of your transactions, absence of contingency plans, and reliance on your investment advisor for advice are all indicators that you are not carrying on a business of writing call options. | Detailed Reasoning - The size, scale and permanency of the activity: Your options were for a significant value of the underlying asset, however in options trading the value of the underlying asset is not taken into account as there is never any actual purchase of the underlying asset. Instead, it is the profit or loss on each transaction which is significant. In your case the price of your commodity moved so much that many of your settlements were around the $Y mark. This amount of profit or loss in a transaction is considered to indicate a business is being carried on. However, in your case your large settlement amounts were the result of your investments being closed out at a large loss, rather than a deliberate strategy to trade in high values. Although your option writing activities are of a reasonably high value you have traded only the minimum amount possible of your commodity. The frequency of your transactions also fall short of what would be expected when carrying on a business of option writing. The size and scale of your activities do not indicate that a business is being carried on. | Detailed Reasoning - Whether the activity would be better described as a hobby, recreational or sporting activity: Your trading activities would not be better described as a hobby, recreational, or sporting activity. Your activities do have some of the characteristics of a business as you have a commercial purpose, a profit motive, and your transactions are of a commercial value. However, the low level of transactions, lack the repetition and regularity, absence of planning and reliance on your investment advisor indicate that you are not carrying on a business. The weighing up all of the relevant factors would then indicate that a business of writing call options is not being carried on. Your commodity trading activities would be considered to be isolated transactions, and are ordinary income. Your gains would be assessable under section 15-15 of the ITAA 1997, while your losses would be deductible under section 25-40 of the ITAA 1997.

Please check this edited version to be sure that there are no details remaining that you think may allow you to be identified. If you have any concerns about this ruling you wish to discuss, you will find our contact details in the fact sheet. | Relevant facts: A few years ago you engaged a foreign investment bank as your investment advisors. On the advice of your investment advisors you undertook investments and other transactions which netted you a small amount of income which was declared as 'other foreign assessable income' in your tax return. | Over the next few years you undertook various transactions with your investment bank. Some of these activities earned interest payments and premiums. You also traded in derivatives. Overall, you earned income, and also made a capital loss. | In the income year ended 30 June 2011 you continued your activities in a similar way with your investment bank. | During this time your investment advisor encouraged you to write call options on a particular commodity. During 2010 you started writing call options in this commodity. You wrote approximately 20 call options during the income period ended 30 June 2011. You earned premiums of approximately $X from this activity. | You did not own any of your underlying asset when you wrote your call options. | As the price of your commodity rose you were required to purchase this commodity at a loss to close out your position. Alternatively, you rolled over your call options believing that your commodity was overvalued, and the price of your commodity would shortly correct itself. Instead, the price of your commodity continued to rise. | You eventually closed out your call options. You made a significant loss of from your writing call options activity.