Edited version of private advice

Authorisation Number: 1051886272823

Date of advice: 17 August 2021

Ruling

Subject: Related payment rule

Question

Will the Payment under the Contract be considered a related payment for the purposes of former Division 1A of former Part IIIAA of the Income Tax Assessment Act 1936 (ITAA 1936)?

Answer

No

This ruling applies for the following periods:

Year ended 30 June 20XX

Year ended 30 June 20XX

Year ended 30 June 20XX

Year ended 30 June 20XX

The scheme commences on:

1 July 20XX

Relevant facts and circumstances

1.            The Trust holds shares in the Company.

2.            The Trust is considering entering a contract with the Bank.

3.            Under the contract, the Trust will be required to make Payment to the Bank in certain circumstances when the Company shares go ex-dividend.

4.            The formula used to calculate the Payment only ever causes part of the Company dividend to pass from the Trust to the Bank.

Relevant legislative provisions

Income Tax Assessment Act 1936 former Part 1A of former Division IIIAA

Income Tax Assessment Act 1936 former section 160APHD

Income Tax Assessment Act 1936 former section 160APHN

Income Tax Assessment Act 1936 former section 160APHO

Income Tax Assessment Act 1997 section 207-145

Reasons for decision

The related payment rule in former Part 1A of former Division IIIAA of the Income Tax Assessment Act 1936 (ITAA 1936) is relevant to determine if an entity is a 'qualified person' in relation to a dividend in order to be entitled to a tax offset in respect of a franking credit on a dividend (subsection 207-145(1) of the Income Tax Assessment Act 1997 (ITAA 1997)).

One of the design features of the imputation system is that entities who are not the true economic owners of a company and so not sufficiently subject to the risks of loss and opportunities for gain associated with ownership are not able to claim a credit for the tax paid by the company under the imputation system.

The test of what constitutes a 'qualified person' is set out in former subsection 160APHO(1) of the ITAA 1936 which broadly provides that if you are not under an obligation to make a related payment in relation to a dividend, you have to satisfy the holding period rule in relation to the primary qualification period, but If you are under an obligation to make a related payment in relation to a dividend, you have to satisfy the holding period requirement within the secondary qualification period. The primary qualification period and secondary qualification period are set out in former section 160APHD of the ITAA 1936.

Former section 160APHN of the ITAA 1936 provides non-exhaustive examples of what constitutes the making of a related payment for the purposes of former Division 1A of the ITAA 1936. Former subsection 160APHN(2) of the ITAA 1936 provides:

The taxpayer or associate is taken, for the purposes of this Division, to have made, to be under an obligation to make, or to be likely to make, a related payment in respect of the dividend or distribution if, under an arrangement, the taxpayer or associate has done, is under an obligation to do, or may reasonably be expected to do, as the case may be, anything having the effect of passing the benefit of the dividend or distribution to one or more other persons.

Former subsection 160APHN(3) relevantly states:

Without limiting subsection (2), the doing of any of the following by the taxpayer or an associate of the taxpayer in the circumstances mentioned in subsection (4) may have the effect of passing the benefit of the dividend or distribution to one or more other person:

(a) causing a payment or payments to be made to, or in accordance with the directions of, the other person or persons; ...

Former subsection 160APHN(4) states:

The circumstances referred to in subsection (3), are where:

(a)          the amount or the sum of the amounts paid, credited or applied; or

(b)          the value or the sum of the values of the services provided, of the property transferred or of the use of the property or money; or

(c)          the amount or the sum of the amounts of the set-offs, reductions or increases;

as the case may be:

(d)          is, or may reasonably be expected to be, equal to; or

(e)          approximates or may reasonably be expected to approximate; or

(f)           is calculated by reference to;

the amount of dividend or distribution.

The Trust propose to enter a contract relating to its shares in the Company, which will include a Payment to the Bank in certain circumstances when the Company shares go ex-dividend.

The amount of the Payment under the contract is calculated by reference to the amount of the Company dividend.

The effect of the Payment is that the Trust will be under an obligation to, or may reasonably be expected to, make payment to the Bank in respect of the Company dividend. That is, the Trust will be required to make payment in certain circumstances.

While the Payment will cause the Trust to be under an obligation to make payment in respect of the Company dividends, and is calculated by reference to the Company dividends, a payment will only be a related payment if it has the effect of passing the benefit of the dividend to another person.

The formula used to calculate the Payment only ever causes part of the Company dividend to pass from the Trust to the Bank and not the whole dividend. Only part or a portion of the benefit of the Company dividend will ever pass from Trust to the Bank under the Contract.

Subsection 160APHN(2) refers to 'anything having the effect of passing the benefit of the dividend or distribution'. It does not refer to having the effect of passing a portion or part of the benefit of the dividend or distribution, which indicates a deliberate intention that paragraph 160APHN(4)(f) should be read ejusdem generis with the two paragraphs above it; i.e. 'equal to' or 'approximates' the amount of the dividend or distribution. Subsection 207-45(1) denies an entity the benefit of franking where the whole of the distribution has been manipulated in some circumstances while subsection 207-45(2) denies an entity the benefit of franking in circumstances where part of a share of a distribution has been manipulated and a determination has been made under paragraph 177EA(5)(b). These provisions support the interpretation that there is a deliberate intention on the part of the legislature to distinguish between the whole of a distribution and a portion of a distribution.

This interpretation is also supported by the following in the explanatory memorandum to Taxation Laws Amendment Bill (No.2) 1999 which introduced the related payment rule which shows that for a payment to be a 'related payment' the benefit passed on must either be equivalent to, or correlate with, the dividend benefit:

4.97 A taxpayer or associate is taken for the purposes of the provisions to have made a related payment if the taxpayer or associate is under an obligation to pass the benefit of a dividend or distribution to other persons. The requirement that the benefit be passed on means that if the benefit of the dividend or distribution remains with the taxpayer, there will not be a related payment....

4.104 Apart from cases where a payment or crediting relates to a particular dividend, there are cases where payments or credits are made in respect of a number of dividends, for example, under index derivatives. Where dividends are received from a number of shares and there is a matching outgoing under an index derivative, there may be a related payment. In some cases the related payment may be calculated in respect of dividends on shares which do not exactly match those held by the taxpayer. However, the match need not be exact for the payment to be a related payment, provided it is substantially the same. This is because small discrepancies in the relevant parcels of shares, particularly those shares with a low weighting in an index, will not necessarily prevent the payment under the derivative from effectively passing the benefit of the dividends to the counterparty. Generally, a correspondence between a share parcel and an index derivative which is sufficiently close to reduce risk materially in a qualification period will, if the index derivative requires a dividend equivalent benefit to pass to the holder of the derivative, also be sufficiently matched with the dividends on the parcel to constitute a related payment... [emphasis added]

4.105 It is necessary for the related payments rule to apply to Share Price Index (SPI) future transactions where the seller of the future hedges by holding the physical stock (ie. a share portfolio which is closely correlated with the All Ordinaries Index (AOI)) and effectively credits the buyer with the estimated dividends on the shares through the price against which the contract is agreed to be settled. This is because otherwise such transactions could be used to generate inappropriate tax benefits. Such benefits would come about because the tax payable on the dividends is offset by the seller paying less tax on the profit on the futures transaction or generating a greater loss (by virtue of the fact that the seller receives less cash on settlement of the contract). The seller, however, remains in the same economic position because any reduction in cash received on the futures transaction is offset by the dividend income. In this case the profit made (and therefore the tax paid) by the seller on the sale price does not include the amount of the expected dividends so that, when the dividends are received, there has been an effective tax deduction against them. Any rebates attaching to the dividend are therefore used to offset the tax payable on other income. Taxpayers entering into such transactions are indifferent to rises and falls in the price of the shares, because any losses or gains made by the seller on the shares will be offset by equivalent gains or losses on the SPI contract. [emphasis added]

Under the contract only part or a portion of the Company dividend will ever pass from the Trust to the Bank.

As such, a payment by the Trust under the contract will not be a related payment for the purposes of former Part 1A of former Division IIIAA of the ITAA 1936.

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