Edited version of your private ruling

Authorisation Number: 1012515294605

Ruling

Subject: Options trading

Question 1:

For the year ended 30 June 2012, is the income derived from your options trading assessable under section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997) as ordinary income from the carrying on of a business?

Answer 1:

No.

Question 2:

For the year ended 30 June 2012, did you either carry out:

· commercial options trading with a profit making purpose; and/or

· a profit making undertaking of options trading?

Answer 2

Yes.

Question 3:

For the year ended 30 June 2012, are the proceeds from your options trading, proceeds from recreational gambling?

Answer 3:

No.

This ruling applies for the following period:

Year ended 30 June 2012.

The scheme commences on:

1 July 2011.

Relevant facts and circumstances

In your ruling application, you stated that you:

· deposited a small amount of cash into your options trading account with an on-line trading firm, from a credit card with an interest rate of A%;

· commenced online trading sometime in the last half of the year;

· traded less than 30 hours per week;

· made more than 150 transactions in the year ending 30 June 20xx;

· used a 'gut feel' to make transaction decisions; and

· made a profit of a certain amount from the options transactions.

According to the further request for information and questionnaire completed by you (signed and dated on a certain date) and sent to the ATO on a certain date you stated that you:

· decided to trade in options 'by chance' and '…have debt so felt it would be great [to] create a little more income from home';

· carried out the options trading as a '…hobby trader and with a passion - in no way was this trading approached as a business venture or structured, nor as an investor and by nature I am not a punter.'

· have no prior trading skills and attributes the profits made to 'having a rational eye for the movement of the market at the time';

· determined the duration of the trades entered into but had no opportunity to cancel, neutralise or stop the trades once they were entered into;

· would read the news and calendars online and studied the market movement by the second when making the option transactions;

· ceased trading in options sometime in the first half of the year ended 30 June 20xx due to personal circumstances and after several losses;

· did not have a business plan or carry out any forward planning or budgeting in relation to the activity;

· traded with no strategy or analytical models;

· traded approximately B hours weekly outside of your full time working hours; and

· are a full time employee with an employer that is not connected with the financial services industry.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 6-5,

Income Tax Assessment Act 1997 Section 8-1,

Income Tax Assessment Act 1997 Section 15-15,

Income Tax Assessment Act 1997 Section 25-40 and

Income Tax Assessment Act 1997 paragraph 118-37(1)(c).

Reasons for decision

Summary

You are not carrying on a business of options trading in the year ended 30 June 20xx. However, you were either carrying out:

· commercial options trading with a profit making purpose; and/or

· a profit making undertaking of options trading.

The proceeds of your options trading are not proceeds from recreational gambling.

Detailed reasoning

The principles set out in Taxation Ruling TR 2005/15 Income tax: tax consequences of financial contracts for differences (TR 2005/15) and ATO Interpretative Decision ATO ID 2010/56 Assessable income: derivation of income - spread betting (ATO ID 2010/56) have been applied.

Participation in options trading has been identified as a commercial transaction and seen as speculation on a financial risk similar to what is discussed in the ATO views contained in TR 2005/15 and ATO ID 2010/56.

Therefore in adopting the above view, where options trading is carried on as a business, the gains from the options transactions will be accounted for under section 6-5 of the ITAA 1997 and the losses under section 8-1 of the ITAA 1997.

If the option trading is not carried on as a business, but is however carried on as either:

· commercial options trading with a profit making purpose; and/or

· a profit making undertaking of options trading,

then any profit will be assessable on revenue account as either ordinary income and accounted for under section 6-5 of the ITAA 1997, or the profit will be assessable as a profit making undertaking in accordance with section 15-15 of the ITAA 1997.

A gain or loss from options trading entered into for the purpose of recreation by gambling will not be assessable income under section 6-5 or section 15-15 of the ITAA 1997, nor be deductible under section 8-1 of the ITAA 1997 or section 25-40 of the ITAA 1997. Further, a capital gain or capital loss from option trading entered into for the purpose of recreation by gambling will be disregarded under paragraph 118-37(1)(c) of the ITAA 1997.

In your case the alternatives have been considered and it has been concluded that your options trading in the year ended 30 June 20xx are either;

· commercial options trading with a profit making purpose; and/or

· a profit making undertaking of options trading, and will therefore be assessable on revenue account.

Question 1

Carrying on a business

In applying factors (a) to (g) from Taxation Ruling TR 97/11 Income tax: am I carrying on a business of primary production? (TR 97/11) to determine whether you were carrying on a business, it is acknowledged that the activity undertaken by you had the purpose of profit, and was also characterised by regular and repetitive activity over a period of time. There were also characteristics of the activity that aligned with the activities being a business, rather than a hobby.

However, your activities also had no 'significant commercial purpose or character' and there was no stated intention of engaging in business. You did not carry on the activities in a similar manner to that of ordinary traders in the business of financial investments, nor did you plan, organise or carry out the activities in a systematic or businesslike manner. Furthermore, there was no permanency in your activities.

Thus, after consideration all of the relevant indicators and the circumstances of your case, it is considered that you were not carrying on a business of options trading.

Question 2

Commercial options trading with a profit making purpose; and/or

A profit making undertaking of options trading. (Not carrying on a business of options trading.)

Section 6-5 states that: 'Your assessable income includes income according to ordinary concepts, which is called ordinary income.' Profit or gain arising from an isolated business or commercial transaction will generally be ordinary income if the taxpayer's purpose in entering into the transaction was to make a profit. This would be the case even if the transaction was not part of the taxpayer's ordinary course of business.

The High Court held in Federal Commissioner of Taxation v. The Myer Emporium Ltd (1987) 163 CLR 199 at 209-210; 18 ATR 693; 87 ATC 4363 (Myer), that:

The authorities establish that a profit or gain so made [in an isolated transaction] will constitute income if the property generating the profit or gain was acquired in a business operation or commercial transaction for the purpose of profit-making by the means giving rise to the profit.

Taxation Ruling 92/3 Income tax: whether profits on isolated transactions are income (TR 92/3) provides the ATO view on whether profits on isolated transactions are income under subsection 25(1) of the Income Tax Assessment Act 1936 (ITAA 1936), now section 6-5.

The definition of 'isolated transactions' in paragraph 1 of TR 92/3 includes 'transactions entered into by non-business taxpayers'.

Paragraph 16 of TR 92/3 states that:

If a taxpayer who is not carrying on a business makes a profit, that profit is income if:

(a) the intention or purpose of the taxpayer in entering into the profit-making transaction or operation was to make a profit or gain; and

(b) the transaction or operation was entered into, and the profit was made, in carrying out a business operation or commercial transaction.

For example, paragraph 19 of TR 2005/15 confirms the principles established in Myer and TR 92/3 are applicable to financial contracts for differences where the profit or loss was made in either a business operation or a commercial transaction for the purpose of profit making.

TR 2005/15 states at paragraph 23 that:

…speculation on a financial risk can be characterised as being commercial, in that it increases the efficiency of the financial markets by adding to the depth and liquidity of the markets.

In concluding that speculation on a financial risk can be characterised as being commercial, TR 2005/15 bases that conclusion on the following attributes of a financial contract for differences:

· it cannot be assigned;

· it does not provide ownership of the underlying asset;

· they are essentially contracts of speculation productive of a gain or a loss stemming from exposure to a short term financial risk; and

· the risks assumed are all the basic subject matter of the financial services industry.

It is considered that options have the same characteristics. They are commercial transactions.

options trading are seen as commercial transactions, this combined with the fact that you had a profit making purpose, means that your net profits from the venture / activity in the year ended 30 June 20xx would be assessable as either ordinary income under section 6-5 of the ITAA 1997, or assessable under section 15-15 of the ITAA 1997 as a profit making undertaking.

Question 3

Recreational Gambling

TR 2005/15 at paragraph 43 establishes that there are two factors that differentiate between profit-making and gambling:

a. the chance-to-skill spectrum; and

b. the private/recreational-to-commercial spectrum.

a. the chance-to-skill spectrum

In TR 2005/15, paragraph 70 states the distinguishing factor between financial contract for differences and recreational gambling is the degree of control investors have in determining when to close out a financial contract for differences. This degree of control allows skill and judgment to be exercised right up to the time of termination.

From the information provided by you and from a review of trading platform Vantage FX which offers option trades, it does not appear that options have the same degree of control as financial contracts for differences as there is no 'close out' option (or stop-loss feature). options appear to offer less control than financial contracts for difference and are therefore one step further away from the skill end of the chance-to-skill spectrum than financial contracts for difference.

Whilst not the same type of control, an element of control lies in the binary option trade that a taxpayer decides to carry out. A trader can choose to carry out a high/low trade, a one touch trade, a boundary trade or a 60 seconds trade. A taxpayer is also able to select the expiry time for the trades. In addition, the target price of the indices, Forex rates, stocks or commodities on which trades are placed are constantly fluctuating and, as you pointed out, require constant concentration to ensure the trade puts you in the best position possible.

It can be concluded that there is skill required in carrying out options trading. Whilst the skill and judgment required for options trading may not be as high as a threshold compared to financial contracts for difference, the skill and judgment required for someone with an intention to profit from the options is over and above the skill required to say, place a bet on horse races or on roulette at a casino.

On a consideration of the overall facts in your case and the particular attributes of options, options trading appears to lie marginally towards the skill end of the chance-to-skill spectrum.

b. the private/recreational-to-commercial spectrum

The more closely an activity is identified as undertaken for recreational purposes, the less likely it will have tax consequences.

The 'conventional' forms of gambling have a strong association with the concept of recreation and in some cases, are a social or community activity. In the case of options trading, financial contract for differences and spread betting, there is no strong link with recreation or with a social or community activity for any of these types of investments, or any link between recreation gambling and the financial investment industry in general.

Case X85 90 ATC 615; (1990) 21 ATR 3728 (Case X85), in considering the loss incurred by a taxpayer involved in a futures contract, states at paragraph 13 that:

The essential question in the gambling cases is whether, by granting deductibility to the expenditure, the tax system is subsidising the personal "consumption"' activities of the taxpayer. It may seem strange, but I understand that there are Australians who view the losing of money at the racecourse or on other forms of gambling as a leisure pursuit.

In your case, you advanced a small amount of cash from a credit card with an interest rate of 18% to act as the capital for options trading, with the intention of creating 'a little more income from home' to pay off an existing debt. An objective view of these facts do not lend themselves to appear as if they are in the pursuit of personal pleasure or recreation at the time the trading commenced. Indeed, you ceased trading due to both health issues and a number of losses. It does not appear that you viewed options trading simply as a leisure pursuit.

TR 2005/15 states at paragraph 43 that 'One would not ordinarily expect a financial contract for differences to be entered into as recreation'. At paragraph 67, TR 2005/15 states 'The action of purchasing financial risk is essentially commercial'.

However, at paragraph 15 and 45 of TR 2005/15 it is conceded that financial contracts for differences can, in limited circumstances, be treated as gambling. Paragraph 45 lists the criteria that would need to be met for financial contracts for differences to be considered gambling:

We have indicated above that the terms of the financial contract for differences are such as to tend to stamp it as an act of commerce. However, a taxpayer who enters into a financial contract for differences only once, or very occasionally, who has no expertise in the price of the underlying by which the gain or loss of the financial contract for differences will be calculated, does not engage in any income-producing activities of a character bearing some association or connection with the financial contract for differences or its underlying, and, in particular, who gambles in the ordinary recreational way and who has entered into the financial contract for differences in circumstances such that the financial contract for differences may be seen to be part of that recreation may establish that the gain or loss is the product of gambling (and not the result of a profit-making endeavour.)

In your case, you carried out more than 150 transactions in a Y month period. This would be considered to be more than 'very occasionally'.

You had no expertise in the price of the underlying and apart from the options transactions themselves, you stated that you had no previous experience in other types of financial trading.

However, particular emphasis is placed in paragraph 45 of TR 2005/15 on financial contract for differences being considered gambling if they are undertaken as part of a larger trend of a taxpayer participating in recreational gambling. For example, a taxpayer who likes to go to the horse races for a bet, goes to their local club to play Keno or plays some online poker and then participates in financial contract for differences on an isolated occasion as part of their overall recreational gambling pursuits.

In your case, no evidence has been provided that your options transactions were part of an overall pursuit of recreational gambling for you. On the contrary, you have said that you are 'not a punter'.

On a consideration of the overall facts in your case and those indicators discussed above, your circumstances push you towards the commercial end of the private/recreational-to-commercial spectrum.

Conclusion

Despite options providing less control to an individual than financial contracts for difference and arguably in your case you are not entirely at the skill end of the chance-to-skill spectrum, you did not participate in the options trading as part of a wider gambling or recreational pursuit.