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  • Applying the last-in first-out method under the holding period rule

    Franking credit trading occurs when franking credits are diverted from the true economic owners of the membership interests to others with more use for the credits.

    To be entitled to a franking offset, a taxpayer is required to be a 'qualified person' in relation to a franked dividend. A shareholder is generally a qualified person if they satisfy the holding period rule under the qualified person's test.

    The last-in first-out (LIFO) method applies to determine which shares or interests in shares are subject to testing for the purposes of the holding period rule. This will generally be when primary securities and certain related securities in the same company have been bought and sold within the relevant qualification period. If a shareholder purchases substantially identical shares over a period, the holding period rule applies a ‘last in first out’ method to establish which shares are tested to meet the rule.

    The LIFO method prevents taxpayers from manipulating the period that shares have been held at risk by buying new shares and choosing to sell other shares from their portfolio held for a longer period.

    The primary securities are the shares or interest in shares held by the taxpayer in the relevant qualification period that carry an entitlement to the particular franked dividend. Shares or an interest in shares bought after the ex-dividend date or that do not carry the entitlement to the dividend are not considered to be primary securities.

    The related securities include all substantially identical shares or interests in shares that are held by connected entities during the relevant qualification period.

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    Grouping securities

    The LIFO method brings together the primary securities and related securities into a group or bundle. The holding period rule applies to this group. Once you have established this group, any shares sold in the group are taken to be disposed of on a last-in first-out basis.

    When a taxpayer sells a security included in the group (of securities) within the relevant qualification period, the date the share was acquired is taken to be the date of acquisition of the most recently acquired securities in the group.

    If (after applying the LIFO method) the shares or interest in shares have not been held at risk for a continuous period of at least 45 days in the relevant qualification period, the taxpayer is not a qualified person. They will not be entitled to the relevant franking credits.

    The LIFO method prevents taxpayers from manipulating the period that shares have been held at risk by buying new shares and choosing to sell other shares from their portfolio that have been held for a longer period.

    Securities to include in the group

    The LIFO method requires that the primary securities (the shares or interest in shares held by the taxpayer in the relevant qualification period) are grouped together with all related securities. Once you have established this group, any sales of shares from the group are taken to be on a last-in first-out basis.

    The related securities include all substantially identical shares or interests in shares that are held by connected entities during the relevant qualification period.

    'Substantially identical' is defined in broad terms. It includes securities that are fungible or economically equivalent to a share or an interest in a share. Any shares or interests in shares held by a connected entity that do not carry an entitlement to receive the particular franked dividend are not considered to be substantially identical to the primary securities.

    For example, where a shareholder:

    • participates in an off-market share buy-back that has a franked dividend component, and
    • acquires additional shares in the company that do not confer an entitlement to participate in the buy-back,

    the additional shares are not primary securities or 'substantially identical' shares to the shares that are entitled to participate in the buy-back. Therefore, the additional shares are excluded from the group for considering the application of the LIFO method in respect of the dividend component of the buy-back price.

    Where a shareholder:

    • participates in an off-market share buy-back by a company that has a franked dividend component
    • acquires additional shares in the company that do not confer an entitlement to participate in the buy-back but for which the shareholder is entitled to receive a separate dividend, and
    • is also eligible for the separate dividend on the shares which are subsequently bought back,

    then in relation to the separate dividend, the additional shares in the company – which the shareholder acquired before the ex-entitlement date for the separate dividend – are either primary securities or 'substantially identical' shares to those held by the shareholder which were eligible for sale into the buy-back. This is the case even though the shareholder was not eligible to sell the additional shares into the buy-back.

    Therefore, in this other example, the additional shares are included in the group to which the LIFO method applies for the separate dividend. Any disposal from this group, including by selling shares in the buy-back, is subject to the LIFO method (see Example 2).

    Connected entities include:

    • the taxpayer (including other members of a consolidated group)
    • an associate of the taxpayer (where the associate is party to an arrangement with the taxpayer)
    • if the taxpayer is a company, other companies in the same wholly owned group.

    What not to include in the group

    You should generally exclude any shares or interest in shares where the entity has elected to use the benchmark portfolio method for being a qualified person for applying the LIFO method.

    This applies as long as you have not bought or sold your shares or interest in shares to avoid applying the LIFO method. Generally a share that is subject to the benchmark portfolio method will not be part of the bundle of related securities. It would not affect the application of the LIFO method.

    The LIFO method also does not 'double count' disposals of securities. It does not apply:

    • where the sale of the shares or interest in shares would not satisfy the holding period rule even if it was not included in the group
    • in a disposal of a security from one member of a wholly owned group to another member of the same wholly owned group.

    Applying the last-in first-out method

    You need to take a consistent approach in applying the LIFO method. This is when you have bought and sold primary and related securities before the ex-dividend date during the relevant qualification period.

    For example, if you have a staggered acquisition of 40,000 shares and a staggered disposal of 8,000 shares before the ex-dividend date during the relevant qualification period, the group on the ex-dividend date will be 32,000 shares.

    In these circumstances there are a number of methods to determine when you acquired the shares that are part of the bundle held at the ex-dividend date. This includes some practices acceptable from a capital gains tax (CGT) perspective, such as first-in first-out (FIFO) and 'loss max'.

    However, these methodologies are not consistent with the LIFO method. The LIFO method is an integrity rule that stops taxpayers circumventing the holding period rule. For this reason, you ought to apply the LIFO method consistently across your portfolio.

    You should apply this consistent method to determine the purchase date of shares or interests in shares that form part of your bundle at the ex-dividend date and for sales after the ex-dividend date.

    Examples of applying the last-in first-out method

    Example 1: buying and selling multiple parcels of shares

    The following example shows how to apply the holding period rule and the last-in first-out (LIFO) method. Follow these steps for the acquisitions and disposals of shares set out in the timelines below.

    Timeline of Step 1: Determine the group of shares on hand as at the ex-dividend date. The pre ex-dividend date sales are grouped and matched on a last-in, first-out basis.

    Step 1: Determine the group of shares on hand as at the ex-dividend date. The pre ex-dividend date sales are grouped and matched on a last-in, first-out basis.

    Timeline. The group on hand as at the ex-dividend date is 32,000 shares,. This is made up of: 4,000 shares on hand from purchase, 10,000 shares from purchase, 8,000 shares on hand from purchase, and 10,000 shares from purchase.

    The group on hand as at the ex-dividend date is 32,000 shares. This is made up of:

    • 4,000 shares on hand from purchase #4
    • 10,000 shares from purchase #3
    • 8,000 shares on hand from purchase #2
    • 10,000 shares from purchase #1.

    Step 2: Apply the LIFO method to the parcel of shares in sale #3 (sold after the ex-dividend date).

    Timeline Step 2: Apply the LIFO method to the parcel of shares in sale #3 (sold after the ex-dividend date).

    The result is that a franking credit entitlement is not available for purchase #4 (4,000 shares) and purchase #3 (10,000 shares). There is no loss of franking credits for purchase #1 and the balance of purchase #2. This is because these parcels have been held for more than 45 days applying the consistent LIFO methodology.

    This means that unless other integrity rules apply, the entity can claim the franking credits attached to 18,000 shares (10,000 from purchase #1 and 8,000 from purchase #2).

    End of example

     

    Example 2: payment of a special dividend in connection with a share buy-back

    The following example shows how to apply the LIFO method in respect of a special dividend which is received on shares which are eligible to participate in an off-market share buy-back.

    A taxpayer acquires 10,000 shares in MegaMetal Ltd on 31 January 2018. On 1 June 2018, MegaMetal announces that it will undertake an off-market share buy-back for all eligible shareholders who are registered on the buy-back record date of 7 June 2018 and that it will also pay a fully franked special dividend on 6 July 2018 to all shareholders who are registered holders on the dividend record date of 25 June 2018.

    The taxpayer tenders 1,000 shares into the buy-back on 20 June 2018 and acquires another 1,000 shares on the following day. On 6 July 2018, the taxpayer receives payment of the special dividend on 11,000 shares and is also notified on 18 July 2018 that MegaMetal bought back the 1,000 shares tendered into the buy-back.

    The special dividend is paid on the 11,000 shares. These are the securities which are tested for LIFO purposes in respect of the special dividend. For the purposes of applying the LIFO method to the special dividend, the ex-share buy-back entitlement shares are grouped together with the cum share buy-back entitlement shares, as both sets of shares are eligible for the special dividend.

    Accordingly, the disposal of the 1,000 shares tendered into the buy-back is considered to come from the entire group eligible for the special dividend such that the LIFO method will treat the 1,000 shares disposed of in the buy-back as the additional shares acquired on 21 June 2018. In these circumstances, the shareholder does not satisfy the holding period rule and therefore is not a qualified person in respect of franking credits on the special dividend paid on the 1,000 shares which MegaMetal bought back.

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    End of example
      Last modified: 31 Oct 2018QC 50650