Edited version of private advice

Authorisation Number: 1051760858430

Date of advice: 9 February 2021

Ruling

Subject: Ordinary income - trading futures

Question

Are the gains or losses from trading option futures contracts respectively assessable income under either section 6-5 or section 15-15; or an allowable deduction under section 8-1 or section 25-40 of the Income Tax Assessment Act 1997 (ITAA 1997) for the Trustee of the Trust?

Answer

Yes

This ruling applies for the following period:

Year ending 30 June 20xx

The scheme commences on:

1 July 20xx

Relevant facts and circumstances

The Trust is involved in investment activities. The Trust trades in options futures contracts and uses specialist advisers who trade on their behalf.

An ES mini futures index contract is an electronically traded futures contract which takes a position on the movement of the index as opposed to a specific share within the index.

Trading by the Trust is done mostly on a weekly basis, with occasionally two trades a week. When the market is very volatile, no trades take place. Most transactions make a profit but when a loss occurs it can be substantial.

The Trust was trading on an expectation that the index market would move over a period of time in such a way as to create a profitable margin in respect of the option futures contracts.

The Trust was also relying on skill and judgment when trading in the option futures contracts.

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 15-5

Income Tax Assessment Act 1997 section 25-40

Reasons for decision

Summary

You were not carrying on a business of trading option futures contracts in the year ended 30 June 20XX. However, you were either carrying out:

•         commercial option futures contract trading with a profit-making purpose; and/or

•         a profit-making undertaking of option futures contract trading.

Therefore, your gains or losses from trading option futures contracts were respectively assessable income under either section 6-5 or section 15-15; or an allowable deduction under section 8-1 or section 25-40 of the ITAA 1997.

Detailed reasoning

Taxation Ruling TR 2005/15 Income tax: tax consequences of financial contracts for differences sets out the income tax consequences of entering into financial contracts for differences. ATO Interpretative Decision ATO ID 2010/56 Assessable income: derivation of income - spread betting considers if gains from financial spread betting are assessable income under section 6-5 or section 15-15 of the ITAA 1997.

Your participation in options futures contract trading is considered to have a profit -making purpose with the transactions having a commercial nature similar to those considered in the ATO views contained in TR 2005/15 and ATO ID 2010/56.

Where option futures contract trading is carried on as a business, the gains will be accounted for under section 6-5 of the ITAA 1997 and the losses deductible under section 8-1.

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

•         commercial option futures contract trading with a profit-making purpose, and/or

•         a profit-making undertaking of option futures contract 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.

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? 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.

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 option futures contract trading.

Commercial option futures contract trading with a profit-making purpose; and/or

a profit-making undertaking of option futures contract trading.

Subsection 6-5(1) of the ITAA 1997 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 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 of the ITAA 1997.

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.

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 paragraphs 11 and 26 of Taxation Ruling TR 2005/15 the Commissioner accepts that a gain from a financial contract for difference will be assessable under section 6-5 of the ITAA 1997 and that the principles in Myer may apply to a taxpayer who carries on a profit-making scheme

In addition, in ATO ID 2010/56 the Commissioner accepts that the principles in Myer may apply to a taxpayer who carries on a profit-making scheme of spread betting.

Further, TR 92/3 states at paragraph 12 and 13 that:

12. For a transaction to be characterised as a business operation or a commercial transaction, it is sufficient if the transaction is business or commercial in character.

13. Some matters which may be relevant in considering whether an isolated transaction amounts to a business operation or commercial transaction are the following:

(a) the nature of the entity undertaking the operation or transaction;

(b) the nature and scale of other activities undertaken by the taxpayer;

(c) the amount of money involved in the operation or transaction and the magnitude of the profit sought or obtained;

(d) the nature, scale and complexity of the operation or transaction;

(e) the manner in which the operation or transaction was entered into or carried out;

(f) the nature of any connection between the relevant taxpayer and any other party to the operation or transaction;

(g) if the transaction involves the acquisition and disposal of property, the nature of that property; and

(h) the timing of the transaction or the various steps in the transaction.

In your case, you are involved in investment activities. You invest in bull-put options trading with the intention of making a profit.

To enable this investment, you engage a broker, who specialise in these trading arrangements.

Due to the complexity of the operation, the frequency and the fluctuations this lends itself to align to the characteristics of commercial trading with a profit-making purpose; and or a profit-making undertaking.

You relied on skills and judgement when trading on the expectation that the index market would move over a period of time in such a way to create a profit margin.

In weighing up these factors and the speculative nature of the bull-put trading undertaken they align with being either commercial trading activities with a profit-making purpose; and/or a profit-making undertaking.

This is supported by the current ATO view documents, TR 2005/15 and ATO ID 2010/56 relating to the characteristics and speculative nature of options futures contracts trading in financial markets.

In further concluding that speculation on a financial risk can be characterised as being commercial, TR 2005/15 at paragraphs 20 to 22 considers the following attributes of financial contracts for differences:

•         they cannot be assigned

•         they do 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 the option futures contracts you trade in have the same characteristics. They were commercial transactions entered into with a profit-making purpose, and/or represent a profit-making undertaking.

Conclusion

Your trading in option futures contracts represent commercial transactions with a profit-making purpose; and/or a profit making undertaking, therefore your net profits from this activity in the year ended 30 June 20XX are assessable as either ordinary income under section 6-5 of the ITAA 1997, or assessable under section 15-15 as a profit making undertaking. Where losses are made, they are deductible under section 8-1, or section 25-40, if the gain is assessable as a profit-making undertaking.