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Ruling

Subject: RBA issued government bonds

Questions and Answers:

1. Are the Commonwealth Government Securities fixed term and coupon bonds, such as the XYZ series, fixed term and coupon bonds issued by semi government authorities and Australian state governments and fixed coupon bonds issued by Australian corporations classified as traditional securities for taxation purposes?

2. Yes.

3. In general (apart from the exclusions listed in sections 26BB and 70B of the Income Tax Assessment Act 1936 (ITAA 1936)), is the gain or loss on the sale of traditional securities, such as fixed term bonds, fixed coupon bonds or unindexed bonds treated as a capital gain or loss?

4. No.

5. Does the capital gains tax discount of 50% apply to the sale of consumer price indexed bonds, where the capital invested is indexed quarterly to the CPI, and where the coupon interest is calculated at the fixed coupon rate on the indexed capital?

6. No.

This ruling applies for the following period

Year ending 30 June 2013

The scheme commences on

1 July 2012

Relevant facts and circumstances

You are an Australian resident. You have not made any tax-timing method elections under Division 230 of the Income Tax Assessment Act 1997 (ITAA 1997).

You own government fixed term bonds which are fixed coupon bonds which are not indexed. You purchased these bonds from the bank at a market price above their face value. As these bonds will mature for their face value, in the relevant year, you will incur a loss on their disposal.

You are also considering purchasing indexed bonds, where the interest is payable at the prescribed coupon rate, applied to the indexed face value and, at maturity, you will receive the adjusted capital value of the security (i.e. the face value as adjusted for inflation over the life of the bond).

About these indexed bonds, the bank website states:

Treasury Capital Indexed Bonds pay interest on a quarterly basis at the prescribed coupon rate, applied to the face value. However, the face value is adjusted by indexing the principal to inflation. (Refer to the Terms and Conditions of Issue for Treasury Indexed Bonds for an explanation of this adjustment process.) At maturity, investors receive the adjusted capital value of the security (i.e. the face value as adjusted for inflation over the life of the bond).

Relevant legislative provisions

Income Tax Assessment Act 1936 Section 159GP

Income Tax Assessment Act 1936 Section 26BB 

Income Tax Assessment Act 1936 Section 70B 

Income Tax Assessment Act 1997 Section 230-10

Income Tax Assessment Act 1997 Section 230-15

Income Tax Assessment Act 1997 Section 230-90

Income Tax Assessment Act 1997 Section 230-100

Income Tax Assessment Act 1997 Section 230-115

Income Tax Assessment Act 1997 Section 230-130

Income Tax Assessment Act 1997 Section 230-135

Income Tax Assessment Act 1997 Section 230-175

Income Tax Assessment Act 1997 Section 230-455

Reasons for decision

Summary

Your fixed coupon government bond is a 'traditional security'. In general, where such a traditional security is acquired and disposed of in the ordinary course of trading on a securities market and/or is not redeemable in exchange for ordinary shares in a company, the gains or losses on the disposal or redemption of such a traditional security are accounted for on revenue account as assessable income or allowable deductions. The gains or losses are not capital gains and losses.

Your Treasury Capital Indexed Bond is a 'qualifying security'. The gains and losses on such a qualifying security, including the gains and losses from indexation and from any discount received or any premium paid at purchase, are accounted for on an annual basis on revenue account, as assessable income or allowable deductions. The gains or losses are not capital gains and losses.

Detailed reasoning

Securities

Section 159GP of the ITAA 1936 defines the term 'security' as:

"security" means-

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

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

(c) a secured or unsecured loan; or

(d) any other contract, whether or not in writing, under which a person is liable to pay an amount or amounts, whether or not the liability is secured.

Traditional securities

Section 26BB of the ITAA 1936, which is about the assessability of gain on disposal or redemption of traditional securities, adopts the same definition of 'security' found in section 159GP.

Section 26BB of the ITAA 1936 defines the term 'traditional security' as:

traditional security , in relation to a taxpayer, means a security held by the taxpayer that:

(a) is or was acquired by the taxpayer after 10 May 1989;

(b) either: (i) does not have an eligible return; or

(ii) has an eligible return, where:

(A) the precise amount of the eligible return is able to be ascertained at the time of issue of the security; and

(B) that amount is not greater than 1½% of the amount calculated in accordance with the formula:

Payments × Term

where:

Payments is the amount of the payment or of the sum of the payments (excluding any periodic interest) liable to be made under the security when held by any person; and

Term is the number (including any fraction) of years in the term of the security;

(c) is not a prescribed security within the meaning of section 26C; and

(d) is not trading stock of the taxpayer.
Section 159GP of the ITAA 1936 defines the term 'eligible return' as:

For the purposes of this Division, there shall be taken to be an eligible return in relation to a security if at the time when the security is issued it is reasonably likely, by reason that the security was issued at a discount, bears deferred interest or is capital indexed or for any other reason, having regard to the terms of the security, for the sum of all payments (other than periodic interest payments) under the security to exceed the issue price of the security, and the amount of the eligible return is the amount of the excess.

In your case, your fixed coupon unindexed bond is a traditional security because it does not have an eligible return, given it was not issued at a discount, does not bear deferred interest and is not capital indexed.

Taxation treatment of traditional securities

In general, section 26BB of the ITAA 1936 provides a gain made on the disposal or redemption of a traditional security is included in assessable income. In other words, in general, section 26BB of the ITAA 1936 provides a gain made on the disposal or redemption of a traditional security is not a capital gain.

Similarly, in general, section 70B of the ITTA 1936 provides a loss on disposal or redemption of a traditional security is an allowable deduction. In other words, in general, section 26BB of the ITAA 1936 provides a loss made on the disposal or redemption of a traditional security is not a capital loss.

Sections 26BB and 70B do list situations where a gain or loss on disposal or redemption is not assessable or deductible and therefore are capital gains and losses. Broadly, these situations include: (i) where the disposal or redemption is in exchange for ordinary shares in a company; and (ii) where the acquisition and disposal or redemption were/are not conducted in the ordinary course of trading on a securities market and there was an apprehension or belief that the issuer may not be able or not willing to discharge all liability to pay amounts under the security.

Qualifying securities

A 'qualifying security' may be either a 'fixed return security' or a 'variable return security'.

Section 159GP of the ITAA 1936 defines a 'qualifying security' as:

"qualifying security" means any security:

(a) that is issued after 16 December 1984;

(b) that is not a prescribed security within the meaning of section 26C;

(ba) that is not part of an exempt series (see subsection (9A));

(c) the term of which, ascertained as at the time of issue of the security will, or is reasonably

likely to, exceed 1 year;

(d) that has an eligible return; and

(e) where the precise amount of the eligible return is able to be ascertained at the time of issue of the security - in relation to which the amount of the eligible return is greater than 1½% of the amount ascertained by multiplying the amount of the payment or the sum of the payments (excluding any periodic interest) liable to be made under the security by the number (including any fraction) of years in the term of the security;

but does not, except as provided by subsection (10), include an annuity.

For the purposes of this Division, there shall be taken to be an eligible return in relation to a security if at the time when the security is issued it is reasonably likely, by reason that the security was issued at a discount, bears deferred interest or is capital indexed or for any other reason, having regard to the terms of the security, for the sum of all payments (other than periodic interest payments) under the security to exceed the issue price of the security, and the amount of the eligible return is the amount of the excess.

Section 159GP of the ITAA 1936 defines a 'fixed term security' as:

"fixed return security" means a qualifying security under which the amount or amounts payable are or consist of:

(a) a specified amount or specified amounts;

(b) an amount or amounts the method of calculation of which does not involve an interest or indexation rate or other factor, being a rate or factor that varies or may vary during the term of the security; or

(c) any combination of amounts referred to in paragraph (a) or (b);

Section 159GP of the ITAA 1936 defines a 'variable return security' as:

"variable return security" means a qualifying security that is not a fixed return security;

In your case, a Treasury Capital Indexed Bond is a qualifying security because it is a variable return security, i.e., it has an eligible return due to being capital indexed.

Taxation treatment of qualifying securities

From 1 July 2010, the rules for the taxation of certain qualifying securities are found in the taxation of financial arrangements (TOFA) provisions contained in Division 230 of the ITAA 1997.

Section 230-10 of the ITTA 1997 explains some of the objects of this legislation are to align more closely the tax and commercial recognition of gains and losses from your financial arrangements by allocating the gains and losses to income years throughout the life of your financial arrangements on a reasonable basis and by generally recognising gains and losses on revenue rather than capital account.

Section 230-15 of the ITAA 1997 provides, in general, subject to its exceptions, gains are assessable and losses are deductible in relation to a financial arrangement.

Subsection 230-15(1) states your assessable income includes a gain you make from a financial arrangement.

Subsection 230-15(2) states you can deduct a loss you make from a financial arrangement, but only to the extent that:

§ you make it in gaining or producing your assessable income, or

§ you necessarily make it carrying on a business for the purpose of gaining or producing assessable income.

The exception under subsection 230-455(1) for certain taxpayers ,where there is no significant deferral, does not apply to the indexed bonds as the arrangement is a qualifying security and the arrangement is to end more than 12 months after you start to have it.

Under subsection 230-100(2) of the ITAA 1997, the accruals method applies to a gain or loss you make on the index bonds as it is a financial arrangement under section 230-45 and there is a sufficiently certain overall gain from the arrangement. Although the amount of the face value is adjusted to inflation, subsection 230-115(4) states that you must assume that the inflation rate remains the same.

Subsection 230-130(1) of the ITAA 1997 provides, the period over which the gain or loss is to be spread, is the period that: (i) starts when you start to have the arrangement; and (ii) ends when you will cease to have the arrangement.

Section 230-135 of the ITAA 1997 explains the gain or loss is to be spread, as follows:

The intervals to which parts of the gain or loss are allocated must:

(a) not exceed 12 months; and

(b) all be of the same length.

Paragraph (b) does not apply to the first and last intervals. These may be shorter than the other intervals.

For each interval:

(a) determine a rate of return; and

(b) determine an amount to which you apply the rate of return.

…in determining the amount to which you apply the rate of return for an interval, have regard to:

(a) the amount or value; and

(b) the timing;

of financial benefits that are to be taken into account in working out the amount of the gain or loss, and were provided or received by you during the interval.

Subsections 230-175(1) and 230-175(2) of the ITAA 1997 provide running balancing adjustments must be made if the financial benefit received or to be received is less or more than the amount estimated under section 230-135.

Section 230-90 of ITAA 1997 explains the 'accruals method' is applied to determine the amount and timing of gains and losses from a financial arrangement if they are sufficiently certain for such accrual to be done. If the accruals method is applied to a gain or loss on the basis of an estimate of a financial benefit and the benefit when received or provided is more or less than the estimate, a balancing adjustment is made to correct for the underestimate or overestimate.

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