Edited version of your written advice

Authorisation Number: 1012795273875

Ruling

Subject: Calculation methodology for CGT

Question 1

Will the Commissioner confirm that the manner in which the capital gain or capital loss is calculated by the taxpayer for the purposes of section 102-5 of the Income Tax Assessment Act 1997 (ITAA 1997) by nominating the specific shares (that is, the parcel of shares) from the taxpayer's aggregated portfolio is allowable in determining the taxpayer's overall net capital gain or loss for a particular year and satisfies the requirements of subsection 121-20(1) of the ITAA 1997?

Answer

Yes.

Question 2

Will the Commissioner confirm that Part IVA of the Income Tax Assessment Act 1936 (ITAA 1936) does not apply to the proposed arrangement?

Answer

Yes.

This ruling applies for the following periods:

1 July 20XX to 30 June 20YY

The scheme commences on:

1 July 20XX

Relevant facts and circumstances

1. The taxpayer is a complying superannuation fund.

2. The taxpayer is managed by a trustee company (the Trustee).

3. The taxpayer invests its members' superannuation money in a range of different asset types such as cash, fixed interest, Australian shares, international shares, etc.

4. To manage these assets, the taxpayer engages Australian and international investment managers. Each investment manager is responsible for a specific amount of the taxpayer's assets. The role of the investment manager is to:

• maintain a portfolio of assets on behalf of the Trustee within the guidelines set out in the investment management agreement;

• use the funds allocated to it by the Trustee to make all the investment decisions;

• instruct a broker to sell the shares;

• be an authorised representative of the Trustee. The investment manager can instruct the broker to make the sale using the Master Custodian's account to settle the transaction; and

• make the decision to what securities to buy, hold or sell, and in what quantities, and instruct the Master Custodian to carry out its decisions.

Master Custodian's roles

5. The Trustee engages XYZ as its Master Custodian, to hold all shares as nominee for the taxpayer and to settle all trades instructed by the investment managers. When the Master Custodian receives instructions to settle a trade, its role is to:

• be responsible for recording the buying and selling of shares in its records on behalf of the Trustee;

• select which parcel of shares is to be disposed of;

• allocate specific share parcels to be disposed of in accordance with the methodology determined by the taxpayer; and

• maintain the taxpayer's accounting and tax records and calculations, so that it can assist the Trustee in meeting its tax and regulatory obligations.

Master Custodian's existing system

6. Under the Master Custodian's existing system, where shares are to be disposed of, the system utilises a 'maximise loss' tax inventory method.

7. CGT records are currently maintained on an investment manager by investment manager basis. Where shares are to be disposed of, the system utilises a "maximise loss" tax inventory method to achieve an optimal capital gain tax outcome at the individual portfolio level as follows:

• purchases and sales of shares by a particular investment manager are recorded separately for each investment manager (i.e. on a single portfolio of assets);

• when an investment manager sells shares, the Master Custodian needs to identify the parcel of shares sold in order to calculate the capital gain or loss arising to the Trustee;

• the selection of shares is restricted to the parcels available in the portfolio in which the disposal was initiated;

• the parcel of shares with the highest cost base for CGT purposes is selected so that the outcome is the smallest possible capital gain or the biggest possible capital loss; and

• the taxpayer's overall CGT position is determined by adding up all the capital gains and losses from each of the portfolios, before offsetting the capital losses against the capital gains, and then claiming the CGT discount to the extent that it is applicable.

Master Custodian's proposed system

8. The Master Custodian offers an enhanced system (the Proposed System) to the taxpayer. The features of the Proposed System are as follows:

• The data about share acquisitions and disposals at the sub-portfolio level will be automatically replicated in an aggregated portfolio.

• The information in the aggregated portfolio will not be distinguished by sub-portfolio.

• Where an investment manager sells a parcel of shares, parcel selection will be performed by the Proposed System at the sub-portfolio level and also at the aggregated portfolio level.

• The parcel selection will occur across the aggregated portfolio using a 'maximise loss' tax inventory method which prioritises parcels of shares that generates the smallest gain or largest loss on disposal.

• The parcel selection criteria can be enhanced by placing a weighting factor to parcels that have been held for less than 12 months. A weighting factor can be set between 0.1 and 1.0. A weighting factor of 1.0 means that the Proposed System is indifferent towards the selection of share parcels that have been held for less than 12 months, regardless of whether those shares parcels are much closer to or further away from qualifying for the CGT discount.

• The method of selecting the nominated shares subject to the CGT event is automated within the proposed system. This is likely to result in different parcels being selected at the sub-portfolio levels and aggregated portfolio level.

• Once a parcel of shares has been selected as the nominated parcel of shares, that selection is final.

• Calculations at the aggregated portfolio level will be used for calculating the taxpayer's tax position.

• Calculations at the sub-portfolio level will continue to be used by the Master Custodian to solely monitor an investment manager's after tax performance.

System capabilities

9. The Master Custodian's system is designed at the individual investment manager level to:

• Record the date that an investment manager entered into a contract to buy or dispose of a parcel of shares.

• Record the name and security identifier (for example, ISIN) of the assets acquired.

• Record the type and class of asset (e.g. ordinary shares).

• Record the number of assets (e.g. the number of shares in the parcel) that have been acquired or disposed.

• Record the cost elements of the parcel of shares including of any incidental costs (e.g. brokerage), in the case of an acquisition.

• Record the reduced cost base when a tax deferred distribution is received.

• Record the 'frozen indexed' cost base where relevant.

• Record the impact of corporate actions including bonus issues, return of capital, share splits, takeovers, etc.

• Record the proceeds received and any incidental costs incurred (e.g. brokerage) in case of a disposal.

• Record the notional nominated parcel of assets that was subject to the CGT event.

• Record the remaining balance of the parcel where it has been partially disposed.

• Each transaction is allocated a system generated unique transaction ID number.

• Transactions in a foreign currency are converted to Australian Dollars at the exchange rate on the contract date.

10. Under the Proposed System, the same information listed above is replicated in the aggregated portfolio.

11. The Master Custodian also performs the following reconciliations:

• The closing balance of assets recorded in its custody system to its accounting and tax system at the individual manager level; and

• The closing balance of assets recorded in the aggregated portfolio to the sum of the individual manager portfolios.

12. Records are kept electronically and the Master Custodian's existing system and the Proposed System meet the record keeping requirements set out in paragraph 37 of the Taxation Ruling TR 2005/9 Income Tax: Record keeping - electronic records (TR 2005/9), with respect to:

• record retention;

• data security and integrity;

• system documentation;

• retaining archival copies; and

• accessibility.

13. With respect to the assets supporting pensions, the taxpayer uses an actuarial approach to determine the exemption for the assets supporting current pensions. The Proposed System will not change this process.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 100-45

Income Tax Assessment Act 1997 Section 102-5

Income Tax Assessment Act 1997 Section 121-20

Income Tax Assessment Act 1997 Subsection 121-20(1)

Income Tax Assessment Act 1997 Section 121-25

Income Tax Assessment Act 1936 Part IVA

Income Tax Assessment Act 1936 Section 177A

Income Tax Assessment Act 1936 Subsection 177A(1)

Income Tax Assessment Act 1936 Section 177C

Income Tax Assessment Act 1936 Subsection 177C(1)

Income Tax Assessment Act 1936 Subsection 177C(4)

Income Tax Assessment Act 1936 Section 177CB

Income Tax Assessment Act 1936 Section 177D

Income Tax Assessment Act 1936 Subsection 177D(2)

Income Tax Assessment Act 1936 Section 177F

Reasons for decision

Question 1

Will the Commissioner confirm that the manner in which the capital gain or capital loss is calculated by the taxpayer for the purposes of section 102-5 of ITAA 1997 by nominating the specific shares (that is, the parcel of shares) from the taxpayer's aggregated portfolio is allowable in determining the taxpayer's overall net capital gain or loss for a particular year and satisfies the requirements of subsection 121-20(1) of the ITAA 1997?

Summary

The manner in which the capital gain or capital loss is calculated by the taxpayer for the purposes of section 102-5 of the ITAA 1997 by nominating the specific shares (that is, the parcel of shares) from the taxpayer's aggregated portfolio is acceptable in determining the taxpayer's overall net capital gain or loss for a particular year and will satisfy the requirements of subsection 121-20(1) of the ITAA 1997.

Detailed reasoning

The method of nominating parcel of shares

The taxpayer's assessable income includes any capital gain made by the taxpayer in the income year pursuant to section 102-5 of the ITAA 1997.

For CGT purposes, where a disposal of a CGT asset (e.g. a parcel of shares) occurs, a capital gain or loss for most capital gains events is worked out in accordance with section 100-45 of the ITAA 1997. Where the shares can be individually distinguished, a capital gain or loss can be determined by reference to the capital proceeds, cost base and the acquisition date of the shares.

Where the disposal of shares form part of a holding of identical shares which are acquired over time, it may not always be possible to distinguish or identify the particular shares that have been disposed of. In these situations, the taxpayer will need to decide which particular shares are being disposed of.

For CGT purposes, the Commissioner will accept the taxpayer's selection of the identity of shares that have been disposed of. CGT Determination TD 33 Capital Gains: How do you identify individual shares within a holding of identical shares? (TD 33), paragraphs 3 and 4 provide:

3. In these circumstances, the taxpayer will need to decide which particular shares are being disposed of. Taxpayers in this situation will need to keep adequate records of the transaction so that the decision can be supported should the income tax return be subject to Tax Office scrutiny at a later date.

4. In the past, where unidentifiable shares have been disposed of, the Commissioner has accepted 'first-in first-out' as a reasonable basis of identification. For CGT purposes, the Commissioner will also accept the taxpayer's selection of the identity of shares disposed of.

Under the taxpayer's selection of the identity of shares method, the taxpayer must keep detailed records of the assets sold and this must be used in determining any capital gain or loss.

The Master Custodian maintains the accounting and tax records to enable the taxpayer to determine its capital gain or loss. The tax records are currently kept separately on the sub-portfolio basis. Under the Proposed System, all relevant information will continue to be recorded in the sub-portfolio and the aggregated portfolio levels. The information in the aggregated portfolio reflects the actual ownership of all the parcels of shares held by the taxpayer.

The Master Custodian performs the parcel selection at the sub-portfolio level and also at the aggregated portfolio level and decides which particular parcel of shares from the aggregated portfolio that have been disposed of for CGT purposes. Gains or losses at the aggregated level will be used to determine the taxpayer's CGT position.

On the basis that the taxpayer maintains sufficient records to specifically identify the shares that have been disposed of, the Commissioner will accept the selection of specific shares, that is, a nominated parcel of shares, for the CGT event, from the aggregated portfolio in order to determine the taxpayer's overall capital gain or loss for the income year.

Record keeping requirements

Section 121-20 of the ITAA 1997 deals with the records that must be kept to determine the capital gain or a capital loss from a CGT event.

Subsection 121-20(1) of the ITAA 1997 provides that:

You must keep records of every act, transaction, event or circumstance that can reasonably be expected to be relevant to working out whether you have made a *capital gain or capital loss from a CGT event. (It does not matter whether the CGT event has already happened or may happen in the future.)

Section 121-20 also specifies that records that are relevant to determine the taxpayer's capital gain or loss are records that:

• identify the date on which the assets are bought or sold;

• identify the price at which the assets are purchased and sold;

• record the details of every act, transaction, event or circumstance that is relevant to work out the capital gain or capital loss from a CGT event; and

• are in English or readily accessible and convertible into English.

Further, section 121-25 of the ITAA 1997 deals with the retention of such records to substantiate the taxpayer's capital gain or loss.

Where electronic records are kept, TR 2005/9 provides at paragraph 22:

Advances in technology (including the internet) have meant that many taxpayers who carry on a business now process and keep their records electronically rather than through a paper based system. This includes encrypted records. The Tax Office requires that records, whether kept on paper or electronically, must be kept accurately so as to enable that person's tax liability to be readily ascertained. The records must be in a form which Tax Office staff can access and understand in order to ascertain that person's taxation liability.

Based on the information provided by the taxpayer regarding the system capabilities, it is considered that the taxpayer has sufficient records to enable it to specifically identify the shares that have been disposed of (at the aggregated portfolio level), and calculate the capital gain or loss in respect of the disposal of the shares.

Accordingly, the Commissioner confirms that the records maintained by the Proposed System satisfy the requirements of subsection 121-20(1) of the ITAA 1997.

Question 2

Will the Commissioner confirm that Part IVA of the ITAA 1936 (Part IVA) does not apply to the proposed arrangement?

Summary

The Commissioner confirms that Part IVA will not apply to the proposed arrangement.

Detailed reasoning

Part IVA is the general anti-avoidance provision which gives the Commissioner the discretion to cancel a 'tax benefit' that has been obtained, or would, but for section 177F of the ITAA 1936, be obtained by a taxpayer in connection with a scheme to which Part IVA applies.

The conditions for the application of Part IVA are:

• a scheme within the meaning of subsection 177A(1) of the ITAA 1936;

• a tax benefit arises that was obtained or would be obtained in connection with the scheme but for Part IVA; and

• having regard to the matters in subsection 177D(2) of the ITAA 1936, the scheme is one to which Part IVA applies.

The scheme

Subsection 177A(1) of the ITAA 1936 widely defines a scheme as:

(a) any agreement, arrangement, understanding, promise or undertaking, whether express or implied and whether or not enforceable, or intended to be enforceable, by legal proceedings; and

(b) any scheme, plan, proposal, action, course of action or course of conduct.

Federal Commissioner of Taxation v Hart [2004] HCA 26; 55 ATR 712 at [43] per Gummow and Hayne JJ:

This definition is very broad. It encompasses not only a series of steps which together can be said to constitute a 'scheme' or a 'plan' but also (by its reference to 'action' in the singular) the taking of but one step.

In the present case, the broad definition of 'scheme' would encompass the proposed arrangement. The scheme includes the use of the Proposed System, the creation of the aggregated portfolio, the selection of parcels of shares from the aggregated portfolio rather than from the sub-portfolios, and the utilisation of the "maximise loss" method.

The tax benefit

In order to consider the application of Part IVA, it is necessary to determine what the 'tax benefit' arising from the scheme is. Subsection 177C(1) of the ITAA 1936 provides that a tax benefit may be obtained by a taxpayer in connection with a scheme shall be read as a reference to:

(a) an amount not being included in the assessable income of the taxpayer of a year of income where that amount would have been included, or might reasonably be expected to have been included, in the assessable income of the taxpayer of that year of income if the scheme had not been entered into or carried out; or

...

(ba) a capital loss being incurred by the taxpayer during a year of income where the whole or a part of that capital loss would not have been, or might reasonably be expected not to have been, incurred by the taxpayer during the year of income if the scheme had not been entered into or carried out; or

Subsection 177C(4) of the ITAA 1936 provides that

To avoid doubt, paragraph (1)(a) applies to a scheme if:

(a) an amount of income is not included in the assessable income of the taxpayer of a year of income; and

(b) an amount would have been included, or might reasonably be expected to have been included, in the assessable income if the scheme had not been entered into or carried out; and

(c) instead, the taxpayer or any other taxpayer makes a discount capital gain (within the meaning of the Income Tax Assessment Act 1997) for that or any other year of income.

As the scheme starts after 16 November 2012, section 177CB of the ITAA 1936 provides direction in identifying tax effects which would have occurred or might reasonably be expected to have occurred if the scheme had not been entered into.

In the arrangement, the reasonable expectation is that if the taxpayer did not enter into the scheme at all, the taxpayer would continue to select the nominated parcel of shares from the sub-portfolios and the CGT position for the taxpayer is determined by adding up all the individual gains or losses from each sub-portfolio. This would result in an increase in capital gains, for a year of income.

After the Proposed System is put in place, the likely benefit would be the enhanced capacity to select the share parcels with highest cost base for CGT purposes from the aggregated portfolio. The Proposed System utilises the 'maximise loss' tax inventory method which aims to generate the smallest gain or largest loss on disposal, thus, resulting in a more favourable tax outcome than that which may have been achieved using the existing system. It is likely that the following tax benefits would arise:

• reduction of capital gains for a year of income; or

• capital losses rather than capital gains for a year of income; or

• discount capital gains rather than non-discount capital gains for a year of income.

Dominant purpose of the scheme

For Part IVA to apply to a scheme, it must be concluded that having regard to certain matters in subsection 177D(2) of the ITAA 1936 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 the purpose of enabling the relevant taxpayer to obtain a tax benefit in connection with the scheme.

Having regard to the relevant matters in subsection 177D(2) of the ITAA 1936, it is concluded that the scheme is not entered into for the sole or dominant purpose of obtaining a tax benefit in connection with the scheme.

This leads to the conclusion that the tax benefit arising from the scheme will not be one to which Part IVA applies.

Accordingly, the Commissioner confirms that Part IVA will not apply to the proposed arrangement

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).