Edited version of your written advice

Authorisation Number: 1012962609978

Date of advice: 8 February 2016

Ruling

Subject: Franking credits, 45 day holding rule

Question

For the purposes of paragraph 207-145(1)(a) of the Income Tax Assessment Act 1997 (ITAA 1997), would you be a 'qualified person' under former section 160APHO of the Income Tax Assessment Act 1936 (ITAA 1936) in relation to franked dividends you receive from shares purchased using a combination of your own funds and funds borrowed under a limited recourse loan?

Answer

Yes, where the shares are continuously held for at least 45 days (not counting the day of acquisition or disposal) around the ex dividend date and the proportion of funds borrowed under the limited recourse loan does not exceed 70%.

This ruling applies for the following period

1 July 2015 to 30 June 2016

The scheme commenced on

1 July 2015

Relevant facts

You intend to use a combination of your own funds and funds borrowed from a relative under a limited recourse loan, to invest in ASX listed equities (shares).

For asset protection purposes you have requested, and the relative has agreed, that the loan be structured on terms identical to a 'limited recourse borrowing arrangement', mirroring those commonly used by Self Managed Superannuation Funds which satisfy the requirements of section 67A of the Superannuation Industry (Supervision) Act 1993 Act.

A 'bare' trust will be established to acquire the ASX listed equities. You will use the total of your own funds and the funds borrowed under the limited recourse loan, to acquire the beneficial interest in the bare trust property (the shares). The rights of the relative as lender in connection with default on the loan would be limited to the shares.

The funds borrowed under the limited recourse loan facility will not exceed 70% of the total funds used to purchase the shares.

Interest will be a commercial rate of interest payable monthly. The relative will include the interest received as assessable income each year.

You will claim a deduction for the interest paid. You will include in assessable income each year the dividends received and, subject to this ruling, the franking credits which attach to any dividends. You will claim a credit for those franking credits in calculating the tax payable. The franking credits received each year will be greater than $5,000.

Relevant legislative provisions

Income Tax Assessment Act 1936 former Part IIIAA

Income Tax Assessment Act 1936 former section 160APHJ

Income Tax Assessment Act 1936 former section 160APHM

Income Tax Assessment Act 1936 former section 160APHO

Income Tax Assessment Act 1997 section Division 207-A

Income Tax Assessment Act 1997 section Division 207-B

Income Tax Assessment Act 1997 section 207-145

Income Tax Assessment Act 1997 section 207-145

Reasons for decision

Summary

For the purposes of paragraph 207-145(1)(a) of the Income Tax Assessment Act 1997 (ITAA 1997), you would be a 'qualified person' under former section 160APHO of the Income Tax Assessment Act 1936 (ITAA 1936) in relation to franked dividends you receive from shares purchased using a combination of your own funds and funds borrowed under a limited recourse loan.

Detailed reasoning

To be eligible for franking credits under the imputation system, paragraph 207-145(1)(a) of the 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 ITAA 1936.

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

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 (former 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' (former 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 former 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).

Paragraph 4.53 of the Explanatory Memorandum to the Taxation Laws Amendment Act (No. 2) 1999 (EM) lists non-recourse loans as one of the possible positions covered by former subsection 160APHJ(2) of the ITAA 1936 for the purposes of calculating the level of risks and opportunities associated with holding shares.

In this case, under the terms of the proposed limited recourse loan, the rights of the relative as lender in connection with default on the loan would be limited to the shares. Therefore, the limited recourse loan is considered to be a non-recourse loan for the purposes of former subsection 160APHJ(2) of the ITAA 1936.

Paragraph 4.54 of the EM states that a non-recourse loan 'effectively contains a put option to sell the shares to the lender, and a delta can be calculated in relation to this notional option'. Therefore, if the arrangement is implemented and the funds borrowed under the non-recourse loan represent 70% of the total funds used to purchase the shares, the delta will be 0.3 (30% risk).

As a result, you will be a 'qualified person' in relation to franked dividends you receive from shares, where the shares are continuously held for at least 45 days (not counting the day of acquisition or disposal) around the ex dividend date and the proportion of funds borrowed under the non-recourse loan does not exceed 70%.

Further information

The tax consequences for a member receiving a 'franked distribution' from an Australian corporate tax entity are set out in Division 207 of the ITAA 1997, comprising sections 207-5 to 207-170. These consequences are based on the gross-up and tax offset treatment that already applied to non-corporate recipients of franked dividends under the pre-1 July 2002 regime.

General rule - gross-up and tax offset

The general rule is set out in Division 207-A of the ITAA 1997. As a general rule, for the income year in which the distribution is made, the recipient of a franked distribution:

(1) includes in assessable income the amount of the franking credit on the distribution. This is in addition to any other amount included in the recipient's assessable income in relation to the distribution itself; and

(2) is entitled to a tax offset equal to the franking credit (sections 207-20 to 214-120).

The general rule does not apply to situations where a distribution flows indirectly to an entity through an interposed trust or partnership. These situations are covered by Division 207-B of the ITAA 1997.