Edited version of your private ruling

Authorisation Number: 1012480148343

Ruling

Subject: Qualified person and franking credits

This edited version is a revision and replaces the public register of private binding rulings reference number 1012404629592. This revised ruling was issued in accordance with section 359-55 of the Taxation Administration Act 1953.

Question 1

Is the Fund a 'qualified person' for the purposes of paragraph 207-145(1)(a) of the Income Tax Assessment Act 1997 (ITAA 1997) in respect of dividends received on the Original Shares acquired prior to the Cum Trading Period?

Answer

Yes

Question 2

Is the Fund a 'qualified person' for the purposes of paragraph 207-145(1)(a) of the ITAA 1997 in respect of dividends received on the Cum Shares acquired during the Cum Trading Period?

Answer

Yes

Question 3

Will the Commissioner make a determination under paragraph 177EA(5)(b) of the Income Tax Assessment Act 1936 (ITAA 1936) in respect of the scheme?

Answer

Yes

The scheme commenced:

1 July 2013

Relevant facts and circumstances

Background

The Fund offers investment services to wholesale investors and the Fund recently implemented an Investment Strategy that is similar to that of other market participants

The Fund is an Australian resident Managed Investment Trust (MIT) and a Managed Investment Scheme (MIS), as defined in the Corporations Act 2001.

The Fund invests in Australian shares which are traded on the Australian Securities Exchange (ASX). The Fund has one class of units on issue and all investors have the same rights and obligations.

Under the Investment Strategy implemented by the Fund:

· The Fund will sell certain Australian shares (Original Shares) it holds in an Australian ASX listed entity after the shares in the entity trade on an ex-dividend basis (for example. after the official ex-date for those shares).

· The Fund is able to purchase Australian shares, on the ASX, on a 'cum dividend' basis.

· During the Cum Trading Period, the Fund will acquire shares (Cum Shares) in the same entity as the Original Shares.

· The Fund will receive dividends on the Original Shares and any franking credits (to the extent to which the dividends are franked).

· The Fund will receive dividends on the Cum Shares and any franking credits (to the extent to which the dividends are franked).

· The gains or losses realised on the Original Shares will be realised on capital account using a 'first in first out' approach.

Other features pertaining to the Investment Strategy include:

· The Fund can accurately track the date and time that each share acquisition or disposal takes place.

· All trades will be conducted on the ASX (on-market) and at the prevailing market price.

· The Fund has no intention to acquire derivatives or to enter other arrangements to reduce the risk on the Original Shares or Cum Shares.

Other relevant matters

· The Fund is not required to make a related payment and will not make any related payments in relation to the dividends.

Assumptions

1. The Cum shares will be held at risk for at least 45 days before they are disposed.

2. The Fund will have a 'net position' of at least 30% of the risks and opportunities in respect of all relevant shares.

3. There are no days on which the Fund has materially diminished risk of loss or opportunities for gain in respect of the shares.

Relevant legislative provisions

Income Tax Assessment Act 1936 Division 1A of former Part IIIA

Income Tax Assessment Act 1936 Section 160APHD

Income Tax Assessment Act 1936 Section 160APHE

Income Tax Assessment Act 1936 Section 160APHI

Income Tax Assessment Act 1936 Subsection 160APHI(1)

Income Tax Assessment Act 1936 Subsection 160APHI(2)

Income Tax Assessment Act 1936 Subsection 160APHI(3)

Income Tax Assessment Act 1936 Subsection 160APHI(4)

Income Tax Assessment Act 1936 Section 160APHM

Income Tax Assessment Act 1936 Subsection 160APHM(1)

Income Tax Assessment Act 1936 Subsection 160APHM(2)

Income Tax Assessment Act 1936 Subsection 160APHM(3)

Income Tax Assessment Act 1936 Section 160APHO

Income Tax Assessment Act 1936 Subsection 160APHO(1)

Income Tax Assessment Act 1936 Paragraph 160APHO(1)(a)

Income Tax Assessment Act 1936 Subsection 160APHO(2)

Income Tax Assessment Act 1936 Subparagraph 160APHO(2)(a)(i)

Income Tax Assessment Act 1936 Subsection 160APHO(3)

Income Tax Assessment Act 1936 Section 177EA

Income Tax Assessment Act 1936 Subsection 177EA(3)

Income Tax Assessment Act 1936 Subsection 177EA(5)

Income Tax Assessment Act 1936 Paragraph 177EA(5)(a)

Income Tax Assessment Act 1936 Paragraph 177EA(5)(b)

Income Tax Assessment Act 1936 Subsection 177EA(17)

Income Tax Assessment Act 1997 Section 207-20

Income Tax Assessment Act 1997 Section 207-145

Income Tax Assessment Act 1997 paragraph 207-145(1)(a)

Corporations Act 2001

Reasons for decision

Question 1 and Question 2

Summary

The Fund will be a 'qualified person' in respect of the dividends received on the Original Shares and the Cum Shares.

Detailed reasoning

Section 207-20 of the ITAA 1997 provides:

(1) If an entity makes a *franked distribution to another entity, the assessable income of the receiving entity, for the income year in which the distribution is made, includes the amount of the *franking credit on the distribution. This is in addition to another amount included in the receiving entity's assessable income in relation to the distribution under any other provision of this Act.

(1) The receiving entity is entitled to a *tax offset for the income year in which the distribution is made. The tax offset is equal to the *franking credit on the distribution.

Therefore, if a corporate tax entity makes a franked distribution to another entity:

· an amount equal to the franking credit on the distribution is included in the receiving entity's assessable income; and

· the receiving entity is entitled to a tax offset for the income year equal to the same amount.

However, paragraph 207-145(1)(a) of the ITAA 1997 states that gross-up and tax offset treatment does not apply where the entity is not a 'qualified person' in relation to the distribution for the purposes of Division 1A of former Part IIIAA of the ITAA 1936 (former Division 1A).

Former Division 1A contains the measures known as the holding period rule and the related payments rule. In broad terms, former Division 1A provides the statutory tests that must be satisfied for a taxpayer to be a 'qualified person' with respect to a franked distribution they have received and thus be entitled to a tax offset for the franking credit attached to the distribution.

Relevantly former section 160APHO of the ITAA 1936 requires the Fund to determine whether they are a 'qualified person' by reference to the 45 day holding period rule. The outcome of this will determine whether they are entitled to franking credits for dividends received.

Whilst former Division 1A was repealed effective 1 July 2002, Taxation Determination TD 2007/11 Income tax: imputation: franked distributions: qualified persons: does an entity have to be a qualified person within the meaning of Division 1A of former Part IIIAA of the Income Tax Assessment Act 1936 to avoid the application of paragraphs 207-145(1)(a) and 207-150(1)(a) of the Income Tax Assessment Act 1997 in respect of a franked distribution made directly or indirectly to the entity on or after 1 July 2002? states that it is necessary to continue to have regard to these rules in determining whether an entity is a 'qualified person' for the purposes of section 207-145 of the ITAA 1997.

The test of what constitutes a 'qualified person' is provided in former subsection 160APHO(1) of the ITAA 1936 as follows:

A taxpayer who has held shares or an interest in shares on which a dividend has been paid is a qualified person in relation to the dividend if:

(a) where neither the taxpayer nor an associate of the taxpayer has made, is under an obligation to make, or is likely to make, a related payment in respect of the dividend - the taxpayer has satisfied subsection (2) in relation to the primary qualification period in relation to the dividend; or

(b) where the taxpayer or an associate of a taxpayer has made, is under an obligation to make, or is likely to make, a related payment in respect of the dividend - the taxpayer has satisfied subsection (2) in relation to the secondary qualification period in relation to the dividend.

In addition, former subsection 160APHO(2) of the ITAA 1936 states:

A taxpayer who has held shares or an interest in shares on which a dividend has been paid satisfies this subsection in relation to a qualification period in relation to the shares or interest if, during the period:

(a) where the taxpayer held the shares - the taxpayer held the shares for a continuous period (not counting the day on which the taxpayer acquired the shares or, if the taxpayer has disposed of the shares, the day on which the disposal occurred) of not less than:

(i) if the shares are not preference shares - 45 days; or

(ii) if the shares are preference shares - 90 days.

Further, former subsection 160APHO(3) of the ITAA 1936 states:

In calculating the number of days for which the taxpayer continuously held the shares or interest, any days on which the taxpayer has materially diminished risks of loss or opportunities for gain in respect of the shares or interest are to be excluded, but the exclusion of those days is not taken to break the continuity of the period for which the taxpayer held the shares or interest.

Consequently if a taxpayer is not under an obligation to make a related payment in relation to a dividend or distribution, the taxpayer will have to satisfy the holding period requirement within the primary qualification period. If a taxpayer is under an obligation to make a related payment in relation to a divided or distribution, the taxpayer will have to satisfy the holding period requirement within the secondary qualification period (former paragraphs 160APHO(1)(a) and 160APHO(1)(b) of the ITAA 1936).

Therefore in the present circumstances, as the Fund will not be required to make a related payment in respect of any of the dividends to which it will be entitled, the relevant holding period (for non-preference shares) is the primary qualification period pursuant to former paragraph 160APHO(1)(a) of the ITAA 1936.

The primary qualification period thus commences on the day after the day on which the Fund acquires the shares, and ends on the 45th day after the day on which the shares become ex-dividend (former section 160APHD of the ITAA 1936). Relevantly a share becomes ex-dividend on the day after the last day on which the acquisition by a person of the share will entitle the person to receive a dividend (former section 160APHE of the ITAA 1936). Further, pursuant to former paragraph 160APHO(2)(a) of the ITAA 1936, the dates of acquisition and disposal are not included in the relevant 45 day period.

In calculating the number of days for which the Fund continuously held the shares, any days on which the Fund has materially diminished risks of loss or opportunities for gain in respect of the shares are to be excluded (former subsection 160APHO(3) of the ITAA 1936). However, the exclusion of those days is not taken to break the continuity of the period for which the Fund held the shares.

The phrase 'materially diminished' has the meaning given by former section 160APHM of the ITAA 1936 (former section 160APHD of the ITAA 1936).

Former subsection 160 APHM(1) of the ITAA 1936 advises:

The regulations may prescribe the circumstances in which a taxpayer is taken to have materially diminished risks of loss or opportunities for gain in respect of shares or interests in shares, and the following provisions of this section have effect subject to any such regulations.

Further, former subsection 160 APHM(2) of the ITAA 1936 provides that:

A taxpayer is taken to have materially diminished risks of loss or opportunities for gain on a particular day in respect of shares held by the taxpayer, or in respect of an interest held by the taxpayer in shares, if the taxpayer's net position on that day in relation to the shares or interest has less than 30% of those risks and opportunities.

In addition, former subsection 160 APHM(3) of the ITAA 1936 states how the net position is worked out:

A taxpayer's net position is worked out using the financial concept known as delta (see section 160APHJ). For example, an option to sell a share with a delta of minus 0.5 in relation to the share reduces the risks of loss and opportunities for gain by 50%.

In the present circumstances, the Fund will be taken to have a materially diminished risk if the 'net position' results in the Fund having less than 30% of the risks and opportunities relating to the shares.

Former section 160APHI of the ITAA 1936 is relevant when calculating the period for which the Fund held shares or an interest in shares (the 'primary securities') during a qualification period.

The holding period operates on a 'last-in first-out basis' (LIFO) (former subsection 160APHI(4) of the ITAA 1936). As a result, a disposal of the primary securities is taken, in certain circumstances, to be a disposal of certain other securities. Conversely, a disposal of certain other securities is taken, in certain circumstances, to be a disposal of the primary securities.

Former subsection 160APHI(1) of the ITAA 1936 provides:

The effect of this section is that, in the calculation of the period for which a taxpayer is taken to have held shares or an interest in shares (the primary securities) during a qualification period in relation to the taxpayer in relation to the primary securities:

(a) a disposal of the primary securities is taken in certain circumstances to be a disposal of certain other securities and not to be a disposal of the primary securities; and

(b) a disposal of certain other securities is taken in certain circumstances to be a disposal of the primary securities and not to be a disposal of the other securities.

Former subsection 160APHI(2) of the ITAA 1936 defines related securities as:

In this section:

related securities means:

(a) the primary securities; and

(b) any shares, or interests in shares, held by connected persons:

(i) that are substantially identical securities in relation to the primary securities; and

(ii) in respect of which a connected person has been paid, or is entitled to be paid, a franked dividend or a franked distribution or, in the case of a connected person that is a company, a rebateable dividend or a rebateable distribution, being in either case a dividend or distribution corresponding to the dividend or distribution paid on the primary securities;

but does not include shares or interests in shares:

(c) in relation to which an election is in force under section 160APHR; and

(d) which were not acquired or disposed of for the purpose, or for purposes that included the purpose (whether or not the predominant purpose), of avoiding the application of this section.

Former subsection 160APHI(3) of the ITAA 1936 defines who are connected persons:

The following persons are connected persons for the purposes of this section:

(a) the taxpayer;

(b) [an associate of the company]

(c) [a company in the same wholly owned group]

Former subsection 160APHI(4) of the ITAA 1936 advises that related securities are to be taken to be disposed of on a last-in first-out basis:

All related securities held by connected persons at a particular time constitute a group of securities for the purposes of this section and, subject to subsections (5), (6) and (7), any disposals of securities in the group that were effected by any connected persons during the qualification period are to be taken, in the order in which they occurred, as having been disposals on a last-in first-out basis, that is to say, as having been:

(a) first, disposals of the latest securities in the group to be acquired by any of the connected persons; and

(b) secondly, disposals of the next latest securities in the group to be so acquired, and so on.

In general terms, the provision provides for all related shares held by a person at a particular time (the 'primary securities' and any substantially identical shares held by connected persons) to be grouped together for determining the period of ownership, with disposals of shares from this group taken to be on a LIFO basis.

The phrase 'at a particular time' in former subsection 160APHI of the ITAA 1936 is not defined. However, in its context, a plain reading of the phrase suggests that the words refer to a particular or definite 'point in time'. That is, there does not appear to be any interpretative basis for concluding that the words are intended to refer to a particular 'period of time'.

On this basis, the relevant point in time (i.e., the test time) for determining whether or not a share is a constituent member of a group of related shares is the time of disposal of that share.

On this interpretation, the effect of former subsection 160APHI(4) of the ITAA 1936 is that the LIFO methodology is applied where a share is disposed of during the share's relevant qualification period and that share, at the time of disposal, is a member of a group of substantially similar shares.

Conversely, former subsection 160APHI(4) of the ITAA 1936 has no effect where a share is disposed of during the share's relevant qualification period and that share, at the time of disposal, is not a member of a group of substantially similar shares (that is, where neither the Fund, nor relevant associated entities, hold substantially identical shares at the time of disposal).

Applying the above principles to the Fund's Investment Strategy and recent transaction (noting that future transactions will be undertaken in this manner in all material aspects) it is evident that the Fund is a 'qualified person' in relation to both the Original Shares and the Cum Shares.

Question 3

Summary

The Commissioner would make a determination under paragraph 177EA(5)(b) of the ITAA 1936 in respect of the scheme.

Detailed reasoning

Section 177EA of the ITAA 1936 is a general anti-avoidance provision that applies to a wide range of schemes designed to obtain imputation benefits. In essence, it applies to schemes for the disposition of shares or an interest in shares, where a franked distribution is paid or payable in respect of the shares or an interest in shares. This would include the current financial arrangement implemented by the Fund.

Subsection 177EA(3) of the ITAA 1936 provides that section 177EA of the ITAA 1936 applies if:

(a)  there is a scheme for a disposition of membership interests, or an interest in membership interests, in a corporate tax entity; and

(b) either:

(i)   a frankable distribution has been paid, or is payable or expected to be payable, to a person in respect of the membership interests; or

(ii)  a frankable distribution has flowed indirectly, or flows indirectly or is expected to flow indirectly, to a person in respect of membership interests, as the case may be;

(c) the distribution was, or is expected to be, a franked distribution or a distribution franked with an exempting credit;

(d)  except for this section, a person (the 'relevant taxpayer') would receive, or could reasonably be expected to receive, imputation benefits as a result of the distribution; and

(e)  having regard to the relevant circumstances of the scheme, it would be concluded that the person, or one of the persons, who entered into or carried out the scheme or any part of the scheme did so for a purpose (whether or not the dominant purpose, but not including an incidental purpose) of enabling the relevant taxpayer to obtain an imputation benefit.

If section 177EA of the ITAA 1936 applies, the Commissioner may make a determination under subsection 177EA(5) of the ITAA 1936 that either a franking debit arises to the company in respect of each distribution paid to the relevant taxpayer (paragraph 177EA(5)(a) of the ITAA 1936) or, in the alternative, that no franking credit benefit arises in respect of a distribution paid to the relevant taxpayer (paragraph 177EA(5)(b) of the ITAA 1936).

In the present circumstances, it is considered that the Investment Strategy will satisfy paragraphs 177EA(3)(a), (b), (c) and (d) of the ITAA 1936. Accordingly, the application of section 177EA of the ITAA 1936 to the Investment Strategy will be dependant upon the presence of a more than incidental purpose of obtaining an imputation benefit such that the requirement in paragraph 177EA(3)(e) of the ITAA 1936 is satisfied.

In arriving at a conclusion as to purpose, the Commissioner must have regard to the relevant circumstances of the scheme which include, but are not limited to, the circumstances set out in subsection 177EA(17) of the ITAA 1936. The relevant circumstances listed there encompass a range of circumstances which, taken individually or collectively, could indicate the requisite purpose. Due to the diverse nature of these circumstances some may not be present at any one time in any one scheme. The assessment of purpose in the context of section 177EA of the ITAA 1936 was recently considered by the High Court in Mills in Commissioner of Taxation [2012] HCA 51. In delivering the unanimous judgement, Gageler, J stated in the context of the assessment of purpose at paragraph 73 as follows:

"73. It has been observed in the context of the more familiar operation of s 177D within Pt IVA that having regard to the eight matters listed in s 177D(b) does not require that they each be analysed individually; provided they are taken into account, a "global assessment of purpose" is permissible and often it is appropriate. The same is true of the eighteen circumstances listed in s 177EA(17) read with s 177D(b)(i)-(viii)."

In applying the 'global assessment of purpose' approach, it is considered based on the relevant circumstances of the scheme that the purpose of enabling the Fund to obtain imputation benefits is more than incidental. The trade would make no sense if the tax considerations were not present as the fund would make a cash loss in the example trade absent the franking credits (as the purchase price of the cum dividend shares was higher than the ex dividend price and the amount of the expected dividend in the example provided).

In this regard the ex-dividend parcel of shares is disposed of within a very short period of time prior to the purchase of the shares cum-dividend on the Special Market, indicating that the timing of the scheme is geared towards the purpose of obtaining franked distributions. In an economic sense, the Fund is only exposed to the price movements of one parcel of shares, as at the start and finish of the Investment Strategy that is what the Fund actually holds. However, pursuant to the Investment Strategy, the Fund generates an additional franking credit benefit from the second parcel of shares, being the difference between the franking credit allocated to the second parcel of shares and the premium paid to acquire those shares (over and above the shares ex-dividend trading price and the amount of the expected dividend on the second parcel of shares).

Based on the information provided, the main benefit generated by the Investment Strategy is the duplication of the receipt of franked dividends without the Fund increasing its exposure to the underlying dividend paying share. This would point strongly to the conclusion of the presence of a more than incidental purpose of obtaining an imputation benefit.

Further, the consideration of section 177EA of the ITAA 1936 does not itself require a counterfactual to determine if there is a tax benefit present in the scheme for the disposition of membership interests. To a certain extent, paragraph 177EA(3)(d) is self executing as it requires the relevant taxpayer to receive or reasonably expect to receive an imputation benefit to enliven the operation of 177EA. However, as Gageler, J stated in the High Court in Mills v Commissioner of Taxation [2012] HCA 51 at paragraph 66:

"…counterfactual analysis is not antithetical to the statutory inquiry mandated by s 177EA(3)(e). Purpose is a matter for inference and incidentally is a matter of degree. Consideration of possible alternatives may well assist the drawing of a conclusion in a particular case that a purpose of enabling a holder to obtain a franking credit does or does not exist and, if such a purpose exists, that the purpose is or is not incidental to some other purpose."

In this context, it is considered that the only reasonable counterfactual would be for the Fund to maintain ownership of the ex-dividend shares. This is also the position of the Fund at the end of the arrangement. The Investment Strategy, when you strip away the franking credit benefit, achieves the maintenance of the Fund's existing ownership of publicly listed shares. Given that the counterfactual would not involve the generation of additional franked dividends, this approach would also strongly support a conclusion as to the presence of a more than incidental purpose of obtaining an imputation benefit.

Having regard to the relevant circumstances of the scheme, the Commissioner believes that the requisite purpose is present and accordingly the Commissioner would make a determination under paragraph 177EA(5)(b) of the ITAA 1936 that no imputation benefit will arise in respect of the franked dividends from the shares acquired cum dividend on an ASX Special market.

Copyright notice

© Australian Taxation Office for the Commonwealth of Australia

You are free to copy, adapt, modify, transmit and distribute material on this website as you wish (but not in any way that suggests the ATO or the Commonwealth endorses you or any of your services or products).