Edited version of private advice

Authorisation Number: 1051630528950

Date of advice: 30 January 2020

Ruling

Subject: Propagation

Question 1

Is the manner in which the capital gain or capital loss calculated by the taxpayer by nominating the specific parcel of shares disposed of from the taxpayer's aggregated portfolio using the propagation system (the System) acceptable in determining the net capital gains or losses of the taxpayer for the purposes of sections 102-5 and 102-10 of the Income Tax Assessment Act 1997 (ITAA 1997) for an income year?

Answer

Yes.

Question 2

If the answer to Question 1 is yes, will the System satisfy the requirements of subsection 121-20(1) of the ITAA 1997?

Answer

Yes.

Question 3

Will Part IVA of the Income Tax Assessment Act 1936 apply to the System utilised by the taxpayer?

Answer

No.

This ruling applies for the following periods:

A number of income years

The scheme commenced during:

An income year

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 does not have any sub-funds within the meaning of section 69A of the Superannuation Industry (Supervision) Act 1993.

        4.        The taxpayer uses the 'unsegregated current pension assets method' under section 295-390 of the Income Tax Assessment Act 1997 in calculating its exempt current pension income for Australian income tax purposes.

        5.        The taxpayer offers its members a range of investment options across various asset classes which include Cash, Fixed Interest, Property, Australian Shares, Overseas Shares and Alternatives.

        6.        The Trustee engages the Master Custodian to provide custodial and investment administration services in relation to its assets.

        7.        The taxpayer consists of two pools of assets, one pool of which the Master Custodian is custodian of while the other pool is for its self-managed option product for its members. The Master Custodian is not the custodian for the self-managed option assets and does not have the data of these assets.

The Master Custodian

        8.        The Master Custodian holds all shares as nominee for the taxpayer, and settles all trades for which it is instructed to by the investment managers.

        9.        When the Master Custodian receives instructions to settle a trade from an investment manager, its role is to:

·                 be responsible for recording the sale in its records on behalf of the Trustee

·                 select which parcel of shares is to be disposed of. This is because the Master Custodian which keeps the records relating to the buying and selling of shares on behalf of the Trustee

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

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

Investment managers

      10.      To manage its assets, the taxpayer engages Australian and international investment managers. Each investment manager is responsible for a specific amount of the taxpayer's assets.

      11.      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, which sets out certain criteria such as limits of exposure to a single asset

·                 use the funds allocated to it by the Trustee to make investment decisions

·                 instruct a broker to sell (when an investment manager decides to sell some of the Trustee's shares)

·                 be an authorised representative of the Trustee, such that it can instruct the broker to make the sale using the Master Custodian's account to settle the transaction

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

      12.      The investment manager does not buy, hold or sell the shares. Nor does it select which parcel of shares is to be sold. Instead, the investment manager instructs the broker to sell a certain number of a type of shares from the Master Custodian's account.

Capital gain tax (CGT) parcel selection process

      13.      The taxpayer's CGT parcel selection process has been based on a propagated parcel selection methodology agreed upon with the Master Custodian (the System).

      14.      The System provided by the Master Custodian has remained unchanged since its commencement and is described as follows:

·                 Data of share acquisitions and disposals are entered into portfolios established for each investment manager (sub-portfolio) and processed at this level.

·                 The data is automatically replicated in an aggregated portfolio created by the Master Custodian. The information in the aggregated portfolio is not distinguished by sub-portfolio.

·                 All of the assets managed by the Master Custodian are included in the aggregated portfolio for the purposes of the parcel selection process, however propagation only occurs for Australian and International equities.

·                 Where an investment manager sells a parcel of shares, parcel selection occurs at the sub-portfolio level, and also at the aggregated portfolio level in respect of fungible assets, i.e. identical in all aspects.

·                 The System allows for parcel selection to occur across the aggregated portfolio using a "maximise loss" tax inventory method. The profit maximisation, first-in first out and specific identification (only available on futures contracts) parcel methodologies are also available to the taxpayer.

·                 The identification and selection of the parcel of shares for propagation is contemporaneous with the actual disposal transaction.

·                 On an aggregated portfolio basis, the maximise loss method prioritises parcels of shares that generate the smallest gain or largest loss on disposal.

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

·                 The Master Custodian utilises multiple sub-custodians across its international investment portfolio, but only one sub-custodian is utilised in each market that the taxpayer is invested in.

·                 Propagation does not occur across assets held by the Master Custodian and its sub-custodians or between separate sub-custodians.

·                 Calculations at the aggregated portfolio level are used for calculating the taxpayer's tax position.

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

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

      15.      Assets identified for disposal under the System are also the assets identified for non-regulatory or accounting purposes by the taxpayer, i.e. assets identified as disposed of for tax are the same assets identified as being disposed of for accounting purposes regardless of variance in tax and accounting cost bases.

      16.      Assets held in custody in Australia and in an overseas jurisdiction are registered in the name of the Master Custodian's related party.

International equities

      17.      Foreign listed securities are held via the taxpayer's sub-custodian or its appointed sub-custodians (the Sub-Custodians) in accordance with relevant market practice and the taxpayer generally uses nominee vehicles to hold the foreign listed securities.

      18.      Whilst the taxpayer holds dual-listed securities on different exchanges, the securities of two different exchanges would be treated as different assets, which can be individually distinguished, for propagation purposes under the System. As such, the System does not allow for propagation to occur between different exchanges for dual-listed securities, even if the asset would be considered fungible from a commercial perspective.

Record keeping

      19.      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 assets (that is, a parcel of identical shares)

·                 name and security identifier (for example, SEDOL) of the assets acquired.

·                 type and class of asset (for example, ordinary shares)

·                 number of assets (for example, the number of shares in the parcel) that have been acquired or disposed

·                 cost elements of the parcel of shares including any incidental costs (for example, brokerage), in the case of an acquisition

·                 reduced cost base when a tax deferred distribution is received

·                 frozen indexed cost base where relevant

·                 impact of corporate actions including bonus issues, return of capital, share splits, takeovers, etc.

·                 proceeds received and any incidental costs incurred (for example, brokerage) in the case of a disposal

·                 notional nominated parcel of assets that was subject to the CGT event

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

      20.      In addition, the Master Custodian's system allocates a system generated unique transaction ID number. Transactions in foreign currency are converted to Australian Dollars at the exchange rate on the contract date.

      21.      The same information listed above at paragraphs 19 and 20 is replicated in the aggregated portfolio.

      22.      The Master Custodian also performs the following reconciliation to validate:

·                 the realised CGT position between the aggregated portfolio and the sub-portfolio is according to the 'maximise loss' tax inventory method

·                 accounting to tax (realised and unrealised) movements between the aggregated portfolio and the sub-portfolio are in line with the previous corresponding period

·                 non-propagated income items (such as dividend income, interest received, etc.) between the aggregated portfolio and sub-portfolio are consistent.

      23.      Records are kept electronically and the Master Custodian's systems meet the record keeping requirements set out in paragraphs 7 and 8 of Taxation Ruling TR 2018/2 Income Tax: record keeping - electronic records with respect to:

·                 Protection from manipulation or alteration

·                 Record retention

·                 Document retrieval, system documentation, encryption keys, convertibility into standard data formatting and identifiability

·                 Accessibility.

Rationale for utilising the System

      24.      The System provides the taxpayer with access to information it needs to make more informed decisions to identify the shares disposed of for CGT purposes.

Relevant legislative provisions

Section 102-5 of the Income Tax Assessment Act 1997

Section 102-10 of the Income Tax Assessment Act 1997

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

Part IVA of the Income Tax Assessment Act 1936

Reasons for decision

Question 1

All legislative references are to the Income Tax Assessment Act 1997 unless otherwise specified.

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

For CGT purposes, where a disposal of a CGT asset (e.g. a parcel of shares) occurs, a capital gain or loss for most CGT events is worked out in accordance with section 100-45. Where the shares disposed 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?, 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, a taxpayer must keep detailed records of the shares 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. Under the System, all relevant information is recorded at both the sub-portfolio and aggregated portfolio levels. The information in the aggregated portfolio reflects the actual ownership of all the parcels of shares held by the taxpayer.

When the Master Custodian receives instructions to settle a trade from an investment manager, the System applies the maximise loss method to select a parcel of identical shares at the time of disposal from the aggregated portfolio.

On the basis that the taxpayer maintains sufficient records to specifically identify the shares that have been disposed of, the Commissioner accepts the taxpayer's selection of specific shares, that is, a nominated parcel of shares, for the CGT event, from the aggregated portfolio under the propagated system in order to determine the taxpayer's net capital gain or loss for the purposes of sections 102-5 and 105-10 for an income year.

Question 2

All legislative references are to the Income Tax Assessment Act 1997 unless otherwise specified.

Section 121-20 provides that records that must be kept to determine the capital gain or a capital loss from a CGT event.

Subsection 121-20(1) 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 provides that a taxpayer must retain such records to substantiate the taxpayer's capital gain or loss.

Where electronic records are kept, Taxation Ruling TR 2018/2 Income tax: record keeping - electronic records 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 of the System's record keeping capabilities, it is considered that the Trustee will have sufficient records to enable it to specifically identify the relevant shares disposed of from the taxpayer and to determine the capital gains and losses generated by the taxpayer in respect of the disposal of the shares.

Accordingly, the Commissioner confirms that the records the taxpayer states are maintained by the System, as described in the Facts, satisfies the requirements of subsection 121-20(1).

Question 3

All legislative references are to the Income Tax Assessment Act 1936 unless otherwise specified.

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

In order for Part IVA to apply, the following requirements must be satisfied:

·                 there is a scheme to which Part IVA applies

·                 a tax benefit was or would (but for subsection 177F(1)) have been obtained

·                 the identified tax benefit was or would have been obtained in connection with the identified scheme, and

·                 the person who entered into or carried out the identified scheme (or any part of the scheme) did so for the purpose of enabling the relevant taxpayer to obtain a tax benefit.

Scheme

A 'scheme' is broadly defined in subsection 177A(1) and can be a series of steps taken together or a single step (refer to Commissioner of Taxation v Hart [2004] HCA 26).

The Fund's implementation and its utilisation of the System will constitute a scheme (the Scheme) for the purposes of subsection 177A(1).

Tax benefit

Having established the existence of a scheme, Part IVA will only apply if it is determined that a tax benefit was or would have been obtained in connection with that scheme.

Subsection 177C(1) identifies a number of tax benefits, including but not limited to:

·                 an amount not being included in the taxpayer's assessable income

·                 a deduction being allowable to the taxpayer

·                 a capital loss being incurred by the taxpayer, and

·                 a foreign tax credit being allowable to the taxpayer.

Section 177CB - the basis for identifying tax benefits

For schemes entered into on or after 16 November 2012, section 177CB provides the framework for deciding under section 177C whether a tax benefit would have occurred, or might reasonably be expected to have occurred, if the scheme had not been entered into or carried out, which is referred to as the tax effects.

The 'would have' (annihilation approach) and 'might reasonably be expected to' (reconstruction approach) limbs of subsection 177C(1) are separate and distinct bases upon which the existence of a tax effect can be demonstrated (refer paragraph 1.44 of Explanatory Memorandum to Tax Laws Amendment (Countering Tax Avoidance and Multinational Profit Shifting) Bill 2013 (the EM)).

The annihilation approach

Subsection 177CB(2) confirms that a decision that a tax effect would have occurred if the scheme had not been entered into or carried out must be based on a postulate that comprises only the events or circumstances that actually happened or existed (other than those that form part of the scheme) (the annihilation approach). In considering such a postulate, the scheme must be assumed never to have happened. That is, it is annihilated, deleted or extinguished to determine the tax effects based on the remaining events or circumstances.

The annihilation approach would typically apply where the scheme in question does not produce any material non-tax results or consequences for the taxpayer (refer paragraph 1.82 of the EM).

The reconstruction approach

Subsection 177CB(3) explains that a decision that a tax effect might reasonably be expected to have occurred if the scheme had not been entered into or carried out must be based on a postulate that is a reasonable alternative to entering into or carrying out the scheme (the reconstruction approach).

In determining whether such a postulate is a reasonable alternative, particular regard must be had to the substance of the scheme and any result or consequence for the taxpayer that is or would be achieved by the scheme. Any results in relation to the operation of the Act (as defined) that would be achieved by the postulate for any person (whether or not a party to the scheme) must be disregarded.

As a result of the Scheme, the taxpayer will have an enhanced capability to select parcels of shares from the entire aggregated portfolio rather than from individual underlying sub-portfolios which would be the case if the System was not utilised, resulting in a more favourable tax outcome than that which may have been achieved under the alternative postulate. As such, it is likely that the following tax benefits to the Fund would arise under the Scheme:

·                 a reduced amount of capital gains included in its assessable income

·                 increased capital losses, or

·                 increased discount capital gains.

Based on the above analysis, it is concluded that a tax benefit will be obtained in connection with the Scheme resulting from the use of the System.

Schemes to which Part IVA applies

Subsection 177D(1) provides that Part IVA applies to a scheme in connection with which the taxpayer has obtained a tax benefit if, having regard to the matters in subsection 177D(2), it would be concluded that a person (who need not be the taxpayer) who entered into or carried out the scheme (or any part of it), did so for the purpose of enabling the taxpayer to obtain a tax benefit.

Subsection 177A(5) makes it clear that the 'purpose' includes the dominant purposes where there are two or more purposes - the 'dominant' purposes being the 'ruling, prevailing or most influential purpose': The Commissioner of Taxation of the Commonwealth of Australia v Spotless Services Ltd & Anor [1995] FCA 958.

Conclusion

Having regard to the relevant factors in subsection 177D(2), it is concluded that the Scheme was not entered into for the dominant purpose of obtaining a tax benefit in connection with the Scheme.

Accordingly, the Commissioner confirms that Part IVA will not apply to the System utilised by the taxpayer.

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