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Ruling

Subject: Capital gains tax

Question and answer:

Does your granting of an option to another party to purchase a property you own constitute a capital gains tax (CGT) event D2?

Yes.

This ruling applies for the following period:

Year ended 30 June 2009

The scheme commences on:

1 July 2008

Relevant facts and circumstances

You own a property (the property).

You granted a call option (the option) to another party to purchase the property in the financial year ended 30 June 2009.

You received $X from the other party by granting the option.

You did not include the amount you received for granting the option in your income tax return for the 2009 financial year or any subsequent year.

You lodged your income tax return for the 2009 financial year in mid 2011 and we issued your notice of assessment in mid 2011.

To date the option has not been exercised, however it still remains current as it has been extended by mutual agreement.

Under the option agreement you will be deemed to have entered into a sale contract for the property when the option is exercised.

Should the option be exercised, under the option agreement the amount you received for granting the option will form part of, and will be deemed to have been paid towards the purchase price of the property.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 104-5/10/40/40(5),

Income Tax Assessment Act 1997 section 108-5,

Income Tax Assessment Act 1997 section 115-25(3), and

Income Tax Assessment Act 1997 section 116-65.

Reasons for decision

Options 

Although an option is given as an example of an 'asset' in section 108-5 of the Income Tax Assessment Act 1997 (ITAA 1997), the term itself is not defined in the Act. In FC of T v Guy 96 ATC 4520, the Full Federal Court said (at p 4526): 

"The word 'option' itself suggests a right in one party unilaterally to require another party to enter a new set of jural relations or to extend or continue an existing jural relationship. Put and call options, options to purchase and options to renew leases are, perhaps, the most common illustrations." 

Options are therefore considered as rights to accept an irrevocable offer within a specified time and the acceptance of the offer creates a contract. A call option provides the grantee of the option the right to acquire an asset from the grantor of the option at a specified price before a specified date.

The CGT consequences of granting an option 

Section 104-40 of the ITAA 1997 specifies the following in relation to the granting of an option:

(1) CGT event D2 happens if you grant an option to an entity, or renew or extend an option you had granted. 

(2) The time of the event is when you grant, renew or extend the option. 

(3) You make a capital gain if the capital proceeds from the grant, renewal or extension of the option are more than the expenditure you incurred to grant, renew or extend it. You make a capital loss if those capital proceeds are less. 

There is an exception to the above under section 104-40(5) of the ITAA 1997 which states that a capital gain or capital loss you make from the grant, renewal or extension of the option is disregarded if the option is exercised. 

It should be noted that under section 115-25(3) of the ITAA 1997 a capital gain arising under CGT event D2 can not be a discount capital gain.

In your case, you signed a written agreement granting a call option to another party to purchase a property you owned.

Therefore, the granting of an option by you constitutes a CGT event D2 and the date of the event is when the option was granted. You should have recorded the amount you received for granting the option in your income tax return for the financial year ended 30 June 2009.

The Capital Gains Tax consequences of exercising an option 

It may be the following year or a subsequent year before the option is exercised. Provisions of the ITAA 1997 provide that if the option is exercised, the granting of the option on a particular date and the exercise of the option is treated as a single transaction in relation to the grantor. 

Taxation Determination TD 16 Capital Gains: What is the date of acquisition (or date of disposal) of an asset acquired (or disposed of) on the exercise of an option? confirms that the date of disposal of an asset under an option is the date of the transaction entered into as a result of the exercise of the option. Accordingly, the date of disposal of the property is the date that the option is exercised. The subsequent sale of the land from exercising the option will be a CGT event A1 under section 104-10 of the ITAA 1997. 

In addition, section 116-65 of the ITAA 1997 provides that where you dispose of a CGT asset because another entity exercises an option you granted in relation to the asset, the capital proceeds from the disposal include any payment you received for granting the option. This means that the capital proceeds from the A1 event include any payment you received for granting the option. Therefore, the original CGT event D2 is disregarded under subsection 104-40(5) of the ITAA 1997. 

Where an option is given in one financial year and exercised in another financial year, an amendment to the taxpayer's income tax assessment for the year in which the option was granted will be necessary.

Further issues for you to consider:

You should lodge an amendment request for your 2009 income tax return to include the amount you received for granting the option.