Rev. Rul. 63-183

Advice has been requested whether a corporation which derives more than 10 percent of its gross income from premiums received for writing (issuing) `put' and `call' options which are not exercised may qualify as a regulated investment company under section 851 of the Internal Revenue Code of 1954.

The taxpayer, an open-end regulated investment company, writes (issues) `put' and `call' options on securities as part of its business activities. More than 10 percent of the taxpayer's gross income for its taxable year 1962 consisted of amounts (premium) which it derived from issuing options which the purchasers (optionees) allowed to expire without exercise. The taxpayer does not qualify as a dealer in options.

Section 851 of the Code provides the rules and limitations applicable in determining whether a domestic corporation shall be considered a `regulated investment company' for Federal income tax purposes. Section 851(b)(2) of the Code provides that a corporation shall not be considered a regulated investment company for any taxable year unless at least 90 percent of its gross income is derived from dividends, interest and gains from the sale or other disposition of stock or securities.

The problem presented is whether premiums received for writing `put' or `call' options which are permitted to expire without exercise are considered `gains from the sale or other disposition of stock or securities' within the meaning of section 851(b)(2) of the Code, it being clear that the premiums cannot be considered `interest' or `dividends' within the meaning of that section.

When either a `put' or `call' option is exercised, the premium paid the writer may be an element in the detemination of the amount of gain from the sale or other disposition of the stock or other securities subject to the option. Thus, under an exercised `call' option the premium the writer has received for writing the `call' is added to the amount realized on sale of the `called' stock to the optionee. Under an exercised `put' option the premium the writer has received decreases his basis in the stock purchased (`put' to him) from the optionee. Rev. Rul. 58-234, C.B. 1958-1, 279.

However, when the optionee permits the `put' or `call' to expire without exercise, the premium the writer has received for writing the option is not associated with, and has no relevance in, fixing the amount of gain from the disposition of any particular stock or securities. Nor can the premium be viewed as gain from the sale or other disposition of the option itself. This is because the writer, who is considered to receive ordinary income when the optionee allows the option to expire without exercise (section 1.1234-1(b) of the Income Tax Regulations), is viewed as being compensated for the privilege of keeping an obligation open and the income he so realizes at cessation of the obligation is in no way attributable to a sale or other disposition. Compare Sidney Z. Mitchell v. Commissioner , 48 Fed.(2d) 697 (1931), certiorari denied, 284 U.S. 646 (1931).

In view of the foregoing, the taxpayer in the instant case is unable to meet the limitation described in section 851(b)(2) of the Code. Accordingly, it is held that the taxpayer does not qualify as a `regulated investment company,' for Federal income tax purposes, for its taxable year 1962.