Edited version of your private ruling

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Ruling

Subject: Trading Stock and Securities Lending Arrangement

Question 1

To the extent that the shares are held by the taxpayer as trading stock, does section 26BC, particularly, subsection 26BC(4) in conjunction with subsection 26BC(12) of the Income Tax Assessment Act 1936 (ITAA 1936) apply to the gains and/or losses of the taxpayer from the year ended 30 June 20XX to the date on which the margin loan provider went into liquidation?

Answer

Yes.

Question 2

If no, or where the Securities Lending Arrangement (SLA) is not completed (for the purposes of section 26BC of the ITAA 1936) and, to the extent that the shares are held by the taxpayer as trading stock, should gains and/or losses on the acquisition and disposal of shares by the taxpayer be dealt with under Division 70 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

Yes.

Question 3

If no, and to the extent that the shares are held on revenue account by the taxpayer, will any gains and/or losses be dealt with under sections 6-5 and 8-1 of the ITAA 1997?

Answer

Not Applicable.

Question 4

If no, is there any other mechanism within the ITAA 1936 or ITAA 1997 by which the taxpayer can account for the gains/losses?

Answer

Not applicable.

This ruling applies for the following period<s>:

Year Ended 30 June 2005

Year Ended 30 June 2006

Year Ended 30 June 2007

Year Ended 30 June 2008

The scheme commences on:

XX December 20XX

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.

During the years ended 30 June 20XX to 30 June 20XX the taxpayer bought and sold listed shares as a share trader. As part of the taxpayer's share trading activities, the taxpayer had a margin loan facility with a margin loan provider.

Consistent with the behaviour of a share trader, the taxpayer generally had a holding period of less than 12 months for shares although some limited circumstances, parcels of shares would be held for longer than 12 months.

The taxpayer, upon purchasing shares would immediately transfer the shares to the margin loan provider, under what has been determined to be a Securities Lending Arrangement (SLA). This had the effect of transferring legal and beneficial ownership in the shares to the margin loan provider.

For the purposes of the SLA, the margin loan provider is the borrower and the taxpayer that is the subject of this application is the securities lender.

When the taxpayer wanted to sell parcels of shares, the taxpayer would send a written request to the margin loan provider requesting the return of the securities. The securities would ordinarily be returned to the taxpayer shortly thereafter. The taxpayer could then sell these shares through the Australian Stock Exchange (ASX).

You state that during the period of the arrangement, neither the taxpayer not the taxpayer's advisors were aware that the legal and beneficial had been transferred to the margin loan provider under the SLA.

During the year ended 30 June 20XX and during the operation of the SLA between the taxpayer and the margin loan provider, the margin loan provider was placed into liquidation and receivers and managers were appointed.

The taxpayer sought to recover shares lent to the margin loan provider but was unable to and became an unsecured creditor of the margin loan provider.

Liquidator's dividends were subsequently paid in tranches to the taxpayer.

It was not until after the liquidation of the margin loan provider that the taxpayer became aware that the legal and beneficial interest in the securities had been disposed of under the SLA. As such, for the purposes of completing the taxpayer's income tax returns for the years ended 30 June 20XX to 20XX, losses and gain in relation to the taxpayer's share trading were previously dealt with under Division 70 of the ITAA 1997 (trading stock provisions).

You note that the taxpayer has previously lodged income tax returns for the years 20XX to 20XX inclusive. The taxpayer's income tax returns for 20XX to 20XX have not yet been lodged.

As the taxpayer and taxpayer's advisors were unaware that the taxpayer had engaged in securities lending, the 20XX to 20XX income tax returns were prepared on the basis that he taxpayer undertook normal margin lending activities whereby legal but not beneficial ownership was transferred and therefore each transfer was dealt with under Division 70 of the ITAA 1997 (trading stock provisions).

The taxpayer now seeks to have these gains and losses dealt with under section 26BC of the ITAA 1936.

The Scheme

In 20XX, the taxpayer entered into a SLA with the margin loan provider.

The SLA provides for the following:

Loans of Securities

(Borrowing Request)

The Lender will lend Securities to the Borrower and the Borrower will borrow Securities from the Lender, in accordance with the terms of this Agreement, regardless of which party is the Lender. In all cases Margin loan provider must have received from the Client and accepted by whatever means) …

Unless otherwise stated in a Confirmation or other correspondence, if Margin loan provider is the Borrow of Securities, the Fee initially will be Interest in the Cash Collateral at the rate and with such other components as otherwise advised to the Client.

Delivery of Securities

(Delivery)

The Lender will procure in the delivery of Securities to the Borrower or deliver such Securities in accordance with the relevant Borrowing Request together with appropriate instructions for or Instruments of transfer (if necessary) duly stamped (if necessary) and such other Instruments (if any) as required to vest title absolutely in the borrower,

(Time for Delivery)

Such securities will be deemed to have been delivered by the Lender to the Borrower on delivery to the Borrower or as it directs of the relevant instruments of transfer and certificates or other documents of title (if any), or in the case of Securities title to which is registered in a computer based system which provides for the recording and transfer of title to the name by way of electronic entries (such as CHESS), on the transfer of title in accordance with the rules and procedures of such system as in force from time to time, or by such other means as may be agreed.

Title, Distributions and Voting

Passing of title

The Parties must execute and deliver all necessary documents and give all necessary instructions to procure that all right, title and interest in….

Will pass absolutely from one Party to the other, free from all liens, charges, equities and encumbrances, on delivery or delivery of the same in accordance with this agreement

(Distributions)

(a) (Cash Distributions)

(b) Unless otherwise agreed, if Income is paid by the issuer in relation to any borrowed Securities on or by reference to an Income Payment Data where those Securities are the subject of a loan under this Agreement, the Borrower must, on the date of the payment of such Income,…,(Relevant Payment Date) pay a sum of money equivalent to that to the Lender would have been entitled to receive (after any deduction, withholding or payment for or on account of any tax made by the relevant issuer… in respect of such Income) had such Securities not been lent to the Borrower and been held by the Lender on the Income Payment Date, irrespective of whether the Borrower received the Income.

(b) (Corporate Actions)

Subject to paragraph (c) (unless otherwise agreed), if in respect of any borrowed Securities or any Collateral, any rights relating to conversion, sub-division, consolidation, pre-emption, rights arising under a takeover offer or other rights, including those requiring election by title holder for the time being of such Securities or Collateral, become exercisable prior to the redelivery of Equivalent Securities or Equivalent Collateral, as the case may be, may within a reasonable time before the later time for the exercise of the right or option, give written notice to the other party that, on redelivery of Equivalent Securities or Equivalent Collateral, as the case may be, it wishes to receive Equivalent Securities or Equivalent Collateral in such form which will arise if the right is exercised or, in the case of a right which may be exercised in more that one manner is exercised as is specified in such written notice…

Transfer

Notwithstanding the use of the expression such as 'borrow', 'lend', 'Collateral', 'Margin', 'redeliver' etc, which are used to reflect terminology used in the market for transactions of the kind provided for in this Agreement, all rights, title and interest in and to the Securities 'borrowed', 'lent' and 'Collateral' which one party transfers to the other in accordance with this Agreement will pass absolutely from one party to the other free and clear of any liens, claims charges or encumbrances or any other interest of the Transferring Party or any third party (other than a lien routinely imposed of all securities of a relevant clearance system) without the transferor retaining any interest or right to the transferred property, the Party obtaining such title being obliged only to redeliver Equivalent Securities or Equivalent Collateral, as the case may be. Each transfer under this agreement must be made so as to constitute or result in a valid and legally effective transfer of the transferring Party's legal and beneficial title to the recipient.

Fees

In respect of each loan of Securities:

(a) for which the collateral is cash, the Collateral Taker must pay a fee to the Collateral Provider in respect of the amount of the Collateral, calculated at the rate initially as agreed by them (and then as may be varied under this agreement)

(b) the Client must pay a fee to Margin loan provider for each loan of Securities in the amount determined from time to time by Margin loan provider and agreed by the client.

Collateral

(Borrower's Obligation to Provide Collateral)

The Client as Borrower or Lender undertakes to deliver to or to deposit with Margin loan provider or its Nominee (or in accordance with Margin loan provider's instructions):

(a) Collateral of the kind specified in the relevant Borrowing Request or as otherwise agreed between the Parties; and

(b) Appropriate instructions for transfer or instruments of transfer duly stamped (if necessary) and such other instruments as may be requisite to vest title to them in Margin loan provider simultaneously with delivery of the Borrowed Securities, in accordance with clause X.

Delivery of equivalent Securities

(Borrower's obligation to redeliver Equivalent Securities)

The Borrower undertakes to redeliver Equivalent Securities in accordance with this agreement and the terms of the relevant Borrowing Request

(Lender may call for delivery of Equivalent Securities)

Subject to clause Y and the terms of the relevant Borrowing Request the Lender may call for the delivery of all or any Equivalent securities at any time by giving notice on any Business Day of not less than the Standard Settlement Time for each Equivalent Securities or the equivalent time on the exchange or in the clearing organisation through which the relevant borrowed Securities were originally delivered. The Borrower must redeliver such Equivalent Securities not later than the expiry of such notice in accordance with the Lender's instructions.

(Lender may terminate loan if Borrower defaults)

If the Borrower does not redeliver Equivalent Securities in accordance with such call the Lender may elect to continue the loan of Securities. If the Lender does not elect to continue the loan, the Lender may by written notice to the Borrower elect to terminate the relevant loan…

Clause Z, which survives the expiry of the SLA states:

Lender's Warranties

Each Party warrants and undertakes to the other on a continuing basis, to the intent that such warranties will survive the completion of any transaction contemplated by this Agreement, that, if acting as the Lender:

…

(c) It is absolutely entitled to pass full legal and beneficial ownership of all Securities provided by it under this Agreement to the Borrower free from all liens, charges, equities and encumbrances; and

The term Collateral is defined as:

(a) Cash;

(b) ASX Traded Shares; and

(c) such other securities or financial instruments or deposits of currency as agreed between the Parties from time to time, or any combination of them which are delivered by the Borrower to the Lender in accordance with this Agreement and includes the certificate or other documents of title (if any)…

The term Equivalent Securities is defined as:

… securities of an identical type, nominal value, description and amount to particular Securities borrowed and such term will include the certificate and other documents of or evidencing title and transfer…

The term Securities is defined as:

… eligible securities within the meaning of section 26BC(1) of the 1936 Tax Act, which the Borrower is entitle to borrow from the Lender and which may be or are the subject of a loan pursuant to this Agreement and that term includes the certificates or other documents of title (if any)

Relevant legislative provisions

Income Tax Assessment Act 1936 Section 26BC,

Income Tax Assessment Act 1936 Subsection 26BC(3),

Income Tax Assessment Act 1936 Subsection 26BC(4),

Income Tax Assessment Act 1936 Subsection 26BC(12),

Income Tax Assessment Act 1936 Subsection 26BC(13) and

Income Tax Assessment Act 1997 Section 70-35.

Reasons for decision

Question 1

Section 26BC of the Income Tax Assessment Act 1936 (ITAA 1936) enables both borrowers and lenders involved in securities lending arrangements to treat the transactions under the securities lending arrangement as if they had not occurred. Section 26BC deals with arrangements where a taxpayer enters into an agreement to dispose of securities to another taxpayer on condition that at some later time the borrower returns replacement securities.

Under a Securities Lending Arrangement (SLA), legal title to shares passes from the lender of the securities, the subject of the securities lending arrangement, to the borrower of the securities (though it is the lender and not the borrower of the shares who is regarded as being entitled to any dividends which may be payable).

Subsection 26BC(3) of the ITAA 1936 describes the type of securities lending arrangement which qualify for the securities lending relief. Section 26BC applies to transactions under a securities lending arrangement where a lender disposes of an eligible security to a borrower. Sub paragraph 26BC(3)(a)(ii) deals with the return of the borrowed securities. Where borrowed securities are re-acquired less than 12 months after the original disposal time by the lender from the borrower then section 26BC applies. This subparagraph defines the terms: 're-acquisition time' as the time the borrower returned the security to the lender; and 'replacement security' as the security returned, which will be either the borrowed security or an identical security.

Under paragraphs 26BC(4)(c) and (d) of the ITAA 1936 the lender's position is determined as if:

· the lender had neither disposed of the borrowed security nor acquired the replacement security paragraph (4)(c);

· the lender had held the borrowed security at all times during the borrowing period paragraph (4)(d); and

· the replacement security will be treated as the borrowed security whether it is or not paragraph (4)(e).

The result of the application of section 26BC of the ITAA 1936 is that where the lender and borrower have met all the requirements of the section the lender will not be subject to any tax consequences as a result of the disposal and re-acquisition of the relevant securities.

In this case the taxpayer had entered into a SLA in 20XX. Under the SLA all right, title and interest in the relevant shares had passed absolutely from the taxpayer to the margin loan provider. The taxpayer did not retain legal and beneficial title to the relevant shares.

Over the period of the SLA the taxpayer transferred the shares to the margin loan provider upon purchase. When the taxpayer wanted to sell the shares, a written request would be sent to the margin loan provider and the securities, or identical securities, would be returned to the taxpayer. Where the time between the transfer of the shares to the margin loan provider and the subsequent reacquisition of the securities is less than 12 months, subsection 26BC(4) of the ITAA 1936 would operate so to treat the transaction as if it had never occurred.

However, where the time between the transfer and the reacquisition of the shares is greater than 12 months, or where no securities were reacquired, then section 26BC of the ITAA 1936 will not apply.

Question 2

Section 70-35 of the Income Tax Assessment Act 1997 (ITAA 1997) provides that a taxpayer who carries on a business must include the value of their trading stock on hand in working out their assessable income and deductions.

Under section 70-35 of the ITAA 1997, the taxpayer is required to include the differences between the value of all trading stock-on-hand at the beginning of the income year and at the end of the income year to ascertain its taxable income.

Trading stock is defined in paragraph 70-10(a) of the ITAA 1997 to include anything produced, manufactured or acquired that is held for purposes of manufacture, sale or exchange in the ordinary course of a business.

Paragraph 3 of Taxation Ruling IT 2670 provides that goods are trading stock on hand for the purposes of section 70-35 of the ITAA 1997 notwithstanding that they have not been physically delivered to the taxpayers business premises or outlet provided the taxpayer is in a positive to dispose of the goods. Accordingly, dispositive power is the appropriate test for determining which taxpayer will account for trading stock on hand.

The facts in this case are similar to the circumstances outlined in IT 2670. Under the SLA entered into between the taxpayer (the lender in respect to the relevant securities) and the margin loan provider (the Borrower), the taxpayer agreed to make those securities available to the margin loan provider for a certain period so that the margin loan provider could deal with the securities on its own behalf. Pursuant to the SLA, the taxpayer was obliged to deliver the relevant securities to the Borrower. Although the Borrower was required to redeliver equivalent securities to the taxpayer under the SLA, the Borrower, had the right to possession of the securities for the purpose of use in the ordinary course of the Borrower's business. As such, the relevant securities at all times were at the risk and in the possession of the Borrower.

Under clause A of the SLA the parties were required to execute and deliver all necessary documents and give all necessary instructions to procure that all right, title and interest in the relevant securities. Title to the securities passed absolutely from the taxpayer to the margin loan provider, free from all liens, charges, equities and encumbrances, on delivery to the Borrower under clause B of the SLA.

Under the SLA all right, title and interest in the relevant securities had passed absolutely from the taxpayer to the margin loan provider. The taxpayer did not retain legal and beneficial title to the relevant securities. The margin loan provider provided security to the taxpayer in order to secure the borrowing. The security provided was Cash Collateral advanced to the taxpayer. At the end of that period, Equivalent Securities of the same number and type as the original securities were to be returned to the taxpayer. The margin loan provider was to pay a fee for the use of the securities for the relevant period. However, Equivalent Securities of the same number and type as the original securities were not redelivered to the taxpayer.

Under the terms of the SLA, the power of disposition over the trading stock was transferred from the taxpayer to the margin loan provider, and as a result, the securities were not trading stock on hand of the taxpayer for the purposes of subsection 70-35(1) of the ITAA 1997.

In accordance with section 70-35 of the ITAA 1997, the opening and closing values of trading stock are compared, and if the closing stock is less then the opening stock, the difference can be claimed as a deduction. If, however, the value of the trading stock is greater then the value of the opening stock, the difference is included in the taxpayer's assessable income.

Conclusion

The lending of the shares is regarded as a disposal, the consideration being the borrower's commitment to redeliver Equivalent Securities. The shares transferred under the SLA were not on hand at the end of the relevant income year as legal title to those shares was transferred to the margin loan provider. Therefore, to the extent the taxpayer trades its shares as trading stock, under section 70-35 of the ITAA 1997 the taxpayer is required to include the differences between the value of all trading stock-on-hand at the beginning of the income year and at the end of the income year to ascertain its taxable income.