Edited version of private ruling

Authorisation Number: 1011711176521

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Ruling

Subject: Tax calculation methodology and record keeping for Securities (Securities listed in paragraph 295-85(3)(b) of the Income Tax Assessment Act 1997 (ITAA 1997) held by a superannuation fund and the application of Part IVA.

Issue 1

Question 1

Can the propagated methodology be used to choose the Securities disposed of to a third party for the purposes of determining the complying superannuation fund's income or deductions arising from that disposal under the following provisions?

(a) Division 230 of the ITAA 1997;

(b) Section 6-5 of the ITAA 1997;

(c) Section 8-1 of the ITAA 1997;

(d) Section 26BB of the Income Tax Assessment Act 1936 (ITAA 1936);

(e) Section 70B of the ITAA 1936; or

(f) Division 16E of the ITAA 1936.

Answer

Yes

Question 2

Will records maintained by the complying superannuation fund satisfy the record keeping obligations for securities (being securities listed in paragraph 295-85(3)(b) of the ITAA 1997) (Securities) in order that particular Securities can be appropriated to a particular sale?

Answer

Yes

Issue 2

Question 1

Does Part IVA of the ITAA 1936 apply to the propagated methodology in respect of making choices to dispose of one Security over another?

Answer

No

This ruling applies for the following periods:

Year ending 30 June 2012

Year ending 30 June 2013

Year ending 30 June 2014

Year ending 30 June 2015

The scheme commences on:

1 July 2011

Relevant facts and circumstances

This ruling is based on the facts stated in the description of the scheme that is set out below. If your circumstances are materially different from these facts, this ruling has no effect and you cannot rely on it. The fact sheet has more information about relying on your private ruling.

The Fund is a complying superannuation fund in accordance with section 995-1 of the ITAA 1997. It utilises a single pool of assets (the portfolio) and unitised structure to provide investment choice options for non-defined benefit accumulation and pension members and investments designated for defined benefit members (both non-pension and pension) of the Fund.

The Fund engages the services of a Custodian. The Custodian undertakes various services and transactions for, and on behalf of, the Fund. These include the following:

· open and maintain bank accounts and securities accounts;

· maintain separate sub-accounts in respect of investment managers or foreign currencies in the records of the Custodian;

· provide various other custodial services such as preparing and executing documents, and the provision of accounting and taxation reporting and services.

The Fund holds a range of Securities in its portfolio. These Securities are segregated into sub-portfolios with each sub-portfolio managed by an individual investment manager (Fund Manager).

Acquisition of Securities

The Fund Manager for each sub-portfolio has the authority to acquire Securities within the terms of their specific mandate.

It is therefore possible (and in fact commonly happens) that the Fund will hold a particular type of Security in more than one sub-portfolio at the same time. For example, the Fund will hold 10 year Australian Treasury Commonwealth Bonds in more than one sub-portfolio contemporaneously.

Record Keeping

The Custodian's electronic recording system together with the physical records contain information in relation to the Securities that allows for the separate identification of parcels of those Securities (a parcel of Securities are those which are identical and acquired at the same time). Hence, for each parcel of Securities, the system and records identify the acquisition date, number of Securities in the parcel, transaction identification number, tax cost, and unit cost.

Sale of Securities - Fund Manager instructions

The Fund Manager for each sub-portfolio also has the authority to sell Securities within the terms of their specific mandate. In general, a sale is effected by the Fund Manager providing a written instruction to their broker, who then puts this sell order into the market at the nominated price. Once the sale occurs, a sale message is sent to the Custodian's data entry unit, and that sale is then appropriately recorded in the electronic recording system

The choice of which of the Securities are disposed of in circumstances where there are multiple parcels, is determined automatically by the system. Currently, this is done in accordance with a general instruction provided by the Fund which is applied at the sub-portfolio level.

The Propagated Portfolio System

The Custodian has recently implemented an upgrade to their electronic recording system.. This will allow the Fund to provide a general instruction that will give the electronic recording system the ability to nominate the Securities that have been sold from any of the sub-portfolios (as noted above, presently this can only be made from the sub-portfolio of the Fund Manager initiating a sale).

The Propagated methodology will create a propagated portfolio which encompasses the tax information of all Securities from all sub-portfolios. It then allows a parcel within this propagated portfolio to be specifically selected (appropriated) for sale. Thus, where a Fund Manager initiates a sale of a Security, the Portfolio system (with the instruction from the Fund) will identify the Securities within the client's total investment portfolio as those which have been sold. Income tax consequences will be determined on the basis of that choice.

Propagated methodology allows the Fund to instruct that one of the following three methods will be applied to its propagated portfolio:

1. First-in-first-out - the selection of the Security/Securities is made according to the earliest acquisition date;

2. Loss maximisation - the selection of the Security/Securities is made so that it will result in the highest tax loss or lowest tax profit; or

3. Profit maximisation - the selection of the Security/Securities is made so that it will generate the highest tax profit or the lowest tax loss.

The Fund has instructed that the loss maximisation method will apply to its propagated portfolio. This will have effect from when the Custodian makes the system operational in relation to the Fund. It will remain as the methodology for the foreseeable future.

Relevant legislative provisions

Income Tax Assessment Act 1936 Section 26BB

Income Tax Assessment Act 1936 Section 70B

Income Tax Assessment Act 1936 Division 16E

Income Tax Assessment Act 1936 Part IVA

Income Tax Assessment Act 1997 Paragraph 295-85(3)(b)

Income Tax Assessment Act 1997 Division 230

Income Tax Assessment Act 1997 Section 6-5

Income Tax Assessment Act 1997 Section 8-1

Further issues for you to consider

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

· whether any gains or losses derived from the disposal of the Securities fall within the ambit of either sections 6-5 or 8-1 or Division 230 of the ITAA 1997 or sections 26BB or 70B or Division 16E of the ITAA36 and

· whether the Securities are of the type listed in section 295-85(3)(b) of the ITAA 1997.

· whether the Securities are held as trading stock (within the meaning of Division 70 of the ITAA 1997.

Should you need a private ruling on these or any other matter(s) you will need to lodge another application.

Issue 1 Question 1

Detailed reasoning

Relevant taxing provisions for the Fund's Securities

In order to answer this question it is first necessary to consider whether the following provisions listed by the Rulee have application to the Securities:

· Division 230 of the ITAA 1997

· section 6-5 of the ITAA 1997

· section 8-1 of the ITAA 1997

· section 26BB of the ITAA 1936

· section 70B of the ITAA 1936

· Division 16E of the ITAA 1936

· Division 230 of the ITAA 1997, section 6-5 and section 8-1 of the ITAA 1997

In relation to the first three provisions (Division 230, section 6-5, and section 8-1 of the ITAA 1997), Division 295 of the ITAA 1997 would ordinarily override the application of those provisions in relation to capital gains tax (CGT) events that happen to CGT assets.

Section 295-85 of the ITAA 1997 makes the CGT rules the primary code for determining the tax treatment of the gains or losses generated on the happening of a CGT event to certain CGT assets owned by a complying superannuation fund. Paragraph 295-85(2)(a) does this by ensuring that the provisions below do not apply to the CGT event:

· section 6-5 of the ITAA 1997 (ordinary income),

· section 8-1 of the ITAA 1997 (amounts you can deduct),

· sections 15-15 and 25-40 of the ITAA 1997 (profit-making undertakings or plans),

· section 230-15 (about financial arrangements), and

· sections 25A and 52 of the ITAA36 (profit-making undertakings or schemes).

However, an exception to this treatment is contained in paragraph 295-85(3)(b) of the ITAA 1997 for a CGT asset which is:

· debenture stock, a bond, debenture, certificate of entitlement, bill of exchange, promissory note or other security,

· a deposit with a bank, building society or other financial institution;

· a loan (secured or not), or

· some other contract under which an entity is liable to pay an amount (whether the liability is secured or not).

This is the exact description of the Securities that the Fund owns. As a consequence the provisions listed in subsection 295-85(2) of the ITAA 1997 may apply as the operative taxing provisions for those CGT assets.

Section 26BB, section 70B, and Division 16E of the ITAA 1936

In relation to the last three provisions (section 26BB, section 70B, and Division 16E of the ITAA 1936), they may also apply as the operative taxing provisions for the Securities for the following reasons.

Sections 26BB and 70B of the ITAA 1936 apply to the disposal or redemption of a traditional security (see subsection 26BB(2) and subsection 70B(2) of the ITAA 1936). A traditional security is defined as, inter alia, a security held by a taxpayer … (see definition in section 26BB(1) of the ITAA 1936, which is also applied to section 70B by subsection 70B(1) of the ITAA 1936). And security is defined in Division 16E of the ITAA 1936 (subsection 159GP(1)). That definition at least covers the meaning of Security the applicant has adopted in this Ruling.

As a consequence each of section 26BB and 70B of the ITAA 1936 may apply as the operative taxing provisions for certain of the Securities.

Division 16E of the ITAA 1936 subjects certain qualifying securities to an accruals taxing regime. A qualifying security for the purposes of Division 16E is, inter alia, any security … (subsection 159GP(1) of the ITAA 1936). As noted above the definition of security at least covers the meaning of Security the applicant has adopted in this Ruling.

As a consequence Division 16E may also apply as the operative taxing provisions for certain of the Securities.

Is there a legislative proscription against choosing a Security for disposal?

None of those operative taxing provisions listed above have rules which would prevent the Fund from making a choice of which Security it disposes of where there is more than one in its propagated portfolio. Similarly, there is no other general provision which explicitly prevents the making of a choice.

Therefore, if the Rulee uses the propagated methodology to make that choice, it will be effective for the purposes of those operative taxing provisions, subject to two matters:

· providing the Fund maintains sufficient records in order that the Security to be appropriated to a sale can be sufficiently identified (see answer to question 2), and

· the application of the general anti-avoidance provision (see answer to question 3).

Question 2

Detailed reasoning

Appropriating particular Securities to a sale

The question of whether the Fund's records are sufficient to make a choice to appropriate particular Securities from the propagated portfolio to a particular sale will depend on the nature and quality of those records. This is essentially a question of degree and fact.

Various taxation rulings deal with the general matter of keeping physical and electronic records (such as Taxation Ruling TR 96/7 and Taxation Ruling TR 2005/9). However, Taxation Ruling TR 96/4 specifically deals with the records that will be regarded as sufficient for the purposes of identifying shares, either for the purposes of valuation or (relevantly) for the purposes of appropriation for sale. Paragraph 14 to 16 of that Ruling states:

For that purpose, it will be necessary for a taxpayer to maintain contemporaneous records that will account for the purchase and sale of shares on a trade by trade basis. Those records will be regarded as sufficient for the purpose of specifically identifying shares if they:

· allocate a specific identity code to, or otherwise identify specifically, each buy or sell transaction;

· identify the company in which a parcel of shares is acquired;

· identify the class of shares acquired;

· identify the date on which shares are bought or sold;

· record the price at which parcels of shares are purchased and sold;

· record the balance of shares acquired in a particular trade where a proportion of those shares are appropriated to a subsequent sale transaction; and

· preserve the integrity of those codes and system through inbuilt system or other audit trails.

In addition, the records of a taxpayer must accurately reflect, in the manner outlined above, any consolidation or splitting of shares, issue of bonus shares, or acquisition of shares under a rights issue or dividend reinvestment scheme.

Where such an accounting system is used, a taxpayer has sufficient information in relation to the acquisition and disposal of shares to enable specific identification of shares appropriated to a particular trade.

It is considered that the principles outlined in those 3 paragraphs are applicable to the Securities of the Fund, suitably adapted for the fact that the relevant Security may not be a share in a company. It is acknowledged that paragraph 3 of that Ruling provides that it does not apply to the trustee of a complying superannuation fund. However, in the present circumstances the general principles expressed in this Ruling are equally applicable to the circumstances of the disposal of Securities by the Fund.

Using the propagated methodology, the Fund will have a realised tax report capturing the following details of its transactions for its parcels of Securities:

· a specific identity code to identify each buy or sell transaction,

· the class and category of the parcel of Securities,

· the date of acquisition/disposal (contract date) of the parcel of Securities,

· the original cost at which the parcel of Securities was purchased and the proceeds from the sale of the parcel of Securities,

· the balance of Securities of a particular class and category in the Fund's propagated portfolio after some of these Securities have been appropriated to a sale transaction, together with relevant attributes (identity code, acquisition cost etcetera).

These records are substantially maintained electronically.

There are principles that ensure the veracity and integrity of electronic records. For example, in the context of taxpayers carrying on a business, paragraph 37 of Taxation Ruling TR 2005/9 notes that the essential elements of an electronic record storage system include:

· record retention;

· data security and integrity;

· system documentation; and

· retaining archival copies; and accessibility.

In the present context, those principles are applicable to the electronic records kept by the Fund. The Fund has provided the relevant detail in regard to the electronic integrity of the electronic recording system, and is extracted in the description of the arrangement above. That information demonstrates that the electronic recording system exhibits integrity attributes consistent with the principles outlined in Taxation Ruling TR 2005/9.

Therefore, it is considered that the electronic records maintained by the electronic recording system (applying the propagated methodology) on behalf of the Fund can be relied upon so that particular Securities from the propagated portfolio can be appropriated to a particular sale.

Issue 2 Question 1

Detailed reasoning

Part IVA of the ITAA 1936 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 of the ITAA 1936, be obtained by a taxpayer in connection with a scheme to which Part IVA applies.

Practice Statement PS LA 2005/24 provides a description of the three elements that must be satisfied in order for Part IVA to apply:

· 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 was or would have been obtained in connection with the scheme; and

· after consideration of the factors specified in section 177D of the ITAA 1936, it is concluded that the scheme was entered or is entered into for the sole or 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.

Gummow and Hayne JJ of the High Court had this to say about that definition in Federal Commissioner of Taxation v Hart [2004] HCA 26; 55 ATR 712 at [43] per:

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 adoption and application of the propagated methodology in appropriating particular Securities to a disposal by the Fund, as described in the facts of this Ruling.

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 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

(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;…

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 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 appropriate Securities for sale from the relevant sub-portfolio of the Fund rather than from the propagated portfolio of the Fund. As a consequence of this, the Fund expects that the scheme will increase its after-tax returns and cashflows by reason of:

· reduced assessable income or increased deductions included in taxable income for a year of income; and/or

· losses or outgoings being incurred rather than income being derived for a year of income.

It is therefore clear that a tax benefit will arise; being the non-inclusion of assessable income or allowing of deduction not otherwise arising or available under the counter-factual.

We also note that subsection 177C(2) of the ITAA 1936 will not change this conclusion. That subsection will, in simple terms, mean no tax benefit arises where the taxpayer makes a choice expressly provided for under the ITAA 1936 or ITAA 1997. However in the present matter, the choice is not a matter expressly provided for under those Acts, but rather provided by the software enhancement. The conclusion as to tax benefit remains as stated in the previous paragraph.

Dominant purpose of the scheme

For Part IVA to apply to the scheme, it must have been entered into for the sole or dominant purpose of obtaining the tax benefit. In determining this regard is to be had to the eight matters outlined in paragraph 177D(b) of the ITAA 1936:

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 (v.

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

In FCT v. Spotless Services Ltd 96 ATC 5201, the joint judgment 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.

Historically limited software capabilities constrained the way the Fund appropriated its Securities to particular disposal transactions. That constraint was the limitation of the sub-portfolio basis of record keeping. This constraint has been removed by the propagated portfolio enhancement. As such, the manner of implementing the scheme is by way of a software update to the electronic recording system which can be made operational at a time of the Fund's choosing. However there is nothing of significance in the way this has been effected.

(ii) The form and the substance of the scheme

The form and substance of the scheme are essentially the same. It has no over-riding commercial effect other than to have the tax outcomes outlined above. After tax results are also affected, but this is of no substance in so far that it merely reflects the tax outcomes.

(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 is able to make the electronic recording system upgrade operational at a time of its choosing. It will do this in the 2011 income year. This is merely a reflection of when those upgrades were available, and when the ATO would provide this private ruling. There is no artificiality or contrivance in relation to the implementation date 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

As noted above, the results of the scheme are substantially limited to the tax effects. But for the scheme, Securities appropriated for disposal will be chosen from the sub-portfolios held by the Fund. As such, the scheme tax benefits described above would not occur. A further consequence is the accounting effects alluded to in paragraph 27 above.

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

The Trustee expects that the arrangement could result in a reduced tax payable by the Fund. Accounting results may also be affected.

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

The Trustee expects that the members and pensioners will have increased after tax returns as a result of the implementation of the propagated methodology.

(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 have been identified by the Trustee.

(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).

The Trustee has a fiduciary obligation to act in the best interest of Fund members and pensioners.

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 any 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 making of a choice under the propagated methodology to appropriate particular Securities to a particular disposal by the Fund.