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Ruling

Subject: Income - securities

Question 1

Will the disposal of the securities give rise to assessable income under section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997) if sold after the specified period?

Answer

Yes

Question 2

Will the disposal of the securities give rise to assessable income under section 6-5 of the ITAA 1997 if sold after the alternative specified period?

Answer

Yes

Question 3

Will the disposal of the securities give rise to a capital gain under part 3-1 of the ITAA 1997 if sold after the specified period?

Answer

No

Question 4

Will the disposal of the securities give rise to a capital gain under part 3-1 of the ITAA 1997 if sold after the alternative specified period?

Answer

No

This ruling applies for the following periods:

1 July 2011 - 30 June 2012

1 July 2012 - 30 June 2013

1 July 2013 - 30 June 2014

1 July 2014 - 30 June 2015

The scheme commences on:

1 July 2011

Relevant facts and circumstances

The taxpayer is a unit trust (the Taxpayer). The Taxpayer proposes to acquire securities.

The securities have been designed to enable investors to gain exposure to a return from investing in a specific commodity without trading and storing.

The security is comprised of a share of nominal value and a beneficial interest in the relevant amount of the commodity, which is held in a separate trust for each holder.

A separate trust is established for each holder of a share and the entitlement is held by the trustee on trust for each holder. The holder will be absolutely entitled to the commodity that corresponds to the share at all times.

The holder of the security will not be entitled to distributions on the security. However, the holder may at any time, redeem all or part of their holding of securities. The holder may also sell their security on the market.

The Taxpayer does not carry on a business of trading in securities.

Previously, the Taxpayer derived income from providing management services. This activity has ceased. The Taxpayer now proposes to operate as an investment trust and derive returns of behalf of the unit holders. The Taxpayer intends to make further investments in the future but there are no further specific transactions in contemplation at this time.

The Taxpayer proposes to acquire a class of the security. This is based upon an expectation that the value of the underlying commodity will increase in a specified time period.

The estimated size of the investment was provided.

The Taxpayer will assess the investment on an ongoing basis and may decide to sell all or part of the securities at any time depending upon market conditions and the Taxpayer's view on the outlook for the securities relative to other investment opportunities.

The Taxpayer has advised that if other investments have a greater outlook you would expect to sell the securities for a gain.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 6-5

Does Part IVA apply to this ruling?

Part IVA of the Income Tax Assessment Act 1936 is a general anti-avoidance rule that can apply in certain circumstances if you or another taxpayer obtains a tax benefit in connection with an arrangement and it can be concluded that the arrangement, or any part of it, was entered into or carried out by any person for the dominant purpose of enabling a tax benefit to be obtained. If Part IVA applies the tax benefit can be cancelled, for example, by disallowing a deduction that was otherwise allowable.

We have not fully considered the application of Part IVA to the arrangement you asked us to rule on, or to an associated or wider arrangement of which that arrangement is part.

If you want us to rule on whether Part IVA applies we will first need to obtain and consider all the facts about the arrangement which are relevant to determining whether Part IVA may apply.

For more information on Part IVA, go to our website www.ato.gov.au and enter 'part iva general' in the search box on the top right of the page, then select: 'Part IVA: the general anti-avoidance rule for income tax'.

Reasons for decision

Subsection 6-5(1) of the Income Tax Assessment Act 1997 (ITAA 1997) defines ordinary income as income 'according to ordinary concepts'. Under subsection 6-5(2) of the ITAA 1997 the assessable income of an Australian resident includes the ordinary income derived directly or indirectly from all sources during the income year.

The tax legislation does not provide specific guidance on the meaning of income according to ordinary concepts. However, a substantial body of case law exists which identifies likely characteristics.

In determining whether an amount is ordinary income, the courts have established the following principles:

· what receipts ought to be treated as income must be determined in accordance with the ordinary concepts and usages of mankind, except in so far as a statute dictates otherwise

· whether the payment received is income depends upon a close examination of all relevant circumstances

· whether the payment received is income is an objective test.

Relevant factors in determining whether an amount is ordinary income include:

· whether the payment is the product of any employment, services rendered, or any business

· the quality or character of the payment in the hands of the recipient

· the form of the receipt, that is, whether it is received as a lump sum or periodically

· the motive of the person making the payment, but noting that this latter factor is rarely decisive, as a mix of motives may exist.

Ultimately, whether or not a particular receipt is ordinary income depends on its character in the hands of the recipient. The whole of the circumstances must be considered.

In FC of T v. The Myer Emporium Ltd 87ATC 4363 (Myer), the Full High Court said (at 4370):

'The periodicity, regularity and recurrence of a receipt has been considered to be the hallmark of its character as income in accordance with the ordinary concepts and usages of mankind.'

Notwithstanding the comments in Myer, a receipt which is not periodic, regular and recurrent will not necessarily preclude the receipt from being considered as ordinary income. The decision in Myer is also authority for the principle that a profit arising from an isolated business transaction can also be income in nature if the taxpayer's purpose for entering into the transaction was to make a profit.

Taxation Ruling TR 92/3 sets out the Commissioner's view on whether profits made from isolated transactions are ordinary income. 'Isolated transactions' refers to:

· those transactions outside the ordinary course of business of a taxpayer carrying on a business; and

· those transactions entered into by non-business taxpayers.

Whether a profit from an isolated transaction is income according to ordinary concepts depends very much on the circumstances of the case. However, where a taxpayer who does not carry on a business makes a profit from an isolated transaction, that profit is income if:

(a) the intention or purpose of the taxpayer in entering into the profit-making transaction or operation was to make a profit or gain; and

(b) the transaction or operation was entered into, and the profit was made, in carrying out a business operation or commercial transaction.

Intention or purpose

The relevant intention or purpose of the taxpayer (of making a profit or gain) is not the subjective intention or purpose of the taxpayer. Rather, it is the taxpayer's intention or purpose discerned from an objective consideration of the facts and circumstances of the case.

It is not necessary that the intention or purpose of profit-making be the sole or dominant intention or purpose for entering into the transaction. It is sufficient if profit-making is a significant purpose.

The taxpayer must have the requisite purpose at the time of entering into the relevant transaction or operation. Example 4 in TR 92/3 states the following:

78. Mr Goldfinger purchased a number of gold bars for $100,000 and, following a sharp rise in the price of gold, sold the gold bars one week later for $110,000. Goldfinger did not carry on a business and had no previous dealings in gold.

79. The profit of $10,000 is income and assessable under subsection 25(1). It can be inferred from the objective circumstances (especially the quick sale following a rise in price and the fact that the asset had no immediate use other than as an object of trade) that profit-making was a significant purpose of Goldfinger in acquiring the gold bars. Furthermore, the substantial amounts of money involved and the nature of the asset traded lead to the conclusion that the transaction was commercial in nature,'

This example illustrates that as the gold had no immediate use other than as an object of trade it can be inferred that the taxpayer had a profit making intention when it acquired the gold. As an investment, gold has no immediate use since it does not generate income over the life of the investment (e.g. dividends, rent, royalties or interest). In this regard, the only return that can be derived from an investment in gold is the profit generated upon resale.

A similar scenario was considered in the Board of Review case, Case S79 85 ATC 577 which involved a taxpayer who invested money in gold and diamonds, but did not recognise income from the sale of these commodities in her income tax returns. The taxpayer claimed that the commodities had been purchased as a hedge against inflation. The Board considered whether the taxpayer's profits from the sale of these commodities were income, and ultimately held that the taxpayer acquired the commodities for the dominant purpose of reselling them at a profit. Importantly, the Board made the following comments (at 58 1-582):

5. For the taxpayer to succeed it must be found that the sole or dominant purpose which actuated the acquisition of these commodities was not the sale of those commodities by the taxpayer at a profit but rather some other purpose. A person who buys such commodities with the dominant purpose of selling them at a profit may well obtain a hedge against inflation and may well have something to leave to the children.

6. In the course of cross-examination the taxpayer conceded that the "something" which she had in mind to leave to the children was not the particular commodities but rather a fund. ... The taxpayer also disclaimed a purpose of using the commodities as security to borrow money. Whilst I accept that the taxpayer expected to hold the commodities, and especially the diamonds, for a considerable time before selling, such an intention is not inconsistent with a sec. 26(a) purpose. Unlike some silver purchased in 1975 and still held, there is no suggestion that the commodities had any sentimental value. Nor was there some special pride of possession in the commodities themselves.

7… I find it quite impossible to imagine that she never expected to vary her investments in these commodities in her lifetime. On the contrary, l am satisfied that she did expect to do so and to thereby make a profit (for tax purposes if not in real terms). Indeed, the gold was sold only 15 months after acquisition in order to buy diamonds because the taxpayer was influenced by a newsletter to vary the investment. The fact that the diamonds were sold earlier than expected does not make the profits tax free, nor does it assist the taxpayer to say that she "never visualized needing to spend the money". I am satisfied that the taxpayer did intend to sell these commodities at a profit although she hoped it would be "later" rather than "sooner".

8. In all the circumstances, and having carefully considered the evidence and the submissions made on the taxpayer's behalf, I have no hesitation in finding, on the balance of probabilities, that the taxpayer acquired the commodities for the dominant purpose of selling them at a profit.

Carrying out a commercial transaction

For a transaction to be characterised as a business operation or a commercial transaction, it is sufficient if the transaction is business or commercial in character.

Paragraph 13 of TR 92/3 lists factors which may be relevant in considering whether an isolated transaction amounts to a business operation or commercial transaction. Relevant factors include:

· the nature of the entity undertaking the operation or transaction;

· the nature and scale of other activities undertaken by the taxpayer;

· the amount of money involved in the operation or transaction and the magnitude of the profit sought or obtained;

· the nature, scale and complexity of the operation or transaction;

· the manner in which the operation or transaction was entered into or carried out;

· if the transaction involves the acquisition and disposal of property, the nature of that property; and

· the timing of the transaction or the various steps in the transaction.

As the Taxpayer is not carrying on a securities trading business, it is necessary to consider if the Taxpayer has entered into a business operation or commercial transaction.

Application to your situation

There is an intention to make a profit

With regard to TR 92/3 and judicial guidance referred to above, the following factors are relevant in considering whether the Taxpayer has a profit making intention when acquiring the security:

· the interest in the underlying commodity has no immediate use other than as an object of trade (i.e. it does not generate any other form of return, other than on resale at a profit);

· the nature of the taxpayer maybe important, especially where the taxpayer is a sophisticated investor;

· the underlying commodity has no sentimental value to the taxpayer or pride of possession to the taxpayer.

Where each of these factors is present there is a degree of certainty in the conclusion that the intention of the taxpayer acquiring the security is to make a profit and that profit making is the very essence of the transaction.

In applying the above guidance to the Taxpayers situation, the following is noted:

· the security does not entitle the Taxpayer to any periodic distributions or returns, it is understood that no such distributions have been paid historically, and the only return that the Taxpayer can generate from the security is from disposal of the security at a higher price than its acquisition price. This is an indication that the security should be simply an 'object of trade'; and

· as the Taxpayer is acquiring the security through a listed product, it is unsustainable that the security should have any sentimental value or pride of possession for the Taxpayer.

The facts suggest the Taxpayer has a profit making intention at the time of acquiring the securities.

The transaction is commercial in nature

The factors in determining whether a transaction is commercial in nature are listed in Paragraph 13 of TR 92/3 and are discussed above. Those factors in relation to this case are discussed:

· the entity undertaking the transaction is a unit trust

· the Taxpayer proposes to operate as an investment trust and derive returns of behalf of the unit holders. the Taxpayer has a history of deriving income from the provision of management services. This activity has ceased. The Taxpayer intends to make further investments in the future but there are no further specific transactions in contemplation at this time

· the amount of money involved in the transaction is significant.

· the transaction is not significantly complex, but there will be a significant investment and given the nature of the asset traded, as discussed above, it is usually considered to be commercial in nature, and

· this is the first transaction proposed by the Taxpayer who intends to trade in the asset upon an expectation that the value of the underlying commodity will increase over a specified period. At the time of acquisition the Taxpayer intends to dispose of the asset within this set timeframe.

From an objective consideration of the factors set out in paragraph 13 of TR 92/3 above it can be concluded that the transaction is commercial in nature.

This is consistent with the conclusion set out in Example 4 in the TR 92/3 above, which states that the nature of the asset traded, in the circumstances, leads to the conclusion that the transaction was commercial in nature. The material difference in this example is noted. In the example the taxpayer acquired and disposed of the asset within a week. In this case the taxpayer intends to acquire and dispose of the asset with a longer specified period. However, the nature of the asset and the significant investment are significant factors in concluding the transaction is commercial in nature.

Summary

On a weighing of the facts it can be concluded that in this situation the acquisition and subsequent disposal of the securities would be beyond that of a mere realisation of a capital asset and amount to an isolated profit making transaction.

There is a demonstrated intention to profit and the transaction will be carried out in a commercial manner. Accordingly, the proceeds will be considered ordinary assessable income under section 6-5 of the ITAA 1997 and the CGT provisions will not apply by virtue of section 118-20 of the ITAA 1997.

Note

Schedule 2F of the Income Tax Assessment Act 1936 contains trust loss measures which may become applicable in your situation.