09 Aug Put and Call Option Agreements save Tax
Before explaining what a put and call option agreement is, we should firstly examine what a “contract” is. In law a contract is formed when certain things happen. Two of the most important things that must happen is that there must be an offer by one party and an acceptance by the other. Without this there is no contract. There are other ingredients in a contract also such as:
- intention to create a legal relationship
- certainty of terms
For the purposes of this discussion the important two ingredients are:
- offer and
A put and call option agreement uses this basic contract law to ensure that a contract does not come into existence until some future time. This is a good example of how very old law can be used in innovative ways even today.
Generally a put and call option agreement works as follows:
I make an offer to you, to buy your property or any other asset but, I say that my offer is not capable of acceptance by you, until some future time. Clearly we do not have a contract. Although I have made an offer, you cannot accepted that offer. It is quite possible that you might walk away from the offer and never accept it. There is no obligation upon you to accept my offer to buy your property.
The offer can also be put the other way around. In the above offer I offer to buy your home. Instead the offer may be an offer from you, to sell your home. Again the offer can be made in such a way that the offer cannot be accepted by me, the buyer, until some future time or upon some future event.
In each case the person receiving the offer can walk away.
The situation becomes interesting when the two offers are put together. The effect then is that I have given an offers to buy and you have given an offer to sell. Neither one of us can compel the others to accept the offer made. However both of us in a position at some future time to accept the received. If the dates are arranged properly I know that if you do not accept my offer to buy then all is not lost, I can still make the deal happen as I can, if I want to, accept your offer to sell. If therefore either one of us wants the deal to happen then it must. A contract will only come into existence if one of the parties accepts the offer.
In other words, both of the parties are able at some point to force the deal. If the first offer is not accepted then the second offer may be. One offer is called the put option and the other is called the call option.
The put and call option is useful when for legal or taxation reasons a person wants to ensure that they can force a deal to occur but, do not want a contract to come into existence until some later time. Why would this be important? A common example of this is the delaying of capital gains tax for one year, or the delaying of Duty.
If I were to sign a contract for the sale of my commercial property on 1 June 2012 then I would incur capital gains tax the 2012 financial year. I do want to make sure that I can tie down the buyer who might change her mind if I wait another 30 days but, I made a large income this year and I would prefer to pay the capital gains tax next year, as I know that my income will be less next year and so the tax rate will be in a lower bracket. The answer, is to use a put and call option that will bind the parties but delay the contract until some time after 30 June.
The term “Put and Call Option” is just a label. These options also go by other names. Always beware of labels. You must ensure that the agreement has the desired effect, this is of course far more important than the label given to the document.
The drafting of these arrangements requires care and precision.