Edited version of private ruling

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Ruling

Subject : Securities lending arrangement and capital gains tax

Issue 1

Question 1

Does section 26BC(13) of the Income Tax Assessment Act 1936 (ITAA 1936) provide the Commissioner with a discretion (which may be exercised) by determining not to amend the Taxpayers income tax return?

Answer

No

Issue 2

Question 1

To the extent that the shares were held on capital account, will section 116-45 of the Income Tax Assessment Act 1997 (ITAA 1997) operate to reduce the capital proceeds?

Answer

Yes

This ruling applies for the following period:

Year ended 30 June 2007

The scheme commences on:

1 July 2009

Relevant facts and circumstances

The Taxpayer held shares in a company.

The trustee of a Trust conducted share trading on behalf of the Trust. The shares held by Taxpayer and the shares held by the Trust were used as security under a securities lending arrangement (SLA).

The SLA provides for the transfer of title in the shares to X Co and for X Co to redeliver equivalent securities under the terms of the SLA.

The Taxpayers lodged their income tax returns on the basis that no disposal of the relevant shares had occurred. Assessments issued in conformity with the lodged returns.

The Taxpayers requested the return of shares transferred under the SLA. The shares were not returned.

The Taxpayers did not have legal or beneficial title to the shares once those shares had been transferred under the SLA.

A Scheme was approved.

Relevant legislative provisions

Income Tax Assessment Act 1936 Section 26BC

Income Tax Assessment Act 1936 Subsection 26BC (3)

Income Tax Assessment Act 1936 Subsection 26BC (4)

Income Tax Assessment Act 1936 Paragraph 26BC (4)(c)

Income Tax Assessment Act 1936 Paragraph 26BC (4)(d)

Income Tax Assessment Act 1936 Paragraph 26BC (4)(e)

Income Tax Assessment Act 1936 Subsection 26BC(13)

Income Tax Assessment Act 1997 Section 103-10

Income Tax Assessment Act 1997 Subsection 103-10(1)

Income Tax Assessment Act 1997 Subsection 103-10(2)

Income Tax Assessment Act 1997 Section 104-25

Income Tax Assessment Act 1997 Section 108-5

Income Tax Assessment Act 1997 Section 116-20

Income Tax Assessment Act 1997 Subsection 116-20(1)

Income Tax Assessment Act 1997 Paragraph116-20(1)(b)

Income Tax Assessment Act 1997 Section 116-45

Income Tax Assessment Act 1997 Subsection 116-45(1)

Income Tax Assessment Act 1997 Paragraph116-45(1)(a)

Income Tax Assessment Act 1997 Paragraph116-45(1)(b)

Income Tax Assessment Act 1997 Paragraph116-45(1)(c)

Income Tax Assessment Act 1997 Subsection 116-45(2)

Income Tax Assessment Act 1997 Paragraph116-45(2)(a)

Income Tax Assessment Act 1997 Paragraph116-45(2)(b)

Reasons for decision

Issue 1

Question 1

Subsection 26BC(13)of the ITAA 1936 Amendment of assessment

Subsection 26BC(4) of the ITAA 1936 provides that, where the conditions contained in subsection 26BC(3) of the ITAA 1936 have been met, where there has been a disposal of a security under a securities lending arrangement or a security has been reacquired under a securities lending arrangement, the lender's position in respect of those arrangements will be determined as if:

· the lender had not disposed of the borrowed security or acquired a replacement security: paragraph 26BC(4)(c) of the ITAA 1936

· the borrowed security was held by the lender at all times during the borrowing period: 26BC(4)(d) of the ITAA 1936 , and

· the replacement security given by the borrower to the lender was the original security, whether or not that security is the identical security: 26BC(4)(e) of the ITAA 1936.

The result is that where the requirements of subsection 26BC(3) of the ITAA 1936 have been met by both the borrower and the lender, the lender will not be subject to any tax consequences in respect to the disposal and reacquisition of the relevant securities.

However, where the conditions contained in subsection 26BC(3) of the ITAA 1936 have not been met, subsection 26BC(13) of the ITAA 1936 states:

Where:

(a) in the making of an assessment this section has been applied on the basis that a circumstance that did not exist at the time of making the assessment would exist at a later time: and

(b) after the making of the assessment the Commissioner becomes satisfied that the circumstance will not exist;

then, in spite of anything in section 170 of the ITAA 1936, the Commissioner may amend the assessment at any time for the purpose of ensuring that this section is to be taken always to have applied on the basis that the circumstance did not exist.

Although the provision uses the word 'may' which prima facie would indicate that this evidences a discretionary provision, in some provisions the word 'may' has been used to refer to an obligatory requirement.

The word 'may' must be read in the context of what the legislation intended the word to mean to achieve the result the statute intended. In Finance Facilities Pty Ltd v. FCT (1971) 127 CLR 106, the High Court examined subsection 46(3) of the ITAA 1936, which provided that the Commissioner 'may allow' a private company a further rebate if dividends were paid in a particular way. The High Court ruled that once the conditions were met, the Commissioner was obliged to allow the rebate. Windeyer J said at 134-5:

This does not depend on the abstract meaning of the word "may" but of whether the particular context of words and circumstance make it not only an empowering word but indicate circumstances in which the power is to be exercised - so that in those events the "may" becomes a "must". Illustrative cases go back to 1693: R. v. Barlow, Carth. 293. Today it is enough to cite Julius v. Lord Bishop of Oxford (1879), 5 App Cas 214; [1874-80] All E.R Rep. 43; and add in this Court Ward v. Williams (1955), 92 CLR 496, at pp 505-506. But I select one other reference out of a multitude: Macdougall v. Paterson (1851), 11 CB 755. There Jervis, CJ, said in the course of the argument (at p 766): "The word 'may' is merely used to confer the authority: and the authority must be exercised, if the circumstances are such as to call for its exercise." And, giving judgment, he said (at p 773): "We are of the opinion that the word 'may' is not used to give a discretion, but to confer a power upon the court and judges; and that the exercise of such power depends, not upon the discretion of the court or judge, but upon the proof of the particular case out of which such power arises."

Support for this approach can also be found in Ex Parte The Carpathia Tin Mining Company Ltd (1924) 35 CLR 552. The High Court was considering subsection 33(1) of the Income Tax Assessment Act 1915-1918 (Cth), which provided that the Commissioner may make such alterations in or additions to any assessment as he thought necessary in order to ensure its completeness and accuracy. In the course of his written judgment, Rich J stated (at 554):

The Commissioner "may" at any time make alterations or additions to an assessment, but the subsection limits them to "such alterations in or additions to any assessment as he thinks necessary in order to insure its completeness and accuracy." No one else's opinion on this subject can be substituted for that of the Commissioner, but, if he forms that opinion, he "may", and therefore, as I think, is bound to, make the proper alteration or addition.

The terminology used in subsection 26BC(13) of the ITAA 1936 is similar to that used in section 170 of the ITAA 1936. Section 170 of the ITAA 1936 also provides that the Commissioner 'may' amend an assessment in various situations. In relation to the former section 170 of the ITAA 1936, the Federal Court in Brownsville Nominees Pty Ltd v. FCT 88 ATC 4513 held that 'It must be noted that subsection170(1) of the ITAA 1936 does not impose a duty on the Commissioner to make an amended assessment. The subsection is enabling in form. The purpose of section 170 is to confer a power on the Commissioner.'

In the context of section 170 of the ITAA 1936 we consider that the Commissioner cannot be compelled to amend an assessment if he does not think it is necessary. However, we also take the view that the Commissioner has an obligation to amend an assessment where he has received sufficient information to form the view that the assessment is incorrect and make the relevant adjustments subject to the good management rule.

In this case the taxpayer had entered into a SLA. Under the SLA all right, title and interest in the relevant shares had pass absolutely from the Taxpayer to X Co. The taxpayer did not retained legal and beneficial title to the relevant shares. The Taxpayer lodged its income tax return for the relevant year on the basis that no disposal of the relevant shares had occurred and assessments issued in conformity with the lodged returns. The assessment was not correct and the relevant adjustments should be made to correct the assessment.

Issue 2

Question 1

Section 116-20 of the ITAA 1997

The term capital proceeds is defined in section 116-20 of the ITAA 1997 as the total of:

(a) the money you have received, or are entitled to receive, in respect of the event happening; and

(b) the market value of any other property you have received, or entitled to receive, in. respect of the event happening (worked out as at the time of the event).

The source of the taxpayer's entitlement and details of the consideration for the transfer of the shares is found in the. Capital proceeds to be received under the SLA.

Subsection 103-10(1) of the ITAA 1997 states that this Part of the ITAA 1997 and Part 3-3 of the ITAA 1997 apply to you as if you have received money or other property, if it has been applied for your benefit or as you direct. Subsection 103-10(2) of the ITAA 1997 states those Parts apply to you as if you are entitled to receive money or other property, if (a) you are entitled to have it so applied; or (b) you will receive it at a later time or the money is payable by instalments.

In this case the taxpayer had an entitlement at the time of the transfer of shares under the SLA.

Capital proceeds are defined in subsection 116-20(1) of the ITAA 1997 to be money received or receivable plus the market value of any property received or receivable in relation to the CGT event, worked out as at the time of the event.

The right to the shares is an asset under section 108-5 of the ITAA 1997 and payment of an amount in satisfaction of the right is capital proceeds for an ending of the asset under subsection 104-25(1) of the ITAA 1997 (CGT event C2). The right is a contractual promise that has been obtained for value and is capable of being assigned. It is a right of a proprietary nature. The taxpayer receives or becomes entitled to receive that right at the time of the disposal of the asset. Accordingly, as stated above, the taxpayer has received property other than money, under section 116-20 of the ITAA 1997 at the time of the relevant CGT event.

Therefore, the taxpayer in effect received capital proceeds when the disposal of its shares occurred, comprising property in the form of the contractual promise to delivery of the equivalent securities.

To determine the capital proceeds received upon the transfer of the shares under the SLA, the right has to be valued at its market value worked out at the time of the event (paragraph 116-20(1)(b) of the ITAA 1997). This is necessary for the purposes of determining the capital gain or loss that is attributable to the disposal of the taxpayer's shares.

Any excess of the market value of the right over the cost base of the right will result in a capital gain under CGT event A1 (section 104-10 of the ITAA 1997) occurring to the taxpayer in the year in which the shares were transferred.

Therefore, in terms of subsection 116-20(1) of the ITAA the taxpayer was entitled to receive, delivery of equivalent securities transferred under the SLA in respect of a CGT event happening.

Section 116-45 of the ITAA 1997

Section 116-45 of the ITAA 1997 applies, in certain circumstances, to reduce the consideration in respect of the disposal of an asset where the whole or a part of the consideration has not been, and is not likely to be, received. As a result, the capital gain arising from the disposal would be reduced.

Section 116-45 of the ITAA 1997 states:

3. The capital proceeds from a CGT event are reduced if:

(a) you are not likely to receive some or all (the unpaid amount) of those proceeds; and

(b) this is not because of anything you (or your associate) have done or omitted to do; and

(c) you took all reasonable steps to get the unpaid amount paid.

The capital proceeds are reduced by the unpaid amount.

Note: This rule exists because the general rules treat you as having received an amount when you are entitled to receive it.

4. There is a further consequence if:

(a) those proceeds are reduced by the unpaid amount; but

(b) you later receive a part of that amount.

Those proceeds are increased by that part.

Under paragraphs 116-45(1)(b) and (c) of the ITAA 1997 the reduction does not apply if the non-receipt of the whole or a part of the consideration is due to an act or thing done, or omitted to be done, by the taxpayer or an associate of the taxpayer, or if the taxpayer has not taken all reasonable action to secure payment of the unpaid part of the consideration.

In the present case, under the SLA the taxpayer was entitled to delivery of equivalent securities. The Taxpayer's legal or beneficial title to the shares had been transferred at the time those shares had been transferred under the SLA.

There is no other action able to be taken by the taxpayer that is likely to result in the taxpayer receiving delivery of some or all of the equivalent securities.

A Scheme was approved.

It is considered that the reduction in the consideration in respect to the transferred shares was not brought about by the taxpayer entering into an arrangement under which the taxpayer agreed to accept less than the full amount outstanding. The reduction in the consideration was not caused by an act or thing done by the taxpayer.

As a result of the action taken by the taxpayer in attempting to obtain delivery it is considered that the taxpayer took all reasonable steps to get the equivalent securities redelivered.

Consequently, the non-receipt of all of the consideration is covered by section 116-45 of the ITAA 1997 because:

· the taxpayer is not able to obtain delivery of the securities under the SLA

· the reduction in the consideration was not caused by an act or thing done by the taxpayer as the taxpayer did not make approaches to other parties under which the taxpayer agreed to a reduction in the consideration, and

· the taxpayer took all reasonable steps necessary, personally and through its legal representative to have securities redelivered.

Therefore, section 116-45 of the ITAA 1997 will operate to reduce the capital proceeds in respect of the shares transferred under the SLA to nil.

However, should the taxpayer receive any consideration in respect to the proceeds to be received under the SLA at a later date, subsection 116-45(2) of the ITAA 1997 will operate to increase the proceeds by the amount received.

Any proceeds received in relation to other actions or rights exercised by the Taxpayer flowing from the disposal of the shares will need to be considered separately as proceeds received in respect of separate CGT assets and events and have not been considered in this ruling.

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