Edited version of private ruling

Authorisation Number: 1011652254693

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Ruling

Subject: Calculation Methodology for CGT

Issue 1

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 income year and satisfies the requirements of subsection 121-20(1) of the ITAA 1997?

Answer

Yes. The Commissioner accepts the manner in which the capital gain or capital loss is calculated by the taxpayer by nominating the specific shares from the taxpayer's aggregated portfolio.

Issue 2

Question 1

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

Answer

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

This ruling applies for the following periods:

Year ending 30 June 2012

Year ending 30 June 2013

Year ending 30 June 2014

The scheme commences on:

1 July 2011

Further issues for you to consider

When considering your request for a private ruling, we have limited our answers to the matters directly raised in your application. This ruling does not provide the Commissioner's view on matters outside the application including:

§ Whether the Trustee is the beneficial owner of all the relevant assets under custodianship or management by different entities: and

§ The characterisation of the gain or loss on disposal of the relevant assets.

Should you need a private ruling on these or any of these matters you will need to lodge another application.

Relevant facts and circumstances

The taxpayer is a complying superannuation fund (the Fund)

The Fund is managed on a day to day basis by a trustee company.

The Trustee engages a large number of fund managers to invest the funds it holds. For each asset class, the Trustee usually engages a number of fund managers with the relevant expertise. Each fund manager is allocated an amount of funds for which it makes all the investment decisions.

The Trustee outsources the custodian role to the Custodian. This entails all investments acquired at the direction of the fund managers being acquired in the Custodian's name on behalf of the Trustee. The Custodian also maintains the accounting and tax records for these investments. The work the Custodian performs for the Trustee includes maintaining the capital gains tax records and calculations on these investments.

The Trustee utilises a single pool of assets and provides different member investment choice options for Superannuation members. From a tax perspective, the Fund as a whole is the taxpayer. The main features are as follows:

§ • The Pension assets of the fund are segregated and are invested in Pooled Superannuation Trusts (PSTs). These assets are therefore not relevant to the proposed arrangement.

§ • Fund managers are appointed by the Trustee to manage a discrete portfolio within a particular mandate, which sets out certain criteria (such as limits of exposure to a single asset). The fund managers decide what shares to hold or trade.

§ • Fund manager portfolios are grouped into asset classes (for example Australian Equities). The asset class is valued, and an interest rate is determined.

§ • The Trustee determines the asset allocation of the member options and the amount awarded to each fund manager. The trustee is also responsible for the appointment or removal of fund managers.

§ • All fund managers are independent of the trustee.

The roles or duties of the Custodian, Fund Managers and After-Tax Service
Provider

The role of the Custodian is as follows:

• To hold on trust all the assets purchased via instructions from the Fund Managers. This includes the legal ownership of the investments (that is, the assets of the Trustee are held in the name of the Custodian).
• The Custodian is responsible for settlement of all trades instructed by an authorized representative that is, a fund manager).
• As it is the Custodian's shares (held on behalf of the Trustee) which are being sold, it is the Custodian who is responsible for settling the trade.
• It is also responsible for the collection of all income entitlements in respect of the investments.
• At the same time, the Custodian records the sale in its records for the Trustee.
• The Custodian selects which parcel of shares are sold as it is the Custodian that keeps the books and records relating to the buying and selling of shares on behalf of the Trustee.
• The Custodian also provides accounting and taxation reports to assist the trustee in meeting its regulatory obligations.
• The Custodian allocates the specific tax lots to disposals in accordance with the methodology determined by the fund.
• The Custodian calculates the value of each portfolio of asset classes and the member options.
• The Custodian also provides accounting and taxation reports to assist the trustee in meeting its regulatory obligations.
• The Custodian allocates the specific tax lots to disposals in accordance with the methodology determined by the fund.
• The Custodian also provides a mandate monitoring service and performance reporting on an individual fund manager basis on a pre-tax basis.

The role of the fund manager is as follows:

• The fund manager maintains a portfolio of assets within the guidelines set out in the Agreement on behalf of the Trustee.
• The fund manager is appointed and awarded with an amount of money to manage.
• When a fund manager decides to sell some of the Trustee's shares, the Fund Manager instructs a broker to sell.
• The fund manager is an authorised representative of the Trustee and is therefore able to instruct the broker to make the sale using the Custodian's account to settle the transaction.
• The fund manager does not buy, hold or sell the shares.
• The fund manager makes the decision as to what securities to buy hold or sell, and in what quantities. It instructs the Custodian to carry out its decisions via contract notes. (Note: the fund manager does not select which parcel of shares is to be sold)
• The fund manager merely tells the broker to sell a certain number of a type of shares from the Custodian's account.
• Where there are voluntary corporate actions, the fund manager will instruct the Custodian
• The fund manager acts in an agent capacity.

The role of the after-tax service provider is as follows:

• The after-tax service provider calculates the after-tax return of each fund managers' portfolios.
• The after-tax service provider sources underlying holdings and transaction data directly from the Custodian in the preparation of the reports
• The after-tax service provider calculates after-tax returns according to its after-tax calculation methodology.
• The after-tax service provider sources an appropriate after-tax benchmark for each portfolio. The benchmark is calculated according to its methodology and is based on the constituents of the fund manager's pre-tax benchmark.
• Reports calculated by the after-tax service provider are provided to both the Trustee and fund managers.

The Aggregated Portfolio System

The capital gains tax records are currently kept by the Custodian on a fund manager by fund manager basis, where the purchases and sales of shares by a particular fund manager are recorded separately for each fund manager. Where a fund manager sells shares in a company on behalf of the Trustee, the Custodian needs to identify the parcel of shares sold in order to calculate the capital gain or loss arising to the Trustee.

Currently, the Custodian makes this selection from the portfolio of shares identified in its system as having been acquired under the instruction of that fund manager. The Trustee adopts a 'specific identification' basis, which essentially chooses the parcel with the highest CGT cost base. The Trustee's overall CGT position is determined by adding up all the gains and losses from each of the fund manager portfolios, before offsetting the losses against the gains and then claiming the one-third discount to the extent it is applicable.

The Custodian is offering an upgraded system. It is proposed that the records for all fund managers in a particular asset class (for example Australian Equities) will be linked to an 'aggregated portfolio'.

Data will continue to be entered into the portfolios established for each fund manager (sub-portfolio) with processing done at that level, but this information will automatically be replicated in the aggregated portfolio. However, the information in the aggregated portfolio will not be distinguished by sub-portfolio.

The Custodian would then perform parcel selection at both the individual manager level (that is, sub-portfolio) and also at the aggregated portfolio level. This is likely to result in different parcels being selected at the sub-portfolio and aggregated portfolio levels. Calculations at the aggregated portfolio level will be used for calculating the Trustee's tax position. The Asset Management Company will continue to calculate manager post-tax performance at the sub-portfolio level solely to monitor manager post-tax performance.

It is intended that an aggregated portfolio be created for Australian and International shares held by the Trustee.

The calculation of accounting gains and losses on disposal of shares in the financial statements, while done on a weighted average cost basis, will be done at the same aggregated level as would be done for tax purposes.

System Capabilities

The Custodian's system is designed at the individual manager level to:
• Record the date that a fund manager entered the contract to buy or dispose of a parcel of assets (that is, a parcel of identical shares).
• Record the name and security identifier for example SEDOL or ISIN) of the assets required.
• Record the type and class of asset for example ordinary shares).
• Record the number of assets (for example 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 (for example 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 etcetera.
• Record the proceeds received and any incidental costs incurred (for example brokerage), in the case of a disposal.
• Record the notional 'nominated parcel of assets' that was subject to the CGT event. Note: This is notional at the individual manager level to allow post tax performance reporting to be produced at the manager level, so that the Trustee can monitor individual manager performance on a pie and notional post tax basis.
• 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.

The same information is replicated in the aggregated portfolio, such that all of the transactions of the individual managers are recorded in the aggregated portfolio.

• The 'nominated parcel of assets' that was subject to the CGT event, may be different to the records at the individual manager level, since the selection is based on all parcels held within the aggregated portfolio. This nominated parcel of assets is what is then used for the Fund's tax records.
• The method of selecting the 'nominated parcel of assets' subject to the CGT event is automated within the system. There are a number of specific parcel selection options supported by the system - the Trustee will utilise the 'maximise loss routine'. This selects the parcels from those available in the aggregated portfolio which results in the smallest capital gain, taking into account any discount available for parcels held more than 12 months (essentially the parcel with the highest CGT cost base).
• Once a parcel of shares has been selected as the 'nominated parcel of assets', that selection is final.
• The aggregated portfolio (rather than the underlying fund manager portfolios) is included in the consolidation to calculate both the accounting and tax results at the Fund level.

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

Relevant legislative provisions

Income Tax Assessment Act 1936 Part IVA.

Income Tax Assessment Act 1936 Section 177A

Income Tax Assessment Act 1936 Section 177C

Income Tax Assessment Act 1936 Section 177D

Income Tax Assessment Act 1936 Section 177F

Income Tax Assessment Act 1997 Section 100-45

Income Tax Assessment Act 1997 Section 102-5

Income Tax Assessment Act 1997 Section 121-20 and

Income Tax Assessment Act 1997 Section 121-25

Issue 1 Question 1

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 (for example 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, 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 circumstances, 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), at paragraph 4 states:

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.

In the present case, the Fund has a number of asset classes and is the beneficial owner of all of its assets. The Fund engages various fund managers to make all investment decisions on its behalf. The Custodian will follow the directions of the fund managers and settle all shares in the Custodian's name as nominee for the Fund.

The custodian also maintains the accounting and tax records for these investments to enable the Fund to determine its capital gain or loss. The tax records are currently kept separately on individual fund manager basis (sub-portfolio).

Under the enhanced record keeping system, all relevant information will continue to be recorded in the sub-portfolios level. The information is also replicated at the aggregated portfolio which reflects the actual ownership level of all the parcels of shares held across the Fund.

The proposed custodian's system would perform the parcel selection at both the individual portfolio level and also at the aggregated portfolio level and decide 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 Fund's CGT tax position.

Where the taxpayer maintains sufficient records to specifically identify the shares and its cost base Nevertheless, TR 96/4 provides guidance on what records should be kept for the purpose of identifying shares. In this respect, it is considered that the key records that a taxpayer needs to maintain for CGT purposes with respect to the identical shares must include (but are not limited to) the following:

§ the specific code of each buy or sell transaction;

§ the date, CGT cost base and reduced cost base, quantity, name of the company, type and class of shares acquired by the taxpayer (that is, the tax attributes);

§ the date, quantity, name and capital proceeds of the shares sold;

§ incidental costs incurred in acquiring or disposing the shares;

§ the calculation of capital gain or loss;

§ the balance of shares remaining in a particular trade and the tax attributes of those shares;

§ any adjustments required under taxation law; and

§ data security and inbuilt system audit trails.

In the present case, the Fund has asserted that the custodian's system is designed to keep the detailed records of both the accounting and tax results at the Fund level as follows:

§ record the date that an investment manager entered the contract to buy or dispose of an asset (that is, a parcel of identical shares);

§ record the name and security identifier of the assets;

§ record the type and class of asset;

§ record 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;

§ 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 etcetera;

§ record the proceeds received and any incidental costs incurred;

§ record the selection of the '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 generate unique transaction ID number; and

§ transactions in a foreign currency are converted to Australian dollars at the exchange rate on the contract date.

Further, the Custodian's system 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 level.

The Fund assures that the records are kept electronically and the custodian's system meets the record keeping requirements set out in TR 2005/9 with respect to:

§ record retention;

§ data security and integrity;

§ system documentation;

§ retaining archival copies; and

§ accessibility.

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

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

Issue 2 Question 1

Part IVA of the ITAA 1936 (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.

Pursuant to Practice Statement PS LA 2005/24, Part IVA applies when the following elements are satisfied:

§ there is a 'scheme' as defined in subsection 177A(1) of the ITAA 1936;

§ a 'tax benefit' as defined in subsection 177C(1) of the ITAA 1936; and

§ after consideration of a number of factors specified in section 177D of the ITAA 1936, it is concluded that the scheme was entered or is entered into for the dominant purpose of obtaining the tax benefit.

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; 2004 ATC 4599 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 arrangements proposed. The applicant also recognises that the establishment and use of the Propagation product, the creation of aggregated portfolio and the share parcels from the aggregated portfolio, rather than from the sub-portfolios, is likely to be within the definition of scheme.

The tax benefit

Subsection 177C(1) of the ITAA 1936 provides that the following tax benefit may be obtained by a taxpayer in connection with a scheme:

(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

(b) a deduction being allowable to the taxpayer in relation to a year of income where the whole or a part of that deduction would not have been allowable, or might reasonably be expected not to have been allowable, to the taxpayer in relation to that year of income if the scheme; 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 had not been entered into or carried out; or

(bb) a foreign income tax offset being allowable to the taxpayer where the whole or a part of that foreign income tax offset would not have been allowable, or might reasonably be expected not to have been allowable, to the taxpayer if the scheme had not been entered into or carried out;

….

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.

In ascertaining whether there has been a tax benefit, regard must be had to the position of what 'might reasonably be expected' to have occurred 'if the scheme had not been entered into or carried out'.

In Peabody v. FC of T 92 ATC 4585; (1992) 24 ATR 58 the High Court said, at [4671]:

A reasonable expectation requires more than a possibility. It involves a predication as to events which would have taken place if the relevant scheme had not been entered into or carried out and the predication must be sufficiently reliable for it to be regarded as reasonable.

In the arrangement, the reasonable expectation is that if the scheme is not entered into, the Fund would continue to select the nominated parcel of shares from the manager investment portfolios and the CGT position for the Fund is determined by adding up all the individual gains or losses from each investment manager portfolio.

After the scheme is put in place, the likely benefit would be the enhanced capacity to select the parcels from the entire aggregated portfolio rather than from the individual portfolios.

The applicant also stated that 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.

It is concluded that there is a reasonable expectation that the Fund will obtain a tax benefit as defined in connection with the scheme.

Dominant purpose of the scheme

For Part IVA to apply to the scheme, it must have been entered into for the dominant purpose of obtaining the tax benefit. To determine whether a taxpayer entered into the scheme with the sole or dominant purpose of obtaining a tax benefit, it is necessary to consider the eight factors in section 177D of the ITAA 1936. The test is whether, having regard to:

(i) the manner in which the scheme was entered into or carried out;


(ii) the form and substance of the scheme;


(iii) the time at which the scheme was entered into and the length of the period during which the scheme was carried out;


(iv) the result in relation to the operation of this Act that, but for this Part, would be achieved by the scheme;


(v) any change in the financial position of the relevant taxpayer that has resulted, will result, or may reasonably be expected to result, from the scheme;


(vi) any change in the financial position of any person who has, or has had, any connection (whether of a business, family or other nature) with the relevant taxpayer, being a change that has resulted, will result or may reasonably be expected to result, from the scheme;


(vii) any other consequence for the relevant taxpayer, or for any person referred to in subparagraph (vi), of the scheme having been entered into or carried out; and


(viii) the nature of any connection (whether of a business, family or other nature) between the relevant taxpayer and any person referred to in subparagraph (vi),

it would be concluded 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.

(i) The manner in which the scheme was entered into or carried out.

In Federal Commissioner of Taxation v. Spotless Services Ltd (1996) 186 CLR 404; 96 ATC 5201; (1996) 34 ATR 183, the joint judgement of the High Court noted that 'manner' and 'entered into' are not to be given any restricted meaning and stated that 'manner' includes consideration of the way in which and method or procedure by which the particular scheme in question was established.

As the applicant pointed out in the application, the Fund has a large number of asset classes and engages a number of managers to invest the funds it holds. Each investment manager manages a portfolio for which they make all the investment decision as to what shares to hold or trade.

The Propagation system in the scheme has been developed by the custodian to expand the services it provides to the Fund. The purpose is to enhance the data available for the Fund at sub-portfolio level and also at the Fund level to enable the Fund to make the relevant decision about the parcel selection.

The scheme is carried out in a manner which would have made practical business sense. The Fund does not obtain a tax benefit greater than what any person or entity would receive when selecting the identity of assets disposed.

(ii) The form and the substance of the scheme

The Propagation product essentially provides the detailed records to enable the Fund to use the 'selection of the identity of shares disposed of' method provided for in TD 33.

Where the same security is held across different portfolios, the Propagation product provides the data available to the Fund and automatically selects the parcels from the aggregated portfolio that achieves the Fund's commercial objective and results in the maximum loss or the minimum gain.

The substance of the arrangement is that the arrangement will typically have the effect of potentially decreasing capital gains, or of deferring capital gains to later periods, by enabling selection of parcels of shares with more favourable cost base attributes.

(iii) The time at which the scheme was entered into and the length of the period during which the scheme was carried out

The Fund will enter into the arrangement between 1 July 2011 and 30 June 2014 and run for an indefinite period. The timing of the scheme is consistent with the stated commercial objective, that is, the introduction and proposed changes to the system and selection method. There is no artificiality or contrivance in relation to the implementation of the scheme.

(iv) The result in relation to the operation of this Act that, but for this Part, would be achieved by the scheme

The relevant result sought by the scheme would be to select the parcels which give the best CGT outcome, mainly by deferring the recognition of a net capital gain or deriving a discount capital gain. This result may nevertheless be weighted against other aspects of the scheme.

Provided the scheme occurs in accordance with TD 33, a correct tax outcome will result, notwithstanding that it will be one which is more beneficial to the taxpayer than under their former practice.

(v) Any change in the financial position of the relevant taxpayer's financial position

The applicant states that the Fund will pay additional fees to the custodian for the provision of this service under the normal commercial arrangements. No other change was identified.

(vi) Any change in the financial position of other person

The custodian's financial position would change, in that the custodian will derive additional custodian fees for the provision of this service. The consequence is commercial in character.

(vii) any other consequence for the relevant taxpayer, or any person referred to in subparagraph (vi), of the scheme having been entered into or carried out

No other consequences identified by the applicant under this paragraph.

(viii) the nature of any connection (whether of a business, family or other nature) between the relevant taxpayer and any person referred to in subparagraph (vi).

As the applicant points out, the custodian is an arm's length service provider to the Fund. The additional service is provided to enable the Fund to gather relevant data of the shares held across portfolios and make the most effective decision.

Conclusion:

Having regard to the relevant factors specified in section 177D of the ITAA 1936, it is concluded that the scheme will not be 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.