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Ruling

Subject: Income-interest

Question 1

Is the term deposit held considered to be a qualifying security?

Answer

Yes.

Question 2

If the term deposit is a qualifying security is the interest included in your assessable income on an accrual basis?

Answer:

Yes.

This ruling applies for the following periods

Year ended 30 June 2012

Year ending 30 June 2013

The scheme commenced on

1 July 2011

Relevant facts

You invested funds in a term deposit with a financial institution for a number of years.

The investment maturity date is a future income year.

The interest rate is a fixed rate of return.

Under the terms of the deposit the interest is to be paid on the date of maturity.

There has been no interest credited or paid for the financial year.

Relevant legislative provisions

Income Tax Assessment Act 1936 section 26C

Income Tax Assessment Act 1936 subsection 159GP(1)

Income Tax Assessment Act 1936 paragraph 159GP(1)(a)

Income Tax Assessment Act 1936 paragraph 159GP(1)(b)

Income Tax Assessment Act 1936 paragraph 159GP(1)(ba)

Income Tax Assessment Act 1936 paragraph 159GP(1)(c)

Income Tax Assessment Act 1936 paragraph 159GP(1)(d)

Income Tax Assessment Act 1936 paragraph 159GP(1)(e)

Income Tax Assessment Act 1936 subsection 159GP(3)

Income Tax Assessment Act 1936 subsection 159GP(6)

Income Tax Assessment Act 1936 subsection 159GP(9A)

Income Tax Assessment Act 1936 section 159GP(10)

Income Tax Assessment Act 1936 section 159GQ

Income Tax Assessment Act 1936 subsection 159GQ(2)

Income Tax Assessment Act 1997 section 6-5

Reasons for decision

Interest is assessable income pursuant to section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997). As your investment is a term deposit, the interest is income according to ordinary concepts and should be included in your assessable income.

Definition of traditional security

Section 159GP(1) of the ITAA 1936 provides the definition of a security which includes a deposit with a bank, building society or other financial institution.

Taxation Ruling TR 96/14 Paragraph 4 item xii provides:

a 'deposit' within the meaning of paragraph (b) of the definition of security in subsection 159GP(1) includes a fixed or term deposit and a current or savings account with a financial institution. A traditional security that is a fixed or term deposit is acquired when the contract between the bank and the depositor is made. A traditional security, being the debt due to a current or savings account holder, is acquired when the account is opened.

Derivation

Taxation Ruling TR 98/1 sets out the Commissioner's policy on the derivation of income. Paragraph 47 of TR 98/1 states that as a general principle, interest income is derived when it is received or credited.

However, Division 16E of Part III of the Income Tax Assessment Act 1936 (ITAA 1936) was enacted to prevent tax deferral opportunities which were available from certain discounted and deferred interest securities.

The effect is that the income will be taxed to the investor each year as it accrues instead of only being taxed at maturity or disposal when it is received in cash or credited.

'Qualifying security' is defined in sub-section 159GP(1) of the ITAA 1936 as any security -

(a) that is issued after 16 December 1984;

(b) that is not a prescribed security within the meaning of section 26C of the ITAA 1936;

(ba) that is not part of an exempt series (see subsection (9A));

(c) the term of which, ascertained as at the time of issue of the security will, or is reasonably likely to, exceed 1 year;

(d) that has an eligible return; and

(e) where the precise amount of the eligible return is able to be ascertained at the time of issue of the security - in relation to which the amount of the eligible return is greater than 1 1/2% of the amount ascertained by multiplying the amount of the payment or the sum of the payments (excluding any periodic interest) liable to be made under the security by the number (including any fraction) of years in the term of the security; but does not, except as provided by subsection (10), include an annuity.

In your case the bank deposit (security) was issued for a number of years. It is not a prescribed security within the meaning of section 26C nor is it considered part of an exempt series with the provision of subsection 159(9A) of the ITAA 1936.

'Eligible return' is defined in subsection 159GP(3) of the ITAA 1936 as:

-... there shall be taken to be an eligible return in relation to a security if at the time when the security is issued it is reasonably likely, by reason that the security was issued at a discount, bears deferred interest or is capital indexed or for any other reason, having regard to the terms of the security, for the sum of all payments (other than periodic interest payments) under the security to exceed the issue price of the security, and the amount of the eligible return is the amount of the excess.-

'Periodic interest' is defined in subsection 159GP(6) of the ITAA 1936 as:

-... where an amount of interest is payable under a security, the amount shall be taken to be periodic interest if the period between the commencement of the period in respect of which the interest is expressed to be payable and the time at which the interest is payable is less than or equal to one year.

Taxation Ruling TR 96/3 states at paragraph 2 that:

-Interest which is not paid at least annually cannot be 'periodic interest'.-

As the interest on this security is only paid on maturity, after two years, it cannot be said to be 'periodic interest'.

Accordingly, there will be an eligible return as the sum of the payments (in this case the interest) will exceed the issue price (in this case the amount invested by you).

The eligible return will be the sum of all payments, other than periodic interest to exceed the issue price. Since the interest has been ascertained not to be periodic interest, the amount of the eligible return is any amounts paid over the initial amount invested.

For example: apply a simple interest calculation on $1,000 invested at 5.00% p.a. annum for 3 years ($1,000 x 0.05% x 3 years = $150). The eligible return would be $150.

As the precise amount of the eligible return can be ascertained at the time of issue of the security, it must be greater than 1 1/2% of the amount ascertained by multiplying the amount of the payment (excluding any periodic interest) liable to be made under the security by the number (including any fraction) of years in the term of the security, to be a qualifying security. The calculation would be:

Amount of payment = $1,150 ($1,000 + $150)

1 1/2% x ($1,100 x 3) = $49.50

As the eligible return would be $150 which is greater than the $49.50 calculated, the term deposit would be a qualifying security and subject to Division 16E.

Section 159GQ of the ITAA 1936 provides the tax treatment for the holder of a qualifying security. It states at subsection (1):

-If a taxpayer holds a qualifying security for all or part of a year of income, the effect on the taxpayer's taxable income is determined by working out the accrual amount for each accrual period in the year of income and then summing the accrual amounts.-

Subsection 159GQ(2) of the ITAA 1936 provides authority to include the accrual amounts in the taxpayer's assessable income.

Accordingly, you should declare the interest on the qualifying security on an accrual basis.