Edited version of private advice

Authorisation Number: 1051916378990

Date of advice: 18 November 2021

Ruling

Subject: Option trading activities - revenue - carry forward trust losses

Question 1

Was the Trust 'carrying on a business' of option trading during the 20XX-XX to the 20XX-XX income years?

Answer

No

Question 2

If the answer to Question 1 is no, were the losses derived from the option trading activities deductible under section 25-40 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

Yes

Question 3

If the answer to Question 1 or Question 2 is yes, can the Trust include a deduction for the losses incurred from the option trading activities in the 20XX-XX to 20XX-XX income years against the assessable income in the 20XX-XX and later income years in accordance with section 36-10 of the ITAA 1997?

Answer

Yes, subject to the Trust meeting the income injection test in Division 270 of Schedule 2F to the Income Tax Assessment Act 1936 (ITAA 1936).

Answer

This ruling applies for the following period:

Financial year ended 30 June 20XX

The scheme commences on:

1 July 20XX

Relevant facts and circumstances

The Trust is a discretionary trust.

B was the trustee of the Trust until a few years ago when C Pty Ltd, a company controlled by B, was appointed trustee.

B is the appointer and guardian of VCT.

The Trust made a family trust election in 20XX and it is still in force. B was nominated as the specified individual.

The Trust commenced option trading in the 20XX-XX income year.

The options were purchased by the Trust to separate B's employment activities from the option trading business activities.

Conducting the option trading business activities through the Trust provided:

•         segregation from B in his own right and

•         protection for him in that any potential claims against him from non-trust related activities would not be recoverable from the trust assets.

Due to the unique economic and financial market circumstances leading up to 20XX, there was a certain business strategy.

In 20XX an opportunity was identified by the trustee, through his expertise gain at work.

The trustee's research determined a potential profit can be derived.

Ideally the trustee would have preferred to purchase overseas exchange traded options where he felt that the opportunity in the financial markets was greatest.

At that time, the trustee was only able to trade ASX exchange traded options.

Contrary to the trustee's belief, the opportunity did not eventuate.

This led to losses being incurred by the trustee that would otherwise have generated super profits if the same strategy was executable using overseas exchange traded options.

Due to a tightening in financial regulations, the regulator had restricted the use of options - both option writing and the purchase of options. Also brokers and regulators increased margining requirements for exchange traded options. This had the effect of limiting the ability to implement the strategy together with a loss incurred on closing out options due to not having sufficient funds to meet margining requirements.

The Trust made a small profit from trading options in the 20XX-XX income year.

In the next two income years, the Trust bought and sold put and call options. The Trust incurred a loss from options trading for those years.

In the following income year, the Trust ceased trading options and incurred a loss from options trading.

The Trust undertook XX options trading transactions during the 20XX-XX and 20XX-XX income years, totalling $XX. The average value of the bought put and call option for the above period was $XX per trade.

The Trust borrowed money from B to fund the options trading activities during those years. Some of the money was repaid a couple of years later.

Since this time, and as at the current time, the Trust still has a loan owing to B of the remainder.

During the period that trading occurred, the trustee spent approximately X hours a day outside of his normal employment duties on the trust's option trading activities.

The amount of tax losses carried forward to later income years reported in the 20XX tax return was $X.

The trustee of the Trust, at the time of undertaking the option trading activities on behalf of the Trust was an employee in a financial services company.

The trustee was accredited as a certain advisor and held a qualification in finance.

He held the options on average for X to X weeks in accordance with his business strategy.

By 20XX the opportunity to make a profit from this strategy had been diminished.

The Trust has remained dormant since then until this income year. The Trust is now carrying on a different income earning activity.

All the income from the Trust for the 20XX-XX income year was distributed to B based on the Trust's distribution statement..

The balance sheet, profit and loss statement, and trade information for the Trust for the relevant income years have been provided.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 25-40

Income Tax Assessment Act 1997 section 36-10

Income Tax Assessment Act 1997 section 118-20

Income Tax Assessment Act 1997 subsection 995-1(1)

Income Tax Assessment Act 1936 Divisions 265 to 272 of Schedule 2F

Reasons for decision

Carrying on a business

'Business' is defined in subsection 995-1(1) of the Income Tax Assessment Act 1997 (ITAA 1997) as 'any profession, trade, employment, vocation or calling, but does not include occupation as an employee'.

Whether the option trading activity is carried on as a business is a question of fact. Case law has determined certain factors as being relevant in making this decision and concluded that no one factor is determinative, it is the overall impression gained.

In Federal Commissioner of Taxation v Radnor Pty Ltd (1991) 22 ATR 344; 91 ATC 4689, (Radnor) Hill J stated 'ultimately, the question of whether the respondent was carrying on a business of dealing in shares is a question of fact and degree, a question of impression.'

And more recently re-iterated in Smith v Federal Court of Taxation 2010 ATC 10-146; [2010] AATA 576 (Smith) Ettinger J stated at paragraph 12 ' by way of general guidance, I am mindful of the frequently cited words from Martin v Federal Commissioner of Taxation (1953) 90 CLR 470:

The test is both subjective and objective: it is made by regarding the nature and extent of the activities under review, as well as the purpose of the individual engaging in them, and ... the determination is eventually based on the large or general impression gained.

Apart from case law, Taxation Ruling TR 97/11 Income tax: am I carrying on a business of primary production? provides the Commissioner's view of the factors used to determine if you are in business for tax purposes. Whilst TR 97/11 specifically discusses primary production activities, the factors can be applied to other types of businesses, such as option trading.

As with case law, no one indicator is determinative. The indicators must be considered in combination and as a whole. Whether a business is carried on depends on the large or general impression gained.

We have taken the following into consideration when making our decision on whether or not the trustee (on behalf of the Trust) was carrying on a business in relation to the trading activities:

•         the trustee used a strategy that he had developed, based on certain assumptions

•         he traded ASX exchange traded options.

•         the strategy didn't go as planned, and losses resulted rather than profits

•         a tightening in financial regulations also restricted the use of options

•         records of the trades have been sourced from the broker

•         the trustee used certain measures

•         the options were held on average for X to X weeks

•         the trustee spent approximately X hours a day on the Trust's option trading activities

•         the trustee was accredited as an advisor and a qualification in finance

•         the trustee undertook XX options trading transactions during the 20XX-XX and 20XX-XX income years, totalling $X, the average value of the options was $X per trade

•         trading was sporadic. There was on average only one trade on any given day and there were often lengthy periods where there were no trades recorded. After X X 20XX there were no further trades.

After considering the facts of the situation and weighing up the factors outlined above, it is considered that the trustee was not carrying on a business in relation to the option buying and selling activities.

Based on the information that has been provided, there has not been repetition and regularity in the trading activities that a person in the business of option trading would display. There is not one factor which provides any weight to the fact that the trustee was carrying on a business in relation to the option trading activities. The intention to make a profit is not, on its own, sufficient to establish that a business is being carried on.

It is the view of the Commissioner that the trustee, on behalf of the Trust, was not carrying on the business of option trading during the 20XX-XX and 20XX-XX income years.

As the trustee was not viewed as carrying on a business in relation to the option trading activities, we will consider whether the activities were of a profit-making nature, or isolated transactions, as follows:

Profits and losses from isolated transactions

Our view on profits and losses from isolated transactions and whether or not they are income or deductions is contained in Taxation Ruling TR 92/3 Income tax: whether profits on isolated transactions are income and Taxation Ruling TR 92/4 Income tax: whether losses on isolated transactions are deductible.

More specifically to buying and selling options and the ability of this kind of activity to be classified as profit or losses from isolated transactions. ATO Interpretative Decision ATO ID 2005/164 Income Tax Capital Gain Tax: CGT event C2 - close out of an exchange traded option, states the following:

Note 1: A profit or gain can constitute assessable income under section 15-15 of the ITAA 1997. To ensure that there is no double taxation under the income and CGT provisions, section 118-20 of the ITAA 1997 reduces the capital gain to the extent that an amount is also included as assessable income under another provision of the ITAA 1997.

Note 2: A loss incurred may be deductible under section 25-40 of the ITAA 1997 if it arose from the carrying on or carrying out of a profit-making undertaking or plan and, had any profit been derived, such profit would have been included in the taxpayer's assessable income under section 15-15 of the ITAA 1997.

Where a taxpayer enters into an option trading transaction in carrying out a profit-making undertaking or scheme, any loss made from that transaction will be an allowable deduction under section 25-40 of the ITAA 1997.

As outlined above, we do not view that the trustee was carrying on a business in relation to the option trading activities. However, the activities were inherently commercial in nature and had a profit-making intention.

As the Commissioner generally regards option trading as 'an act of commerce', the trading will be viewed as activities carried out by the trustee as part of a profit-making undertaking for the following reasons:

•         the commercial character or nature of the option buying and selling

•         the short period of time that the Trust held the options, and

•         the number of transactions undertaken during some periods.

Any losses that the trustee has made from the option trading during either the 20XX-XX or 20XX-XX income years can be claimed as deductions in the income year in which the loss was made.

Note: While a capital gains tax (CGT) event C2 will occur on the close-out of an option, any capital gain or capital loss arising as a result of the CGT event will be reduced to the extent that it is included under another provision, such as section 25-40 of the ITAA 1997 (section 118-20 of the ITAA 1997). As the activity would be on revenue, there would be no capital gains to which the discount could be applied.

Deduction of trust losses

Trusts retain revenue and capital losses that may be carried forward and claimed as a deduction or in calculating the trust's net capital gain. Divisions 265 to 272 of Schedule 2F of the Income Tax Assessment Act 1936 (Schedule 2F) contain the rules for trust losses and other deductions. These rules require different categories of trusts to satisfy one or more tests to claim a deduction for revenue losses or bad debts.

Subdivision 272-D of Schedule 2F provides the mechanism by which the trustee of a trust may elect to be treated as a family trust. A family trust election can only be made if the trust satisfies the family control test. The test is passed when the family group has power to obtain beneficial enjoyment of income and capital directly or indirectly (section 272-87 of Schedule 2F).

For the 20XX and later income years, trustees can make family trust elections specifying an earlier income year provided certain conditions are met. These conditions require that from the beginning of the specified income year until 30 June of the income year immediately preceding the one in which the election is made:

•         the trust passes the family control test in section 272-87 of Schedule 2F (as mentioned above), and

•         any conferrals of present entitlement to, or any actual distributions of, income or capital of the trust during that period have been made on or to the individual specified in the election or members of that individual's family group (subsection 272-80(4A) of Schedule 2F).

The trustee of the trust made a family trust election in the 20XX-XX income year and it is still in force.

A family trust is an 'excepted trust' as defined in section 272-100 of Schedule 2F. The provisions of Schedule 2F that impose the various tests limiting the deductibility of tax losses or bad debts explicitly exclude excepted trusts. However, family trusts are treated differently from the other kinds of excepted trusts in that these trusts are still subject to the 'income injection test'.

The income injection test in in Division 270 of Schedule 2F provides that a trust will be unable to deduct a loss or other allowable deduction, if:

•         there is a 'scheme' under which the trust derives assessable income,

•         a person not connected with the trust (an outsider) injects income or provides some other 'benefit' (directly or indirectly) to the trustee or a beneficiary (or an associate), and

•         the trustee or a beneficiary (or an associate) also provides a benefit to the outsider, and

•         it is reasonable to conclude that the arrangement was entered into wholly or partly, but not merely incidentally, because the deduction would be allowable.

A 'benefit' is any type of monetary benefit or advantage and/or the doing of anything that results in the derivation of assessable income which includes services, a right, entitlement or debt forgiveness (section 270-20 of Schedule 2F).

In this case, the Trust has carried forwarded losses from option trading activities.

The Trust is entitled to claim a deduction for revenue losses incurred in prior years subject to meeting the income injection test in Division 270 of Schedule 2F to the ITAA 1936.