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Subject: Deduction for loss on disposal of securities

Question 1

Is a deduction allowed in the year of disposal, under section 70B of the Income Tax Assessment Act 1936 (ITAA 1936), for a loss arising from the disposal of traditional securities?

Advice/Answers

Yes

This ruling applies for the following period

Year ended 30 June 2012

The scheme commenced on

1 July 2011

Relevant facts and circumstances

The scheme to which this ruling applies involves a claim to deduct losses incurred on disposal of traditional securities.

The entity is a defined benefits superannuation fund (the Fund).

Background to investments

The Fund invested in various traditional securities. The traditional securities were acquired and disposed of at various times during the relevant income year. Some traditional securities realised a gain on disposal and others a loss on disposal.

The traditional securities that are the subject of this ruling:

· realised a loss on disposal,

· were not segregated exempt assets or segregated current pension assets, and

· were marketable securities.

The disposal of the traditional securities did not take place in the ordinary course of trading on a securities market.

There were no specific concerns at the time of disposal in relation to the issuer's ability to meet its liabilities.

Relevant legislative provisions

Income Tax Assessment Act 1936 Section 26BB

Income Tax Assessment Act 1936 Subsection 26BB(1)

Income Tax Assessment Act 1936 Section 70B

Income Tax Assessment Act 1936 Subsection 70B(2)

Income Tax Assessment Act 1936 Subsection 70B(4)

Income Tax Assessment Act 1936 Paragraph 70B(4)(a)

Income Tax Assessment Act 1936 Paragraph 70B(4)(b)

Income Tax Assessment Act 1936 Paragraph 70B(4)(c)

Income Tax Assessment Act 1936 Paragraph 70B(4)(d)

Income Tax Assessment Act 1936 Paragraph 70B(4)(e)

Income Tax Assessment Act 1936 Subsection 70B(5)

Income Tax Assessment Act 1936 Subsection 70B(7)

Income Tax Assessment Act 1936 Subsection 159GP(1)

Reasons for decision

Summary

A deduction is allowed in the year of disposal, under section 70B of the ITAA 1936, for a loss arising from the disposal of the traditional securities.

Detailed reasoning

Losses on the disposal or redemption of 'traditional securities' are deductible under subsection 70B(2) of the ITAA 1936 in the year of disposal or redemption.

Section 70B of the ITAA 1936 was introduced as the counterpart of section 26BB of the ITAA 1936. Section 26BB includes in assessable income certain gains derived from the disposal or redemption of traditional securities, while section 70B of the ITAA 1936 provides a deduction for a loss on the disposal or redemption of traditional securities in the income year in which the disposal or redemption takes place.

Under subsection 26BB(1) a 'security' is given the meaning contained in Division 16E of the ITAA 1936 (subsection 159GP(1)) to include:

(1) a stock, bond, debenture, certificate of entitlement, bill of exchange, promissory note or other security;

(2) a deposit with a bank, building society or financial institution;

(3) a secured or unsecured loan; or

(4) any other contract under which a person is liable to pay an amount.

Traditional securities

The Commissioner's views on traditional securities as they relate to section 26BB and section 70B of the ITAA 1936 are set out in Taxation Ruling 96/14: Traditional Securities.

The term 'traditional security' is defined in subsection 995-1(1) of the Income Tax Assessment Act 1997 (ITAA 1997) as having the meaning given by subsection 26BB(1). That subsection broadly provides that a traditional security is a security:

(1) acquired after 10 May 1989;

(2) that is not a 'prescribed security' (i.e. Commonwealth securities that do not bear interest);

(3) that is not trading stock of the taxpayer; and

(4) that does not have an 'eligible return', or where it does have an eligible return, it must not exceed the prescribed level.

In the present case, the Commissioner agrees that the securities that are the subject of this private ruling are traditional securities within the meaning of section 26BB of the ITAA 1936.

Where deduction not allowable under section 70B

Subsection 70B(2A) of the ITAA 1936 states that:

A deduction is not allowable under subsection (2) for a loss on the disposal or redemption of traditional securities that are:

(a) segregated exempt assets (for the purposes of the Income Tax Assessment Act 1997) of a life assurance company; or

(b) segregated current pension assets (as defined in the Income Tax Assessment Act 1997) of a complying superannuation fund.

In this case, the applicant confirmed that the traditional securities are not segregated exempt assets or segregated current pension assets. Therefore, subsection 70B(2A) of the ITAA 1936 does not apply.

Subsections 70B(2B), 70B(2C) and 70B(3) of the ITAA 1936 also disallow a deduction under 70(B)(2) under certain circumstances. However, these subsections are not relevant to the current case.

Subsection 70B(4) of the ITAA 1936 states:

If:

(a) a taxpayer disposes of a traditional security or a traditional security of a taxpayer is redeemed; and

(b) there is a loss on the disposal or redemption; and

(c) in the case of a disposal or redemption of a marketable security:

(i) the taxpayer did not acquire the security in the ordinary course of trading on a securities market; and

(ii) at the time the taxpayer acquired the security, it was not open to the taxpayer to acquire an identical security in the ordinary course of trading on a securities market; and

(d) in the case of a disposal of a marketable security - the disposal did not take place in the ordinary course of trading on a securities market; and

(e) having regard to:

(i) the financial position of the issuer of the security; and

(ii) perceptions of the financial position of the issuer of the security; and

(iii) other relevant matters;

it would be concluded that the disposal or redemption took place for the reason, or for reasons that included the reason, that there was an apprehension or belief that the issuer was, or would be likely to be, unable or unwilling to discharge all liability to pay amounts under the security;

a deduction is not allowable to the taxpayer under this section in respect of so much of the amount of the loss as is a loss of capital or a loss of a capital nature.

Section 70B of the ITAA 1936 was enacted in 1989. By way of background to the 1992 amendments to section 70B (which included subsection 70B(4)), the Treasurer confirmed (Explanatory Memorandum to Taxation Laws Amendment Bill (No. 5) 1992 (1992 EM) at p. 56) that:

It was not intended that gains and losses of a genuinely capital kind would be affected by the traditional securities rules contained in sections 26BB and 70B of the ITAA 1936. What was intended to be brought onto revenue account were gains and losses in value attributable to movements in interest rates or other market adjustments.

Given that the intention was for Section 70B of the ITAA 1936 not to include gains and losses of a genuinely capital kind, in explaining the need for the enactment of subsection 70B(4) of the ITAA 1936, the Treasurer said (also at p. 56 of that 1992 EM)):

However, claims for deduction under section 70B have been sought for losses of the capital amount of an investment that relates to the inability or unwillingness of the financial institution or other borrower to meet its obligations under the terms of the security, that is, for capital losses due to default. Some capital losses in that category have been caused by failures of financial institutions and from the forgiveness of loans, the latter particularly in relation to inter group company loans or related partnership loans. In these kinds of circumstances, of course, there could be no corresponding assessable gain to which section 26BB could apply.

Subsection 70B(4) of the ITAA 1936 therefore acts to prevent deductions from being allowable under section 70B for a loss of a capital nature on the disposal or redemption of a traditional security, where it would objectively be concluded that a reason for the disposal or redemption was an apprehension or belief that the issuer would be unable or unwilling to discharge its obligations to make payments under the security. There will be no loss of the deduction, however, in cases where the traditional security is a marketable security and the losses arise from a disposal that takes place in the ordinary course of trading on a securities market (p. 57 of the 1992 EM).

The guidance provided in the 1992 EM on the application of section 70B of the ITAA 1936 was applied in WRBD v Commissioner of Taxation [2009] AATA 368; 2009 ATC 1-007; 75 ATR 712 (WRBD Case). That case involved the issue of deductibility of losses arising from the disposal of convertible notes after a company was placed in receivership.

In referring to the 1992 EM, Justice Mushin and Senior Member Pascoe state in the WRBD Case judgement that:

53. In our view, the extrinsic material referred to above demonstrates the primacy of the reason for disposal of a traditional security, whether marketable or not. The provisions of paragraph (e) of the subsection are fundamental to the interpretation of the legislation. That is, if the reason or part of the reason, for the disposition of the security is that which is contemplated by the paragraph, the subsection immediately becomes relevant. We derive that conclusion from the passages which we have emphasised in both the Explanatory Memorandum and the Second Reading Speech by which the subsection was introduced to Parliament quoted above.

54. Once the subsection becomes relevant in accordance with that which we have expressed in the previous paragraph, the next question is whether the security is a marketable security. If it is a marketable security as in the present matter, the deduction is only available from income in the relevant year if the acquisition and disposal of the security both took place on the open market or, in the case of the acquisition of the security, an identical security could have been purchased on the open market.

The ATO's response to the above case was outlined in a Decision Impact Statement DIS 2008/3272-3278 (WRBD DIS) issued on 10 September 2009. The statement includes the following on the ATO view of the decision:

The Tax Office considers the effect of the decision is that:

• if a traditional security is not a marketable security and paragraph 70B(4)(e) applies to the disposal or redemption of the traditional security, a deduction is not available under subsection 70B(2) as subsection 70B(4) applies. The Tribunal held that once the purpose of the disposal is in accordance with paragraph (e), the deduction is not available because the security cannot be disposed of on the market.

• if a traditional security is a marketable security and paragraph 70B(4)(e) applies to the disposal or redemption of the traditional security, a deduction is not available under subsection 70B(2) unless both the acquisition and sale of the marketable security took place on the open market, or in the case of the acquisition of the security, an identical security could be acquired in the ordinary course of trading on a securities market.

• Subsections 70B(4)(c) and (d) should be read conjunctively rather than disjunctively.

• The failure to dispose of a marketable security other than on the market means that a deduction is not available under subsection 70B(2) as subsection 70B(4) applies.

Applying the guidance provided in the WRBD DIS to this case, it is therefore necessary to determine if the securities are:

· traditional securities,

· marketable securities,

· securities that were both the acquired and sold on the open market, or in the case of the acquisition of the disposal of the traditional securities did not take place in the ordinary course of trading on a securities market, an identical security could have been acquired in the ordinary course of trading on a securities market, and

· securities to which paragraph 70B(4)(e) of the ITAA 1936 applies.

Traditional securities and marketable securities

In the present case, as stated above, the Commissioner agrees that the securities that are the subject of this private ruling are traditional securities within the meaning of section 26BB of the ITAA 1936.

A marketable security is a traditional security that is covered by paragraph (a) of the definition of 'security' in subsection 159GP(1) of the ITAA 1936. That paragraph is extremely wide in its terms, and refers to 'stock, a bond, debenture, certificate of entitlement, bill of exchange, promissory note or other security'. The Commissioner agrees that the traditional securities are marketable securities.

Subparagraphs 70B(4)(c) and (d) - Acquisition and sale took place on the open market, or in the case of the acquisition, an identical security could have been acquired in the ordinary course of trading on a securities market.

Taking into account the guidance provided in the WRBD DIS, a deduction will not be denied by subsection 70B(4) of the ITAA 1936 if the marketable security is acquired and disposed of by a taxpayer in the ordinary course of trading on a securities market. A deduction will also not be denied if, in the case of the acquisition of the security, it was open to the taxpayer to acquire an identical security in the ordinary course of trading on a securities market.

Turning to whether or not the Fund acquired the security in the ordinary course of trading on a securities market, this is a matter of fact based on subjective purposes and the objective evidence provided. It is considered that the legislation is from the perspective of the rulee, in that, it is the rulee that must not have acquired the security in the (rulees) ordinary course of trading on a securities market.

In the PBR application, it is not put forward that the Fund acquired the securities in the (ordinary) course of trading. Also, there was no indication that the Fund intended to trade on the securities with a hope to make a profit on their resale due to favourable market movements. On the contrary, the indicators are that the Fund purchased the traditional securities on investment account seeking to obtain the interest income and not, necessarily, making a profit from either market price movements or from a trading business on the securities (or any other securities for that matter).

Accordingly, as it is considered that the Fund acquired the traditional securities on investment account, the condition at subparagraph 70B(4)(c)(i) of the ITAA 1936 is satisfied. With regard to subparagraph 70B(4)(c)(ii) of the ITAA 1936, it is considered that for the same reasons it was not open to the Fund to acquire identical securities in the ordinary course of trading on a securities market. Therefore, subparagraph 70B(4)(c)(ii) is also satisfied.

The disposal of the traditional securities did not take place in the ordinary course of trading on a securities market. Based on this, it is accepted that subparagraph 70B(4)(d) of the ITAA 1936 is also satisfied.

Application of paragraph 70(B)(4)(e) of the ITAA 1936

The condition in paragraph 70B(4)(e) of the ITAA 1936 is that:

having regard to:

(i) the financial position of the issuer of the security; and

(ii) perceptions of the financial position of the issuer of the security; and

(iii) other relevant matters;

it would be concluded that the disposal or redemption took place for the reason, or for reasons that included the reason, that there was an apprehension or belief that the issuer was, or would be likely to be, unable or unwilling to discharge all liability to pay amounts under the security.

Paragraph 70B(4)(e) of the ITAA 1936 requires regard to be had to the financial position of the 'issuer' of the security for determining whether a deduction is allowable under section 70B of the ITAA 1936 for a loss on the disposal of a traditional security.

The term 'issuer' is defined in subsection 70B(7) of the ITAA 1936 as:

Issuer, in relation to a security at a particular time, means the person who, if the amount or amounts payable under the security were due and payable at that time, would be liable to pay the amount or amounts.

In the definitions section of the 1992 EM, 'issuer' is described as meaning 'the person who at any time has a liability to pay amounts under a security'.

In this particular case, there were no specific concerns at the time of disposal in relation to the issuer's ability to meet its liabilities. It is accepted that in these circumstances, it could not be said that there is an apprehension or belief that the issuer was, or would be likely to be, unable or unwilling to discharge all liability to pay amounts under the security.

Based on the above, it is considered that the condition in paragraph 70B(4)(e) of the ITAA 1936 is not satisfied.

Summary - Subsection 70B(4)

For the reasons outlined above, the losses incurred on disposal of the traditional securities are properly characterised as revenue losses as all of the requirements in subsection 70B(4) of the ITAA 1936 are not satisfied. Therefore, a deduction is allowable under section 70B of the ITAA 1936 for the losses incurred on the disposal of each of the traditional securities.

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