Assessability of premiums receivable on the sale of options

When are premiums receivable on options sold by a commodity producer as part of a strategy to hedge commodity price risk, assessed under section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Premiums receivable on options sold to hedge commodity price risk, are derived as assessable income under section 6-5 of the ITAA 1997 in the income year in which they are due and receivable.

The taxpayer, a commodity producer, is exposed to fluctuating prices on the sale of its commodities.

In order to offset the risk of fluctuating prices the taxpayer adopts various hedging strategies designed to ensure its commodity sales revenue, together with any gains or losses on its hedging transactions, is within an acceptable range. These strategies involve the sale and the acquisition of options, or the use of option transactions in combination with other derivatives.

On selling the options the taxpayer becomes entitled to receive a premium from the purchaser, which represents a non-refundable receipt for the rights conveyed by the option. Each premium is received two days after the sale of the option.

The options sold by the taxpayer as part of its hedging strategies are an integral part of its business, designed to protect its revenue in the event of a fall in the price of the commodity it produces for sale.

Subsection 6-5(2) of the ITAA 1997 provides that the assessable income of an Australian resident taxpayer includes ordinary income derived directly or indirectly from all sources during the income year.

In Brent v. Federal Commissioner of Taxation (1971) 125 CLR 418 at 427-428; 71 ATC 4195 at 4200; (1971) 2 ATR 563 at 569-570, Gibbs J, in considering the meaning of the word 'derived' said: The word "derived" is not necessarily equivalent in meaning to "earned". "Derive" in its ordinary sense, according to the Oxford English Dictionary, means "to draw, fetch, get, gain, obtain (a thing from a source)". It has become well established that unless the Act makes some specific provision on the point the amount of income derived is to be determined by the application of ordinary business and commercial principles and that the method of accounting to be adopted is that which "is calculated to give a substantially correct reflex of the taxpayer's true income" (Commissioner of Taxes (South Australia) v The Executor, Trustee and Agency Company of South Australia Limited (Carden's Case) (1938), 63 CLR 108, at pp 152-4; 1 AITR 416, at pp 441-2).

His Honour then quoted Dixon J, with whom Rich and McTiernan JJ concurred, in Carden's Case : Speaking generally, in the assessment of income the object is to discover what gains have during the period of account come home to the taxpayer in a realised or immediately realisable form.

A gain has 'come home' to the taxpayer if a debt is presently recoverable by action or the taxpayer is not obligated to take any further steps to be entitled to payment (be it actual or constructive payment) ( FC of T v. Australian Gas Light Co 83 ATC 4800; (1983) 15 ATR 105; Henderson v. Federal Commissioner of Taxation (1970) 119 CLR 612; 70 ATC 4016; (1970) 1 ATR 596; Arthur Murray (N.S.W.) Pty Ltd v. Federal Commissioner of Taxation (1965) 114 CLR 314; 14 ATD 98; (1965) 9 AITR 673; J Rowe & Son Pty Ltd v. Federal Commissioner of Taxation (1971) 124 CLR 421; 71 ATC 4157; (1971) 2 ATR 497.

In addition, where a debt is presently recoverable by action, generally, there will be a present right to receive an amount in question. That amount will be quantifiable and not subject to any contingency or defeasibility ( Gasparin v. Federal Commissioner of Taxation (1994) 50 FCR 73; 94 ATC 4280; (1994) 28 ATR 130; Barratt & Ors v. Federal Commissioner of Taxation (1992) 36 FCR 222; 92 ATC 4275; (1992) 23 ATR 339, Farnsworth v. Federal Commissioner of Taxation (1949) 78 CLR 504; (1949) 9 ATD 33; (1949) 4 AITR 258.

The premiums receivable on options sold as part of a strategy to reduce the risk of adverse commodity price movements and therefore protect the taxpayer's revenue stream are derived in carrying on a business for the purpose of producing assessable income and are assessable under section 6-5 of the ITAA 1997.

The taxpayer is due to receive the premium from the purchaser when the option is sold and does not have to take any further steps to be entitled to the premium. It is at this time that a present entitlement to the premium exists and comes home to the taxpayer in a realisable form and the amount receivable is derived for the purposes of section 6-5 of the ITAA 1997.