ATO Interpretative Decision
ATO ID 2009/54
Income tax
Deductibility of an amount paid on the cash settlement of an exercised optionFOI status: may be released
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This ATO ID does not take account of the effect of Tax Laws Amendment (Taxation of Financial Arrangements) Act 2009 that implements Stages 3 and 4 of the reforms to the taxation of financial arrangements (TOFA 3 and 4).
This ATOID provides you with the following level of protection:
If you reasonably apply this decision in good faith to your own circumstances (which are not materially different from those described in the decision), and the decision is later found to be incorrect you will not be liable to pay any penalty or interest. However, you will be required to pay any underpaid tax (or repay any over-claimed credit, grant or benefit), provided the time limits under the law allow it. If you do intend to apply this decision to your own circumstances, you will need to ensure that the relevant provisions referred to in the decision have not been amended or repealed. You may wish to obtain further advice from the Tax Office or from a professional adviser.
Issue
When is an amount paid on the cash settlement of an exercised option deductible under section 8-1 of the Income Tax Assessment Act 1997 (ITAA 1997)?
Decision
An amount paid on the cash settlement of an exercised option is deductible under section 8-1 of the ITAA 1997 when the option is exercised.
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 commodity options, or the use of commodity option transactions in combination with other derivatives.
As part of this strategy the taxpayer sold an option which gave the counterparty the right, but not the obligation, to buy a certain quantity of a particular commodity at a fixed price (the strike price) on the expiry date of the option.
The option was exercised on the expiry date. The contract was cash settled, as intended by the parties and provided for under the contract, with the taxpayer agreeing to pay an amount equal to the difference between the strike price and the market price of the commodity on the expiry date. The taxpayer made the payment 12 days after the expiry date.
Reasons for Decision
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 & Ors v. Federal Commissioner of Taxation (1981) 144 CLR 616; (1981) 81 ATC 4031; (1981) 11 ATR 505.
The option sold by the taxpayer is part of its hedging strategies, which form 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. The amounts paid on cash settling the option is an outgoing necessarily incurred in carrying on a business for the purpose of gaining or producing assessable income. The outgoing is not capital or of a capital nature.
The amount paid on cash settling the option is incurred at the time the option is exercised. 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.
Date of decision: 30 June 2009Year of income: Year ending 31 December 2004 Year ending 31 December 2005
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
(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
Related Public Rulings (including Determinations)
Taxation Ruling TR 97/7
ATO ID 2009/53
ATO ID 2009/55
ATO ID 2009/56
Keywords
Call options
Commodity transactions
Deductions & expenses
Financial derivatives
Financial instruments
Hedging
Incurred
Ordinary course of business
Put options
ISSN: 1445-2782