6 October 1999 External T.I. 9916955 - COVERED CALL OPTIONS, QUALIFIED INVESTMENTS

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: Can a personally designed call option that does not trade on a prescribed stock exchange be a qualified investment for purposes of an RRSP?

Position: Yes.

Reasons: To be a qualified investment a call option has to give the RRSP the right to acquire property that is a qualified investment. The requirement that the option trade on a prescribed stock exchange has been removed. However, such purchases by an RRSP will be scrutinized to ensure 1) they do not occur at more than fair market value or 2) that the exercise of the option by the RRSP is never intended to occur or 3) that the option is not exercised in circumstances where in an arm's length situation the option would have been exercised. In these circumstances, an over-payment, the whole purchase price and/or the foregone benefit in the RRSP may be considered a premium or gift subject to Part X.1 tax.

xxxxxxxxxx 991695
M. P. Sarazin

Attention: XXXXXXXXXX

October 6, 1999

Dear Sirs:

Re: Writing Covered Call Options in an RRSP

This is in reply to your letters dated June 17, 1999 and July 15, 1999, wherein you requested our views regarding the application of various provisions of the Income Tax Act (the "Act") to an annuitant's proposal to write covered call option in his or her registered retirement savings plan ("RRSP") account.

The call option will be personally designed by the annuitant and it will not trade on a prescribed stock exchange. The RRSP will sell the options to the annuitant for cash. Since there will be no obligation to exercise the option and the option could expire, the RRSP may retain both the cash and the underlying security. Consequently, there is potential for increasing the value of the RRSP through these transactions between the RRSP and annuitant.

Comments

It appears that the opinion you seek relates to specific proposed transactions and, therefore, we bring to your attention Information Circular 70-6R3 dated December 30, 1996, issued by Revenue Canada. Confirmation of tax consequences with respect to proposed transactions involving specific taxpayers will only be provided in response to a request for an advance income tax ruling. However, we can provide you with the following general comments.

It is the Department's position that the writing of a covered call option where the RRSP holds the underlying property is not subject to the rules governing qualified investments because it does not involve the acquisition of property by the RRSP. Furthermore, where the holder of the covered call option exercises the right to purchase the property, it is Departmental practice not to apply the provisions of subsection 146(9) of the Act to the annuitant. This subsection deals with the disposition of property for less than fair market value.

There is no provision in the Act preventing an annuitant from carrying out transactions with his or her RRSP and the Department accepts such transactions when they are at fair market value. We would have to review the facts in each case to determine the tax consequences related to any situation involving an annuitant acquiring covered call options from his or her RRSP. Based on our review of the series of transactions, we would be able to determine whether the transactions represent bona fide transactions and whether they are carried out at fair market value.

Where the annuitant acquires the call option for more than fair market value, the excess will be considered a premium or gift to the RRSP.

Where the annuitant acquires the option at fair market value but does not exercise the call option under circumstances where such action would be expected in an arm's length situation, we would look at the series of transactions to determine whether the value of the foregone benefit would constitute a premium or gift to the RRSP. In addition, in that situation, the cash initially paid to the RRSP may also constitute a premium or gift to the RRSP.

Furthermore, where the annuitant paid fair market value for the option but had no intention to ever exercise the covered call options, the acquisition cost paid by the annuitant, and the foregone benefit, if any, left in the RRSP in respect of the covered call options, may each be considered a premium or gift to the RRSP.

Any such amount which is a premium or gift ("undeducted RRSP premium" as that term is used in subsection 204.2(1.1) of the Act) is subject to tax under Part X.1 of the Act.

We trust our comments will be of assistance to you.

Yours truly,

Patricia Spice
for Director
Financial Industries Division
Income Tax Rulings and
Interpretations Branch
Policy and Legislation Branch