27 July 1994 External T.I. 9416565 - RRSP ENTERING INTO A SPREAD WITH OPTIONS

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 an RRSP can enter into a "spread" without offending the qualified investment rules or other provisions.

Position TAKEN:

No

Reasons FOR POSITION TAKEN:

Might offend the qualified investment rules incidentally where cash left with broker (margin) and probably would subject RRSP to tax under 146(4) because the buying and selling of options in these circumstances is a business activity.

XXXXXXXXXX		941656

Attention: XXXXXXXXXX

July 27, 1994

Dear Sirs:

Re: Registered Retirement Savings Plan (RRSP)

This is in reply to your letter of June 22, 1994, in which you ask for our opinion concerning an RRSP entering into a "spread" involving LEAP's (long term equity-anticipation units) and whether this is permitted under the Income Tax Act. All references to this statute are to the Income Tax Act S.C. 1970-71-72, c. 63 as amended to June 23, 1994 - the "Act". We refer to options in the following discussion but our comments are equally applicable to LEAP's. The "spread" as described by you would involve an RRSP purchasing a call option - a qualified investment where the conditions in paragraph 4900(1)(e) of the Income Tax Regulations are satisfied - which has a maturity date in 2 years and then writing a call option with a maturity date of 1 year.

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 the Departmental practice not to apply to the annuitant the provisions of subsection 146(9) of the Act. This subsection deals with dispositions of property for less than fair market value.

You indicate that a writing of a call option might be considered "covered" where the RRSP holds a call option for the same investment and the call option has an expiration date equal to or later than the exercise date of the written call option. The Department's position as discussed in the preceding paragraph extends only to the writing of covered call options "where the RRSP holds the underlying property".

Although the rules concerning "qualified investments" may not be relevant, entering into a "spread", such as simultaneously writing a naked call option with a higher exercise price against a call option purchased by the RRSP, would be indicative, in our opinion, of the RRSP carrying on a business and could subject the RRSP to taxation under subsection 146(4) of the Act. The writing of a call option is essentially equivalent to a short sale and the purchase of the investment or call option to cover the short sale is not for portfolio (investment) purposes, but done only to conclude the sale.

Where a "spread" is closed out prior to the exercise date of the call option - that is, without acquiring and selling the respective shares - any income or loss produced thereby is income or loss from trading and not derived from holding a portfolio of qualified investments. Whether an RRSP which trades in this manner is carrying on a business can only be determined by an examination of all the relevant facts, but a single such transaction could produce that result. There is always the possibility that an RRSP which trades in options which are qualified investments may be held to be carrying on a business as the volume of transactions increases. However, in such a situation there is, theoretically, the prospect of the RRSP exercising an option and holding the shares as investments. In the case of a "spread" this is an unlikely result since the two elements of the transaction are closed out together.

We would further point out that where the 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. In this regard, 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 subparagraph 204(e)(i) of the Act. Subsection 146(10) of the Act would require the annuitant to include in income the fair market value of the deposit.

Although the foregoing comments are an expression of opinion only and are not binding on the Department, we trust they explain our position satisfactorily.

Yours truly,

for Director
Financial Industries Division
Rulings Directorate
Policy and Legislation Branch