Edited version of your private ruling

Authorisation Number: 1012524274944

Ruling

Subject: Dividend run-up strategy

Question 1

Will the Fund be entitled to a tax offset on the basis that it is a 'qualified person' for the purposes of Division 1A of former Part IIIAA in respect of a franked distribution made to the Fund in relation to shares that are subject to the Strategy?

Answer

Yes

Question 2

Will the Investors be entitled to a tax offset for their share of the franking credit on the basis that they are 'qualified persons' for the purposes of Division 1A of former Part IIIAA in respect of a franked distribution which flows indirectly to them in relation to shares that are subject to the Strategy?

Answer

Yes

Question 3

Will section 177EA operate to deny the Fund and/or the Investors entitlement to the tax offset in respect of a franked distribution relating to shares that are subject to the Strategy?

Answer

No

This ruling applies for the following periods:

Income year ending 30 June 2014

Income year ending 30 June 2015

Income year ending 30 June 2016

The scheme commences on:

As of the date of this ruling, the scheme is yet to commence.

Relevant facts and circumstances

The Fund intends to implement a dividend run-up strategy (the Strategy) to exploit the dividend run-up phenomenon, described by the applicant to this ruling as a phenomenon by which some shares have a price run-up in the period leading up to the ex-dividend date. Generally, dividend run-up strategies attempt to capitalise on the phenomenon by overweighting those shares that are considered likely to experience the phenomenon prior to the ex-dividend date and selling them on or after that date.

To implement the Strategy the Fund is proposing to:

· select and acquire publicly listed shares which (based on current research) are likely to experience the dividend run-up phenomenon; and

· enter into Hedges designed to reduce the risk of trading losses in excess of the benchmark.

The Fund may choose to lock in the run-up profit and exit the Strategy in respect of a particular share prior to the ex-dividend date if the returns (excluding consideration of franking credits but including the cost or receipt with respect to the Hedges) expected under the Strategy are achieved without continuing to hold that share until the ex-dividend date.

Back testing conducted by the Trustee suggests that the post-costs performance of the Strategy adds a figure (pre tax and pre franking credits) in respect of each implementation of the Strategy, which is considered material and appropriate for the Fund.

For the purposes of Division 1A of former Part IIIAA, the Fund is not a widely held trust within the meaning of that term as defined in former section 160APHD.

All legislative references in this ruling are to the Income Tax Assessment Act 1936 unless otherwise indicated.

Assumptions

1. Ordinary shares acquired under the Strategy will be held for a continuous period of at least 45 days (excluding the date of acquisition and disposal) if they are held until the ex-dividend date.

2. Preference shares will not be acquired under the Strategy.

3. The delta of the net positions in respect of shares held in a company (including those previously held and those acquired under the Strategy) will not be less than 0.3.

4. The Fund will not be involved in an arrangement (including under the terms of any hedging arrangements entered into) amounting to an obligation to make, or to be likely to make, a 'related payment' for the purposes of former section 160APHN.

5. In respect of the Investors:

(a) their entitlements to the corpus of the Fund are fixed and indefeasible;

(b) each Investor will hold units in the Fund for a continuous period of at least 45 days and this period will correspond, at least to the extent of a continuous period of 45 days, with the period mentioned in assumption 1;

(c) none of the Investors will be involved in an arrangement amounting to an obligation to make, or to be likely to make, a 'related payment' for the purposes of former section 160APHN;

(d) none of the Investors will take a position in respect of their interest in the relevant shares outside of the Fund; and

(e) they are:

· an individual; or

· a corporate tax entity; or

· the trustee of a trust that is liable to be assessed on a share of, or all or a part of, the trust's net income under section 98, 99 or 99A; or

· the trustee of an FHSA trust; or

· the trustee of a complying or non-complying superannuation fund, a complying or non-complying approved deposit fund, or a pooled superannuation trust; or

· an exempt institution that is eligible for a refund (as defined in section 207-115 of the Income Tax Assessment Act 1997 (ITAA 1997)).

Relevant legislative provisions

Income Tax Assessment Act 1936 former Division 1A, Part IIIAA

Income Tax Assessment Act 1936 former section 160APHD

Income Tax Assessment Act 1936 former paragraph 160APHJ(10)(c)

Income Tax Assessment Act 1936 former section 160APHL

Income Tax Assessment Act 1936 former subsection 160APHL(7)

Income Tax Assessment Act 1936 former subsection 160APHL(8)

Income Tax Assessment Act 1936 former subsection 160APHL(10)

Income Tax Assessment Act 1936 former subsection 160APHM(2)

Income Tax Assessment Act 1936 former subsection 160APHM(3)

Income Tax Assessment Act 1936 former section 160APHN

Income Tax Assessment Act 1936 former section 160APHO

Income Tax Assessment Act 1936 former subsection 160APHO(2)

Income Tax Assessment Act 1936 former subsection 160APHO(3)

Income Tax Assessment Act 1936 former subsection 160APHU(1)

Income Tax Assessment Act 1936 subsection 177D(2)

Income Tax Assessment Act 1936 paragraph 177D(2)(a)

Income Tax Assessment Act 1936 paragraph 177D(2)(b)

Income Tax Assessment Act 1936 paragraph 177D(2)(c)

Income Tax Assessment Act 1936 paragraph 177D(2)(d)

Income Tax Assessment Act 1936 paragraph 177D(2)(e)

Income Tax Assessment Act 1936 paragraph 177D(2)(f)

Income Tax Assessment Act 1936 paragraph 177D(2)(g)

Income Tax Assessment Act 1936 paragraph 177D(2)(h)

Income Tax Assessment Act 1936 section 177EA

Income Tax Assessment Act 1936 subsection 177EA(3)

Income Tax Assessment Act 1936 paragraph 177EA(3)(a)

Income Tax Assessment Act 1936 paragraph 177EA(3)(b)

Income Tax Assessment Act 1936 paragraph 177EA(3)(c)

Income Tax Assessment Act 1936 paragraph 177EA(3)(d)

Income Tax Assessment Act 1936 paragraph 177EA(3)(e)

Income Tax Assessment Act 1936 paragraph 177EA(5)(b)

Income Tax Assessment Act 1936 subsection 177EA(14)

Income Tax Assessment Act 1936 paragraph 177EA(14)(a)

Income Tax Assessment Act 1936 paragraph 177EA(14)(b)

Income Tax Assessment Act 1936 paragraph 177EA(14)(c)

Income Tax Assessment Act 1936 paragraph 177EA(14)(d)

Income Tax Assessment Act 1936 paragraph 177EA(14)(e)

Income Tax Assessment Act 1936 paragraph 177EA(14)(f)

Income Tax Assessment Act 1936 subsection 177EA(17)

Income Tax Assessment Act 1936 paragraph 177EA(17)(a)

Income Tax Assessment Act 1936 paragraph 177EA(17)(b)

Income Tax Assessment Act 1936 paragraph 177EA(17)(c)

Income Tax Assessment Act 1936 paragraph 177EA(17)(d)

Income Tax Assessment Act 1936 paragraph 177EA(17)(e)

Income Tax Assessment Act 1936 paragraph 177EA(17)(f)

Income Tax Assessment Act 1936 paragraph 177EA(17)(g)

Income Tax Assessment Act 1936 paragraph 177EA(17)(ga)

Income Tax Assessment Act 1936 paragraph 177EA(17)(h)

Income Tax Assessment Act 1936 paragraph 177EA(17)(i)

Income Tax Assessment Act 1936 paragraph 177EA(17)(j)

Income Tax Assessment Act 1997 Subdivision 207-B

Income Tax Assessment Act 1997 subsection 207-20(2)

Income Tax Assessment Act 1997 section 207-45

Income Tax Assessment Act 1997 subsection 207-50(3)

Income Tax Assessment Act 1997 Subdivision 207-E

Income Tax Assessment Act 1997 section 207-110

Income Tax Assessment Act 1997 section 207-115

Income Tax Assessment Act 1997 subsection 207-145(1)

Income Tax Assessment Act 1997 subsection 207-150(1)

Reasons for decision

Question 1

Generally, an entity in receipt of a franked distribution is entitled to a tax offset equal to the franking credit on the distribution for the income year in which the distribution is made:
see subsection 207-20(2) of the ITAA 1997.

However, subsection 207-145(1) of the ITAA 1997 will deny a tax offset otherwise provided under subsection 207-20(2) of the ITAA 1997 if the entity in receipt of the franked distribution is not a 'qualified person' in relation to the distribution for the purposes of Division 1A of former Part IIIAA.

Pursuant to former section 160APHO, the Fund will be a qualified person in relation to a franked distribution if the shares to which the distribution relates (being shares held for the purposes of the Strategy) have been held for a continuous period of not less than 45 days, excluding the days of acquisition and disposal and excluding any days on which the Fund has materially diminished risks of loss or opportunities for gain in respect of those shares.

A taxpayer is taken to have materially diminished risks of loss or opportunities for gain with respect to shares they hold if their 'net position' results in them having less than 30 per cent of the risks and opportunities relating to the shares, as provided by former subsection 160APHM(2). A taxpayer's net position is worked out using the financial concept known as delta (former subsection 160APHM(3))¹.

On the basis of the facts and assumptions set out in this ruling, the Fund will be a qualified person for the purposes of Division 1A of former Part IIIAA in respect of a franked distribution made to it in relation to shares that are subject to the Strategy as:

· the cumulative delta of the net positions held by the Fund will be at least 0.3;

· the Fund will not have an obligation under the Strategy to make, or to be likely to make, a 'related payment' in respect of the franked distribution which would impact the qualified person test (former paragraph 160APHJ(10)(c)); and

· the shares will be held for a continuous period in excess of 45 days (not including the date of acquisition or disposal) (former subsection 160APHO(2)) over which the Fund would not be considered to have materially diminished risks of loss or opportunities for gain in respect of the shares (former subsection 160APHO(3)).

Accordingly, the Fund will be entitled to a tax offset equal to the franking credit on the franked distribution for the income year in which the distribution is made.

Question 2

Under subsection 207-50(3) of the ITAA 1997, a franked distribution flows indirectly to a beneficiary of a trust in an income year if, and only if:

· the distribution is made to the trustee of the trust, or flows indirectly to the trustee from another trust distribution; and

· the beneficiary has a share of the trust net income for that year.

Therefore, if a franked distribution is made to the Trustee of the Fund and the Investors receive a share of the trust net income for that income year, a franked distribution is taken to flow indirectly to the Investors.

Generally, an entity to whom a franked distribution flows indirectly in an income year is entitled to a tax offset for that income year that is equal to its share of the franking credit on the distribution: sections 207-45 and 207-110 of the ITAA 1997, as appropriate.

However, subsection 207-150(1) of the ITAA 1997 will deny a tax offset otherwise provided under section 207-45 or 207-110 of the ITAA 1997 if the entity to whom the franked distribution flows indirectly is not a 'qualified person' in relation to the distribution for the purposes of Division 1A of former Part IIIAA.

Pursuant to former section 160APHO, an Investor will be a qualified person in relation to a franked distribution if the Investor's interest in the shares to which the distribution relates (being shares held for the purposes of the Strategy) has been held for a continuous period of not less than 45 days, excluding the days of acquisition and disposal and excluding any days on which the Investor has materially diminished risks of loss or opportunities for gain in respect of that interest.

A taxpayer is taken to have materially diminished risks of loss or opportunities for gain with respect to an interest in shares they hold if their 'net position' results in them having less than 30 per cent of the risks and opportunities relating to the interest, as provided by former subsection 160APHM(2)².

The manner in which an Investor's interest in the relevant share is to be calculated in determining whether the Investor is a qualified person for the purposes of former section 160APHO in relation to a dividend paid on the share is set out in former section 160APHL.

On the basis of the facts and assumptions set out in this ruling, the Investors will be qualified persons for the purposes of Division 1A of former Part IIIAA in respect of a franked distribution which flows indirectly to them (as beneficiaries of the Fund) in relation to shares that are subject to the Strategy as:

· the trustee of the Fund is a qualified person in relation to the franked distribution (former subsection 160APHU(1));

· the delta in respect of the net position for the relevant interest in a share held by the Investors will be as per the delta in respect of the net position for that share held by the Fund, that is, at least 0.3;

· the Investors will not have an obligation under the Strategy to make, or to be likely to make, a 'related payment' in respect of the franked distribution which would impact the qualified person test (former paragraph 160APHJ(10)(c)); and

· the interest in the shares will be held for a continuous period in excess of 45 days (not including the date of acquisition or disposal) (former subsection 160APHO(2)) over which the Investors would not be considered to have materially diminished risks of loss or opportunities for gain in respect of the interest (former subsection 160APHO(3)).

Accordingly, the Investors will be entitled to a tax offset for their share of the franking credit on the franked distribution for the income year in which the distribution flows indirectly to them.

Question 3

Subsections 207-145(1) and 207-150(1) of the Income Tax Assessment Act 1997 (ITAA 1997), as appropriate, will deny a tax offset otherwise provided to an entity under Subdivision 207-B or Subdivision 207-E of the ITAA 1997 if the Commissioner has made a determination under paragraph 177EA(5)(b) that no imputation benefit is to arise in respect of a franked distribution that is made, or flows indirectly, to that entity.

A determination under paragraph 177EA(5)(b) may be made by the Commissioner where the requirements of subsection 177EA(3) are satisfied. According to subsection 177EA(3), section 177EA applies if:

(a) there is a scheme for a disposition of membership interests, or an interest in membership interests, in a corporate tax entity; and

(b) either:

(i) a frankable distribution has been paid, or is payable or expected to be payable, to a person in respect of the membership interests; or

(ii) a frankable distribution has flowed indirectly, or flows indirectly or is expected to flow indirectly, to a person in respect of the interest in membership interests, as the case may be; and

(c) the distribution was, or is expected to be, a franked distribution or a distribution franked with an exempting credit; and

(d) except for this section, the person (the relevant taxpayer) would receive, or could reasonably be expected to receive, imputation benefits as a result of the distribution; and

(e) having regard to the relevant circumstances of the scheme, it would be concluded that the person, or one of the persons, who entered into or carried out the scheme or any part of the scheme did so for a purpose (whether or not the dominant purpose but not including an incidental purpose) of enabling the relevant taxpayer to obtain an imputation benefit.

With respect to paragraph 177EA(3)(a), subsection 177EA(14) defines a 'scheme for a disposition' of membership interests or an interest in a membership interest inclusively, by reference to a scheme which involves any of the matters set out in paragraphs 177EA(14)(a) to (f). The acquisition of shares and the entry into the hedging arrangements (to the extent that they substantially alter the risks of loss, or opportunities for gain) by the Fund under the Strategy should be regarded as a scheme for the disposition of membership interests in a corporate tax entity, thereby satisfying paragraph 177EA(3)(a) (paragraphs 177EA(14)(b) and (e)).

Where the shares acquired under the Strategy are held until the ex-dividend date, the Strategy is expected to result in franked distributions being paid to the Fund in respect of those shares, which in turn will give rise to franked distributions flowing to the Investors through their investment in the Fund, thereby satisfying paragraphs 177EA(3)(b) and (c).

As confirmed in response to questions 1 and 2 of this ruling, both the Fund and the Investors (each being the 'relevant taxpayer' for the purposes of section 177EA) will be entitled to receive an imputation benefit (i.e. the tax offset) as a result of the franked distribution, thereby satisfying paragraph 177EA(3)(d).

Pursuant to paragraph 177EA(3)(e), it is necessary to consider whether, having regard to the 'relevant circumstances of the scheme' (including those comprised at subsection 177EA(17)), it would be concluded that a person who entered into or carried out the scheme had a purpose of enabling the Fund or the Investors to obtain an imputation benefit and, if so, whether such a purpose was more than an incidental purpose. The relevant circumstances of a scheme listed at subsection 177EA(17) are:

(a) the extent and duration of the risks of loss, and the opportunities for profit or gain, from holding membership interests, or having interests in membership interests, in the corporate tax entity that are respectively borne by or accrue to the parties to the scheme, and whether there has been any change in those risks and opportunities for the relevant taxpayer or any other party to the scheme (for example, a change resulting from the making of any contract, the granting of any option or the entering into of any arrangement with respect to any membership interests, or interests in membership interests, in the corporate tax entity);

(b) whether the relevant taxpayer would, in the year of income in which the distribution is made, or if the distribution flows indirectly to the relevant taxpayer, in the year in which the distribution flows indirectly to the relevant taxpayer, derive a greater benefit from franking credits than other entities who hold membership interests, or have interests in membership interests, in the corporate tax entity;

(c) whether, apart from the scheme, the corporate tax entity would have retained the franking credits or exempting credits or would have used the franking credits or exempting credits to pay a franked distribution to another entity referred to in paragraph (b);

(d) whether, apart from the scheme, a franked distribution would have flowed indirectly to another entity referred to in paragraph (b);

(e) if the scheme involves the issue of a non-share equity interest to which section 215-10 of the Income Tax Assessment Act 1997 applies - whether the corporate tax entity has issued, or is likely to issue, equity interests in the corporate tax entity:

(i) that are similar, from a commercial point of view, to the non-share equity interest; and

(ii) distributions in respect of which are frankable;

(f) whether any consideration paid or given by or on behalf of, or received by or on behalf of, the relevant taxpayer in connection with the scheme (for example, the amount of any interest on a loan) was calculated by reference to the imputation benefits to be received by the relevant taxpayer;

(g) whether a deduction is allowable or a capital loss is incurred in connection with a distribution that is made or that flows indirectly under the scheme;

(ga) whether a distribution that is made or that flows indirectly under the scheme to the relevant taxpayer is sourced, directly or indirectly, from unrealised or untaxed profits;

(h) whether a distribution that is made or that flows indirectly under the scheme to the relevant taxpayer is equivalent to the receipt by the relevant taxpayer of interest or of an amount in the nature of, or similar to, interest;

(i) the period for which the relevant taxpayer held membership interests, or had an interest in membership interests, in the corporate tax entity;

(j) any of the matters referred to in subsection 177D(2).

It is necessary to consider each of the factors listed in subsection 177EA(17) in order to determine whether paragraph 177EA(3)(e) will be satisfied such that section 177EA could apply to deny the Fund and/or the Investors entitlement to the tax offset.

Paragraph 177EA(17)(a)

There are three types of gains that might be made from holding the shares acquired by the Fund under the Strategy: trading gains; gains referable to dividends on the shares; and gains referable to franking credits. There is, however, also a risk that trading losses will arise in relation to the shares, and/or that the dividends (and associated franking credits) payable in respect of the shares may be more or less than expected at the time of their acquisition by the Fund. This suggests that the risks and opportunities associated with the ownership of the shares under the Strategy reside with the Fund.

The Hedges entered into by the Fund will have the effect of limiting the Fund's (and the Investor's) exposure to movements in the market price of the shares held by the Fund, yet the level of risk and opportunity remaining subsequent to the Fund's entry into the Hedges indicate a purpose other than one of enabling the Fund and the Investors to obtain the imputation benefit.

The duration of the holding is specifically referable to the research which drives the timing for the Strategy to maximise the potential for trading gains as a result of the dividend run-up phenomenon. The fact that the shares may even be disposed of prior to the ex-dividend date (in which case the Fund and Investors will not obtain any franking credits) indicates that the duration for which the shares will be held is suggestive of a purpose other than to obtain the imputation benefit.

Paragraphs 177EA(17)(b) to (h)

None of the factors listed in paragraphs 177EA(b) to (h) are relevant and/or point to there being more than an incidental purpose of obtaining an imputation benefit under the Strategy.

Paragraph 177EA(17)(i)

The Fund will hold the acquired shares for a relatively short period of time. Generally, a short holding period is a relevant circumstance that weighs in favour of there being a more than incidental purpose of obtaining an imputation benefit, and may be contrasted with a situation where an investor has no predetermined strategy of buying, and then selling the shares within a short period but actually does so to take advantage of price movements in the shares.

This view is somewhat offset by the fact that the holding period for the acquired shares is intended to maximise the trading gains attributable to the dividend run-up phenomenon, as determined by research. The relatively short holding period is therefore considered critical to the implementation of the Strategy and points away from there being more than an incidental purpose of obtaining the imputation benefit.

Paragraph 177EA(17)(j)

Paragraph 177EA(17)(j) imports the eight factors listed in subsection 177D(2) to the list of relevant factors to be considered in determining the relevant 'purpose' under section 177EA.

§ the manner in which the scheme was entered into or carried out (paragraph 177D(2)(a))

It is accepted that the acquisition of the shares and entry into the Hedges by the Fund under the Strategy is principally to take advantage of the dividend run-up phenomenon on a partly protected basis.

The satisfaction of the 45 day holding period rule when the shares are held to the ex-dividend date occurs as an incidental consequence of the Strategy rules which are based on extensive research undertaken by the Trustee and others and are designed to optimise the dates of acquisition and disposal of the relevant shares so as to maximise the trading gains available due to the phenomenon.

The principal intent of the Strategy to maximise trading gains is confirmed further by the fact that

the rules of the Strategy allow for the shares to be sold prior to the ex-dividend date where the required gain can be realised (in which case dividends and franking credits are not even received).

On the basis of the above, it is considered that the manner in which the Strategy is carried out does not indicate a more than incidental purpose of obtaining an imputation benefit.

§ the time at which the scheme was entered into and the length of the period during which the scheme was carried out (paragraph 177D(2)(c))

Implicit in the approach to dispose of the shares held under the Strategy within such a relatively short period of time after their acquisition is the intention to make trading gains in the run-up to the ex-dividend date (as well as to capture dividends and any associated franking credits).

As concluded above with respect to paragraph 177EA(17)(i), the short period during which the Strategy will be carried out does not, under the circumstances, indicate a more than incidental purpose of obtaining an imputation benefit.

§ the result in relation to the operation of the ITAA that, but for Part IVA, would be achieved by the scheme (paragraph 177D(2)(d))

But for the operation of Part IVA, the Fund (and indirectly the Investors) will obtain additional franking credits as a result of the implementation of the Strategy if the shares are held to the ex-dividend date. However, as the expected average return of the Strategy (pre tax and pre franking credits) is significant for the Fund, the Strategy is likely to be implemented in the event that franking credits are not available.

§ 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 (paragraph 177D(2)(e))

As a result of the implementation of the Strategy, the Fund (and indirectly the Investors) are expected to be in a better financial position as a result of the trading gains made and, to the extent that the shares are held to the ex-dividend date, the dividends and franking credits received.

None of the other matters listed in paragraphs 177D(2)(b), (f), (g) and (h) are relevant and/or point to there being more than an incidental purpose of obtaining an imputation benefit under the Strategy.

Weighing up the relevant circumstances

The predominant purpose of the Fund is to implement the Strategy in order to take advantage of the dividend run-up phenomenon and make trading gains which will enhance its rate of return.

Trading gains expected to be made as a result of a reliance on the dividend run-up phenomenon will only be made by disposing of the relevant shares on or after the ex-dividend date. Arguably, the receipt of franking credits by the Fund and the Investors as a result of the implementation of the Strategy (where it is not exited prior to the ex-dividend date) therefore merely follows on from, and is incidental to, the Fund's purpose of benefiting from such trading gains.

On balance, the relevant circumstances of the Strategy (where entered into and carried out in the manner described in this ruling, including the assumptions upon which the ruling is based) do not point to there being a more than incidental purpose of enabling the Fund and the Investors to obtain a franking benefit, and the requirements of paragraph 177EA(3)(e) will not be met. As such, the Commissioner will not make a determination under paragraph 177EA(5)(b) to deny them their entitlement to the tax offset otherwise provided under Subdivision 207-B or 207-E of the ITAA 1997.

¹ To have a net position equal to 30 per cent of the risks or opportunities with respect to a share requires a delta of 0.3.

² To have a net position equal to 30 per cent of the risks or opportunities with respect to an interest in a share requires a delta of 0.3.