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Replies to Queries -- 2 - Gains on options

01 August 2001
Issue: 3818 / Categories:

Fungible assets were the subject of an article in Taxation, 28 June 2001 at pages 307 to 309. I would be grateful for readers' views as to whether the principles set out in that article are applicable to financial futures.

Suppose that I sell 100 FTSE futures in February, buy them back (to close) early in April, and late in April sell another 100 for delivery the same month. How is the gain calculated on the first transaction in April?

Fungible assets were the subject of an article in Taxation, 28 June 2001 at pages 307 to 309. I would be grateful for readers' views as to whether the principles set out in that article are applicable to financial futures.

Suppose that I sell 100 FTSE futures in February, buy them back (to close) early in April, and late in April sell another 100 for delivery the same month. How is the gain calculated on the first transaction in April?

Section 143(5), Taxation of Chargeable Gains Act 1992 provides that the closing out of a futures contract constitutes the disposal of an asset (namely his outstanding obligations under the first mentioned contract). As the financial futures are fungible assets, one would expect the thirty-day rule in section 106A(5) of the Act to apply so that the two April transactions are matched with each other. However, section 143(5) seems to operate by matching the closing contract with the initial February bargain and then it goes on to treat the difference between the sum received and the sum paid as the chargeable gain. There seems to be two rules applicable to the situation, both with contradictory effects.

Would readers care to surmise what the solution is? Should the legislation contradict itself whilst, under self assessment, the Revenue has abdicated all responsibility for determining the assessable amount and transferred responsibility to the confused taxpayer?

(Query T15,849) – Optionholder.

 

The key to understanding this may be in the different natures of shares and futures. The futures contract may be an asset, but it may also be a liability – 'selling' the contract means that you might (in theory) be required to deliver, so you 'buy' in order to cancel or close it out. There is no equivalent transaction for shares.

Accordingly, the normal situation in which the 'bed and breakfast' rules apply is when shares are 'bought, then sold, then bought again'. In the situation described by 'Optionholder', the futures have been 'sold, then bought, then sold again'. Even if 'sold' futures count as a fungible asset for this purpose, the 'bed and breakfast' rules surely do not operate in reverse.

On the first sale, the identification rules would work through all the normal steps (same day, next 30 days, back to 6 April 1998, section 104 pool holding, 1982 pool, pre-1965) and find nothing, and so have to look to the next available purchase. This is what is also required by section 143(5). The new sale later in the same month would be an entirely new transaction, because there is no reason for it to be anything else.

If 'Optionholder' deals in all three transactions with the same counterparty, that counterparty will have a purchase followed by a sale followed by a further purchase. This is not the transaction described in section 143(5); if the futures are truly fungible (i.e. they are exactly the same contract), then the 'bed and breakfasting' rules will apply. The sale and purchase in April will be matched together, and the base cost carried forward for capital gains tax purposes will be the February figure.

This distinction between 'purchased' and 'sold' futures contracts may not make sense to someone who works in the options markets, who may regard them as much more similar than the legislation does – but the 'capital gains tax shares job' must be the equivalent of the salt mines for the poor Parliamentary draftsman, who probably has no greater understanding of the complex transactions of the financial markets than the next person, and whose rules are written down on one day and then have to be applied to a range of unimagined new transactions and instruments that the financiers have dreamed up the next.

I hope I am not, but I may be alone in sympathising with the person who writes the capital gains tax rules on securities – Castlegate.

 

It is not obvious that the three transactions described are identical with those hypothesised in section 143(5), Taxation of Chargeable Gains Act 1992. The latter refers to the position where 'a person who has entered into a futures contract closes out that contract by entering into another futures contract with obligations which are reciprocal to those of the first-mentioned contract'. 'Optionholder', however, mentions a buy back of the February futures unrelated to the sale later in April.

Inland Revenue Statement of Practice SP14/91 discusses the tax treatment of transactions in financial futures and options, with particular reference to section 143, Taxation of Chargeable Gains Act 1992. It is said that 'financial futures' is a wide term, offering various possibilities of settlement, a remark also applicable to options. The statement is mainly significant when considering the distinction between capital and revenue transactions, although the question here seems to concern a private individual rather than an institution.

Except as regards corporation tax, section 106A, Taxation of Chargeable Gains Act 1992 contains the general matching rules. For the reasons given above, the two April transactions appear to be paired, with the logical outcome that the individual ends up with the same exposure as that which commenced in February, until such time as the April sale is resolved.

This interpretation would offer favourable opportunities for taper relief, assuming that this type of instrument could appropriately be held for over thirty-six months. – Lane.

Issue: 3818 / Categories:
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