Exchange Traded Options: derivation of premiums receivable

Where an individual taxpayer carries on the business of trading in exchange traded options (ETOs), are the premiums receivable from that activity derived under section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997) at the time an ETO is registered with the Australian Clearing House Pty Ltd (ACH)?

Yes. Where an individual taxpayer carries on the business of trading in ETOs, the premiums receivable from that activity are derived as assessable income under section 6-5 of the ITAA 1997 at the time an ETO is registered with the ACH.

The taxpayer is an individual who carries on the business of trading in ETOs over listed shares on the Australian Securities Exchange's Options Market. The taxpayer routinely and systematically takes (buys) and writes (sells) ETOs with the expectation of profit.

The taxpayer uses a broker to trade in ETOs.

After writing an ETO contract it is registered with the ACH. On registration the taxpayer becomes entitled to receive a premium.

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 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). . . . In the course of a judgment with which Rich and McTiernan, JJ., concurred, Dixon, J., as he then was, said (at 63 CLR, p 155; 1 AITR, at p 442): '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 realized or immediately realizable form'.

The taxpayer's business involves the routine and systematic taking and writing of ETO contracts with the expectation of profit. The premiums received from these repetitious and recurring transactions represent ordinary income derived from the carrying on of a business of dealing in options. As these activities amount to the carrying on of a business, it is appropriate to account for the premiums received on a gross-receipts basis (see Investment and Merchant Finance Corporation Limited v. Federal Commissioner of Taxation (1971) 125 CLR 249 at 264; 71 ATC 4140 at 4147; (1971) 2 ATR 361 at 369).

Upon registration of an ETO with the ACH, the taxpayer becomes entitled to receive a non-refundable premium. It is at this point that a recoverable debt comes into existence.

For the purposes of section 6-5 of the ITAA 1997, the gross amount of the premium is derived when the ETO contract is registered with the ACH. This is the time when the amount has come home to the taxpayer in a realisable form (see The Commissioner of Taxes (S.A.) v. Executor Trustee and Agency Co. of South Australia Ltd (1938) 63 CLR 108 at 155; (1938 ) 5 ATD 98 at 132; (1938) 1 AITR 416 at 442).