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Ruling

Subject: Qualified person for franking credits

Question 1

If you invest in widely held trusts that invest in ASX 200 shares with a weighting of shares that track the S&P ASX 200 Index (for example, SPDR S&P/ASX 200 Fund) and also diminish the risk of those investments with ASX SPI 200 futures contracts (or similar ASX SPI 200 derivatives) by a delta of minus 0.67 or greater, will you be a qualified person for the franking rebates in respect to dividends received from the shares investments?

Answer:

Yes

Question 2

If you directly invest in a portfolio of ASX 200 shares with a weighting of shares that tracks the S&P ASX 200 Index, trading occasionally between the secondary qualification period to rebalance the portfolio, and also diminish the risk of those investments with ASX SPI 200 futures contracts (or similar ASX SPI 200 derivatives) by a delta of minus 0.67 or greater, will you be a qualified person for the franking rebate in respect to dividends received from the share investments?

Answer:

Yes

This ruling applies for the following periods

Year ending 30 June 2013

Year ending 30 June 2014

Year ending 30 June 2015

The scheme commences on

1 July 2012

Relevant facts and circumstances

You intend to invest in widely held trusts who invest in ASX 200 shares with a weighting of shares that track the S&P ASX 200 Index (e.g. SPDR S&P/ASX 200 Fund, Vanguard ASX300 ETF, iShares MSCI Australia 200) and also diminish the risk of those investments with ASX SPI 200 futures contracts (or similar ASX SPI 200 derivatives) by a delta of minus 0.67 or greater. The short derivative positions will be rolled over on a periodic basis, dependent upon their expiry.

You are also considering directly investing in a portfolio of ASX 200 shares with a weighting of shares that tracks the S&P ASX 200 Index, trading occasionally between the secondary qualification period to rebalance the portfolio, and also diminish the risk of those investments with ASX SPI 200 futures contracts (or similar ASX SPI 200 derivatives) by a delta of minus 0.67 or greater. The short derivative positions will be rolled over on a periodic basis, dependent upon their expiry.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 207-145

Income Tax Assessment Act 1936 Section 160APHO

Income Tax Assessment Act 1936 Section 160APHM

Income Tax Assessment Act 1936 Section 160APHJ

Income Tax Assessment Act 1936 Section 160APHL

Income Tax Assessment Act 1936 Section 160APHP

Income Tax Assessment Act 1936 Section 160APHI

Income Tax Assessment Act 1936 Section 160APHF

Reasons for decision

To be eligible for franking benefits under the imputation system, paragraph 207-145(1)(a) of the Income Tax Assessment Act 1997 (ITAA 1997) states that the entity receiving the franked distribution must be a 'qualified person' for the purposes of Division 1A of former Part IIIAA of the Income Tax Assessment Act 1936 (ITAA 1936).

For an entity to be qualified person, the entity must satisfy the holding period requirement during the relevant qualification period.

Where the entity has made, is under an obligation to make or is likely to make a related payment in respect of the dividend, the secondary qualification period is the relevant qualification period (subsection 160APHO(1) of the ITAA 1936).

The secondary qualification period for ordinary shares means the period beginning on the 45^th day before, and ending on the 45^th day after, the day on which the shares became ex dividend.

The Explanatory Memorandum to the Taxation Laws Amendment Act (No. 2) 1999 ('EM') explains the related payments rule will generally apply when a portfolio of shares is hedged with a futures contract, as follows:

4.103 Likewise, where the price paid for a security includes an estimated dividend component, the offset of the interest component by the estimated dividend component will be a related payment. For example, the theoretical price of a share under a futures contract is usually calculated by taking the current market price, adding interest on the outstanding share price for the term of the contract, and subtracting expected dividends: the subtraction from the price of the expected dividends is a related payment.

4.104 Apart from cases where a payment or crediting relates to a particular dividend, there are cases where payments or credits are made in respect of a number of dividends, for example, under index derivatives. Where dividends are received from a number of shares and there is a matching outgoing under an index derivative, there may be a related payment. In some cases the related payment may be calculated in respect of dividends on shares which do not exactly match those held by the taxpayer. However, the match need not be exact for the payment to be a related payment, provided it is substantially the same. This is because small discrepancies in the relevant parcels of shares, particularly those shares with a low weighting in an index, will not necessarily prevent the payment under the derivative from effectively passing the benefit of the dividends to the counterparty. Generally, a correspondence between a share parcel and an index derivative which is sufficiently close to reduce risk materially in a qualification period will, if the index derivative requires a dividend equivalent benefit to pass to the holder of the derivative, also be sufficiently matched with the dividends on the parcel to constitute a related payment.

4.105 It is necessary for the related payments rule to apply to Share Price Index (SPI) future transactions where the seller of the future hedges by holding the physical stock (ie. a share portfolio which is closely correlated with the All Ordinaries Index (AOI)) and effectively credits the buyer with the estimated dividends on the shares through the price against which the contract is agreed to be settled.

The holding period requirement will be met if the entity holds the shares 'at risk' for a continuous period (not counting the day of acquisition or disposal) of at least 45 days (for ordinary shares) during the relevant qualification period (subsections 160APHO(2) and (3) of ITAA 1936).

Shares will be held 'at risk' on a particular day if the taxpayer's net position on that day in relation to the shares has at least 30% of the risks and opportunities associated with holding the shares (subsection 160APHM(2) of the ITAA 1936).

The taxpayer's net position is determined using the financial concept known as 'delta' (subsection 160APHM(3) of the ITAA 1936). Briefly, delta measures the percentage change in the price of one security relative to the percentage change in the price of another. A net position is defined in subsection 160APHJ(5) of the ITAA 1936 as the sum of the taxpayer's long and short positions in the shares, calculated on the basis of their deltas. For example, where shares have been hedged to a level of 70%, the delta will be 0.3 (30% risk).

Subsection 160APHJ(2) of the ITAA 1936 lists some examples of positions which, because they relate to "substantially similar or related property", will have a delta in relation to the underlying shares held by the taxpayer. Substantially similar or related property is considered to refer to property sufficiently similar to the underlying shares so as to exhibit a correlation in price movements.

This correlation is between shares, interests in shares or property that the taxpayer is connected to. In defining the scope of this correlation it is essential to restrict the analysis to factors that are not too remote.

Subsection160APHL(7) of the ITAA 1936 provides a trust holding in relation to a widely held trust is a long position with a delta of + 1 in relation to itself. In explaining section 160APHP of the ITAA 1936, the EM adds:

4.143 A taxpayer who holds an interest in shares as a beneficiary of a widely-held trust on which a distribution has been paid will be a qualified person in relation to any dividend paid on the shares from which the distribution is derived if the taxpayer has held the interest in shares during the relevant qualification period in relation to the interest

4.144 Unlike closely-held trusts, where a trustee of a widely-held trust enters into a position with respect to shares or an interest in shares (relevant shares) which form the property of the trust, the beneficiaries of the trust are not deemed to have entered into a proportionate position with respect to their interests in the relevant shares.

4.145 Therefore, beneficiaries of widely-held trusts do not have to be concerned with whether the trustee of the trust has taken a position with respect to the shares in the trust property. Only positions entered into personally by the beneficiary can materially diminish risk in relation to the beneficiaries interest. Provided the beneficiary personally satisfies the holding period requirements, the beneficiary will be a qualified person.

In your case, you will be a 'qualified person' in relation to franked dividends you receive from an investment in ASX 200 shares with a weighting of shares that track the S&P ASX 200 Index, where you also diminish the risk of those investments with ASX SPI 200 futures contracts by a delta of minus 0.67 or greater and where you trade occasionally outside of the secondary qualification period to rebalance the portfolio.