Deduction: payments for margin calls by an option trader

Is the taxpayer, an option trader, entitled to a deduction under section 8-1 of the Income Tax Assessment Act 1997 (ITAA 1997) for payments made to a broker in respect of margin calls on exchange-traded options (ETOs)?

No. An option trader is not entitled to a deduction under section 8-1 of the ITAA 1997 for payments made to a broker in respect of margin calls on exchange-traded options.

The taxpayer carries on a business of transacting in ETOs on the Australian Stock Exchange (ASX) by routinely and systematically taking (buying) and writing (selling) ETOs in the expectation of profit.

The taxpayer made payments to their broker to cover margin obligations in respect of ETO contracts.

ETOs are deliverable, standardised, margined options over specified individual equities and indices.

A margin is an amount calculated by a clearing house to cover the risk of financial loss on an options contract due to an adverse market movement. Margins are designed to protect the financial security of the market and may be payable in cash or by providing other collateral.

Margin deposits ensure that writers (sellers) of options are in a position to meet their obligations if the options are exercised by the option takers (buyers). The primary objective of requiring margin cover, according to the ASX, is 'to ensure that option positions can be liquidated (closed out) and the obligation removed'.

The clearing house notifies each broker of their margin obligations daily. It is the broker who is legally obliged to settle with the clearing house. The broker will generally require their clients to deposit cash or provide other security to enable the broker to settle their obligations.

If the underlying share price goes up, the writer of a call option is required to provide further cash or security as the potential obligation under the option contract is larger. If the investor/trader has other option positions, their entire options portfolio may be taken into account for purposes of calculating the margin.

Margins are recalculated daily and their level may go up or down depending on whether the market has moved in or against the taxpayer's favour. The late payment of a margin may result in an option position being closed out.

When a margin obligation ceases to exist, the amount held in the margin account is credited back to the taxpayer.

Section 8-1 of the ITAA 1997 allows a deduction for losses or outgoings to the extent that they are incurred in gaining or producing assessable income or 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.

Margins that are deposited with the broker remains the property of the taxpayer, the broker being allowed to draw on the funds to cover the taxpayer's obligation or potential obligation under the options contract. Margins deposited are no more than contributions of capital to a fund to provide for contingencies of the business rather than outgoings incurred in meeting such contingencies (see Ransburg Australia Pty Ltd v. FC of T 80 ATC 4114; (1980) 10 ATR 663 ( Ransburg's Case )).

Ransburg's Case concerns the deductibility of payments, under a provision that is equivalent to subsection 8-1 of the ITAA 1997, between related companies to secure 'indemnity' against future liability for employees' holiday and long service leave pay. The majority (Deane and Fisher JJ) of the Full Federal Court denied deductibility under subsection 51(1). Deane J at ATC 4116; ATR 664 said: The outgoings in the present case which were made to provide future funds which were intended to, but which need not necessarily, be applied in relation to such future payments to employees cannot, however, any more be properly so characterised than could a payment by a taxpayer to the credit of a savings bank account properly be characterised, for the purposes of s.51(1) of the Act, by reference to the object or objects to which the taxpayer proposed, at some future time, to apply the proceeds of the account. ... They represented capital set aside to provide for revenue contingencies of the business rather than outgoings of revenue incurred in meeting such contingencies. They were not deductible pursuant to s.51(1) of the Act.

Accordingly, the taxpayer is not entitled to a deduction under section 8-1 of the ITAA 1997 for margins deposited with the broker.