Private ruling: Income tax - Non-commercial losses - Income requirement
Published: May 2014
Ruling period: Income year ended 30 June 20ZZ
Date scheme commenced: 1 July 20YY

Ruling: Q1: Do you satisfy the income requirement in subsection 35-10(2E) of the Income Tax Assessment Act 1997 for the income year ended 30 June 20ZZ? | A1: Yes

Relevant facts and circumstances: You are employed as a portfolio manager. You also operate a business of trading in exchange traded options (ETOs). The ETOs you trade relate to underlying shares. The ETOs are traded through an Exchange Traded Option (ETO) trading account you hold. When you buy a put option you have the right, but not the obligation, to sell the underlying shares for the specified exercise price. When you sell a put option, you are obliged to buy the underlying shares at the exercise price if you are allocated an exercise notice. When you buy a call option you have the right, but not the obligation to buy the underlying shares for the specified exercise price. When you sell a call option, you are obliged to sell the underlying shares at the exercise price if you are allocated an exercise notice. When you exercise a bought option or are exercised against on a sold option, you are required to acquire or dispose of the underlying shares. The shares that you acquire or dispose of as a result of options being exercised are not held on capital account. For a bought call option or a sold put option, you can choose to not buy the shares by exiting your position in the options market. For a sold put option this is achieved by entering into the options market and buying the put option back. For a bought call option this is achieved by selling the call option. Your strategy is to buy the shares instead of exiting via the options market because transaction costs are higher in the options market. That is, the bid ask spread costs are substantial versus simply buying the stock and selling it on market at an opportune time. Your strategy when turning over positions is to turnover large positions. You concentrate turnover in one particular security because transaction costs are fixed. That is, the cost for selling a small position is similar to the cost for trading a large position. Your trading strategy is to continuously arbitrage. Decisions to sell shares are based on volatility. In the income year ended 30 June 20ZZ the holding period for shares you held was longer due to low volatility. During the income year ended 30 June 20ZZ the allowable deductions attributable to your ETO trading exceeded the assessable income from your ETO trading. During the income year ended 30 June 20ZZ you had assessable income and allowable deductions in relation to your employment. During the income year ended 30 June 20ZZ you also had interest and dividend income. The interest income does not form part of the assessable income from your ETO trading business for the income year ended 30 June 20ZZ. You received the dividend income from various shares you hold. All the shares, with the exception of shares in entity A, were purchased through exercised put and call options held under your ETO trading account. The shares in entity A were purchased in an off market transfer at market value and are unrelated to your ETO trading. Ninety per cent of the total value of your shares has been sold.

Relevant legislative provisions: Income Tax Assessment Act 1997 section 4-15 | Income Tax Assessment Act 1997 subsection 35-10(2) | Income Tax Assessment Act 1997 subsection 35-10(2E)

Reasons for decision: Summary: Based on the figures submitted with your private ruling application you satisfy the income requirement in subsection 35-10(2E) of the Income Tax Assessment Act 1997 (ITAA 1997) for the income year ended 30 June 20ZZ. | Detailed Reasoning - Detailed reasoning: The rule in subsection 35-10(2) of the ITAA 1997 refers to an excess of amounts attributable to a business activity that could otherwise be deducted over assessable income from that business activity. Whether an amount of assessable income is 'from' a business activity, depends on whether that activity is the source or origin of that income based on the ordinary meaning of 'from' (see BHP Petroleum (Timor Sea) Pty Ltd & Ors v. Minister for Resources (1994) 49 FCR 155; (1994) 28 ATR 16), or whether that income is an incident of carrying that activity on (see Kidston Goldmines Ltd v. Federal Commissioner of Taxation (1991) 30 FCR 77; 91 ATC 4538; (1991) 22 ATR 168). The income requirement in subsection 35-10(2E) of the ITAA 1997 is satisfied for an income year if the sum of your taxable income for that year, your reportable fringe benefits total for that year, your reportable superannuation contributions for that year and your total net investment losses for that year is less than $250,000. Taxable income is defined in section 4-15 of the ITAA 1997 as assessable income minus deductions. The term 'deduction' is defined in subsection 995-1(1) of the ITAA 1997 to mean an amount that you can deduct. When working out your taxable income for the purposes of subsection 35-10(2E) of the ITAA 1997, the excess referred to in subsection 35-10(2) of the ITAA 1997 is disregarded. ATO Interpretative Decision ATOID 2009/59 Income Tax - Shares acquired and disposed of in an options trading business: trading stock considers whether shares acquired and disposed of as part of a business of trading in exchange traded options (ETOs) are trading stock for the purposes of section 70-10 of the ITAA 1997. In ATOID 2009/59 the taxpayer conducted a business of trading in ETOs. As part of that activity the taxpayer sold a put option over a listed share and at a later date 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. Based on these facts it was determined that the shares are trading stock for the purposes of Division 70 of the ITAA 1997. The general principle in ATOID 2009/59 is that where shares acquired in the conduct of an options trading business are held for the purpose of sale and such sale takes place shortly after acquisition, the shares can be trading stock. ATOID 2009/59 notes that 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)). | Detailed Reasoning - Application to your circumstances: During the income year ended 30 June 20ZZ the allowable deductions attributable to your ETO trading exceeded the assessable income from your ETO trading resulting in an ETO trading loss. During the income year ended 30 June 20ZZ you had assessable income and allowable deductions in relation to your employment. Clearly the amounts related to your employment are not related to your ETO trading business activity and will be included when working out your taxable income for the purposes of subsection 35-10(2E) of the ITAA 1997. During the income year ended 30 June 20ZZ you also had interest and dividend income. The dividend income includes dividends received from Entity A shares. As the interest income does not form part of the assessable income from your ETO trading business for the income year ended 30 June 20ZZ, it will be included when working out your taxable income for the purposes of subsection 35-10(2E) of the ITAA 1997. Whether the dividends you received during the income year ended 30 June 20ZZ are included in your taxable income for the purposes of subsection 35-10(2E) of the ITAA 1997 depends on whether or not they form part of the assessable income from your ETO trading business. It is considered that, acquiring and disposing of shares is an integral part of your ETO trading business activity. When you exercise a bought option or you are exercised against on a sold option, you are required to acquire or dispose of the underlying shares. Your business strategy with regard to bought call options or sold put options of buying shares instead of exiting your position via the options market to minimise costs results in the acquisition of shares. With the exception of the Entity A shares, all the shares from which you received dividend income were purchased through exercised put and call options held under your ETO trading account. Your business strategy of turning over large positions to minimise costs and your decision making based on volatility both influence the turnover of shares. Ninety per cent of the total value of the shares had been disposed of. Based on the ordinary meaning of 'from', as your business activity is primarily that of trading ETOs, it cannot be said that the assessable income arising from the shares acquired as a consequence of your ETO trading activity has its source or origin in that activity. However, with the exception of the Entity A shares, as the shares were acquired as part of the more general conduct of carrying on your ETO trading business, there is a sufficiently proximate relationship between the assessable income that arises from the shares and your ETO trading business activity and it can fairly be said that the assessable income is an incident of carrying on that business. Additionally, applying the principles in ATOID 2009/59, it is considered that, with the exception of the Entity A shares, the shares acquired and disposed of as part of your business of trading in ETOs are trading stock for the purposes of section 70-10 of the ITAA 1997. As they are considered to be trading stock, then it necessarily follows that the dividends from these shares will form part of the assessable income from your ETO trading business activity. Accordingly, with the exception of the dividends received from your Entity A shares, the dividend income you received in the income year ended 30 June 20ZZ can be taken into account for the purposes of calculating the assessable income from your ETO trading business activity. The dividends received from the Entity A shares in the income year ended 30 June 20ZZ will form part of your taxable income for the purposes of subsection 35-10(2E) of the ITAA 1997. Based on the figures you have submitted with your ruling application, as the dividend income exclusive of the dividend amounts received from the Entity A shares form part of the assessable income from your ETO trading business activity, you satisfy the income requirement in subsection 35-10(2E) of the Income Tax Assessment Act 1997 (ITAA 1997) for the income year ended 30 June 20ZZ.