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.
XXXXXXXXXX
Dear XXXXXXXXXX
This is in reply to your letter of March 23, 1993 requesting changes to the Income Tax Act (the "Act") so that certain transactions by a registered retirement savings plan ("RRSP") regarding call options and put options will result in the RRSP acquiring a qualified investment.
This Department's responsibility is to interpret and administer the law as enacted whereas recommending changes to existing legislation is the responsibility of the Department of Finance. We are therefore forwarding your letter to that Department and suggest that you contact them at the following address should you wish to follow up on the matter:
Department of Finance Tax Policy Branch Pensions, Trusts, Insurance and Resources L'Esplanade Laurier 140 O'Connor Street Ottawa, Ontario K1A 0G5
The following comments reflect our views on the application of the law to the issues you raise.
Acquisition of Call Options
An RRSP that acquires a call option has acquired a qualified investment if the option is listed on a prescribed stock exchange in Canada and gives the RRSP the right to acquire property (e.g., a share) that is a qualified investment. As indicated in paragraph 14 of Interpretation Bulletin IT-320R2, such an option is a "warrant or right" that qualifies pursuant to paragraph 4900(1)(e) of the Income Tax Regulations (the "Regulations").
On February 4, 1993, the Department of Finance released "Draft Amendments On Qualified Investments For RRSPs". One of the amendments proposes to remove the requirement in paragraph 4900(1)(e) of the Regulations that the warrant or right (call option) must be listed on a prescribed stock exchange in Canada.
Writing of Covered Call Options
The writing of covered call options is not subject to the rules governing qualified investments because it does not involve the acquisition of property by the RRSP. Instead, cash is received as a means of possibly increasing the proceeds from the sale of shares, bonds, warrants or Canadian dollars.
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 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 an RRSP has the underlying qualifying investment and the holder of the covered call option has in fact exercised his right to purchase under the option, it is Departmental practice not to apply to the annuitant 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.
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. In the case of a naked call option, the RRSP contracts an obligation to sell investments (shares, bonds, warrant, currency, etc.) 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 purchase, it may have to borrow the funds or draw on an established line of credit. In such a case, paragraph 146(4)(a) of the Act may apply to tax the RRSP on its taxable income for the year.
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. 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 thus apply to the annuitant so as to include in his income the fair market value of the deposit. 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 the deposit is "money" within the provisions of subparagraph 204(e)(i) of the Act and subsection 146(10) of the Act would not be applied to the annuitant.
Put Options
As stated in paragraph 14 of IT-320R2, an RRSP that acquires a put option has acquired a non-qualified investment. This is based on the understanding that the put option involves the right to dispose of the underlying shares rather than a "right to acquire" shares as required under paragraph 4900(1)(e) of the Regulations.
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. The RRSP does not acquire a right in this case. Instead, cash is received as a means of possibly reducing the cost of acquiring shares. The writing of put options is not subject to the rules governing qualified investments, and is an acceptable RRSP activity.
Where an RRSP is required to leave cash (margin) on deposit with the broker to cover the possible exercise of an option by the option holder to purchase the shares, such cash may or may not be a qualified investment as discussed above.
We trust our comments are of assistance.
Yours truly,
for DirectorFinancial Industries DivisionRulings Directorate
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