Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the CRA.
Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle de l'ARC.
Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the Department.
Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle du ministère.
Principal Issues:
Whether or not a short sale covered by a convertible debenture would be a qualified investment. Clarification of a previous letter sent to the same firm.
Position TAKEN:
It would be a qualified investment. I gave her our general position on call options and put options.
Reasons FOR POSITION TAKEN:
Positions have previously been taken
5-950712
XXXXXXXXXX M.P. Baldwin
Attention: XXXXXXXXXX
June 9, 1995
Dear Sirs:
Re: RRSPs and short sale of shares
This is in reply to your facsimile of March 6, 1995 in which you request a technical interpretation on the short sale of shares covered by a long convertible debenture as a qualified investment for an RRSP. In this type of transaction the Department would consider the transaction as being similar to the writing of a covered call option. The following reflects the Department's views on the qualified investment rules for an RRSP and how they relate to call options.
Acquisition of Call Options
An RRSP that acquires a call option has acquired a qualified investment if the option gives the RRSP the right to acquire property that is a qualified investment. Such an option is a "warrant or right" that qualifies pursuant to paragraph 4900(1)(e) of the Income Tax Regulations. The former additional requirements that the "warrant or right" must be listed on a prescribed stock exchange in Canada was removed from the legislation in 1994, effective after 1992.
Writing of Covered Call Options
The writing of covered call options is not subject to the rules governing qualified investments as the RRSP is not acquiring an option that gives it the right to acquire property. Instead, cash is received by the holder of the covered call option. Cash is a qualified investment if it is money that is legal tender in Canada.
The holding of the underlying qualifying investment by a broker or depositary acting as agent for the RRSP trust until the time of the exercise or expiry of the option does not constitute the borrowing of money on the security of such investments for the purposes of paragraph 146(10)(b) of the Income Tax Act (the "Act"). Furthermore, the segregation of the underlying investments to be held by the broker does not affect their status if they are otherwise qualified investments.
Where the RRSP has the underlying qualifying investment and the holder of the covered call option has in fact exercised his or her right to purchase under the option, it is Departmental practise not to apply to the annuitant of the RRSP the provisions of subsection 146(9) of the Act. Subsection 146(9) concerns dispositions of property by an RRSP for less than fair market value and would otherwise apply to include any excess of the fair market value over the consideration received in the income of the annuitant.
Writing of Naked Call Options
In general, we consider the writing of naked call options as being speculative in nature and inconsistent with the intent behind the concept of qualified investments for RRSPs. Consequently, an RRSP engaged in this activity could be considered to be carrying on a business, thus resulting in the application of paragraph 146(4)(b) of the Act and the taxation of the RRSP on its taxable income for the year.
We understand that in the case of a naked call option, the RRSP contracts an obligation to sell an investment that it does not have at the time of writing the option. It is reasonable in our view to assume that funds will be available in the RRSP to purchase those investments in order to cover the possible exercise of the option by the option holder. If the RRSP does not have sufficient funds for such purpose and instead borrows funds or draws on an established line of credit, paragraph 146(4)(a) of the Act may also apply to tax the RRSP on its taxable income for the year.
In addition, where an RRSP is required to leave cash on deposit (margin) with a broker to cover the possible exercise of the option by the option holder to purchase the shares from the RRSP, such cash may or may not be a qualified investment. It is our view that if the cash is left on deposit with the broker for any length of time, the deposit would not be a qualified investment by reason of paragraph (a) of the definition of qualified investment in section 204 of the Act. As a result, subsection 146(10) of the Act would include the fair market value of the deposit in the income of the annuitant of the RRSP. If, however, the cash (margin) is deposited with the broker and the transaction will be concluded within a few days, it is our view that subsection 146(10) of the Act would not be applied to the annuitant.
Put Options
An RRSP that acquires a put option has acquired a non-qualified investment, since the put option does not give the RRSP the "right to acquire property" but rather a right to dispose of the underlying property.
The writing of a put option represents an agreement to purchase shares if the person who holds the option exercises his right to sell within a specified time. Again the RRSP does not have the "right to acquire property"; however, the cash received will be a qualified investment if it is legal tender in Canada.
Where an RRSP is required to leave cash (margin) on deposit with the broker to cover the possible exercise of a put by the holder, such cash may or may not be a qualified investment, as discussed above.
We trust our comments will be of assistance to you.
Yours truly,
for Director
Financial Industries Division
Income Tax Rulings and
Interpretations Directorate
Policy and Legislation Branch
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