Edited version of your written advice

Authorisation Number: 1051201422761

Date of advice: 13 March 2017

Ruling

Subject: Rollover relief on securities lending arrangements

Question 1

Would the automatic rollover relief available to taxpayers engaging in eligible securities lending arrangements in section 26BC of the Income Tax Assessment Act 1936 (ITAA 1936) apply to the transfer of shares from Taxpayers A and B to the Trust under the respective securities lending arrangements?

Answer

Yes

Question 2

Where the shares acquired by Taxpayers A and B before 20 September 1985 are “lent” to the Trust under the respective securities lending arrangements, will the replacement securities returned to Taxpayers A and B maintain their pre-CGT status per subsection 26BC(6A) of the ITAA 1936?

Answer

Yes

Question 3

Would Taxpayers A and B be entitled to claim a tax offset for franking credits attached to the dividends received by the Trust on the shares?

Answer

Yes

This ruling applies for the following periods:

2016-17 income year

The scheme commences on:

The scheme has yet to commence

Relevant facts and circumstances

Taxpayers A and B are Australian resident private companies that hold shares in a public company listed on the Australian Stock Exchange (ASX).

Some of the shares held by Taxpayers A and B in the ASX listed company are pre-CGT shares.

A scheme is proposed whereby Taxpayers A and B each enter into separate written Securities Lending Agreements (SLAs) with the trustee of the Trust.

Under the proposed SLAs:

● Taxpayers A and B will agree to lend the ASX listed company shares to the trustee of the Trust and the trustee of the Trust agrees to borrow the securities from Taxpayers A and B in accordance with the terms set out in the SLAs

● Taxpayers A and B will procure the delivery of the ASX listed company shares to the trustee of the Trust and will provide the appropriate instruments required to vest title in those share to the trustee of the Trust

● the shares will be transferred using a Standard Transfer Form which records details such as the issuer of the security, the description and quantity of the securities, the consideration/value of the transfer as well as full transferor and transferee details

● the trustee of the Trust will become the registered security holder of the ASX listed company shares subject to the SLAs

● where a dividend is paid by the ASX listed company on shares which, on a payment date, are still borrowed, the trustee of the Trust will receive payment of the dividend

● the trustee of the Trust will pay to Taxpayers A and B a sum of money equivalent to the amount that Taxpayers A and B would have been entitled to receive (after taking into account any deduction, withholding or payment for or on account of any tax made by the relevant issuer) had the ASX listed company shares not been loaned and been held by Taxpayers A and B on the payment date

● the trustee of the Trust is required to give to Taxpayers A and B a “Transfer of Distribution Statement” in a form which is acceptable for the purposes of section 216-30 of the ITAA 1997 in respect of the dividend received on the borrowed ASX listed company

● in consideration for Taxpayers A and B entering into the proposed SLA, the trustee of the Trust will pay interest to both Taxpayers A and B in respect of each loan of ASX listed company shares made under the proposed SLA equivalent to that payable by arm's length parties

● the interest will accrue daily, be calculated on the basis of a 365 day year and all accrued but unpaid interest will be capitalised on the last business day of each month

● the trustee of the Trust will pay interest to Taxpayers A and B quarterly in arrears; and

● in respect of each loan of ASX listed company shares, the trustee of the Trust must redeliver equivalent securities to Taxpayers A and B within 12 months or five (5) business days after the date of a default notice.

The terms of the SLAs to be entered into between Taxpayer A and the ASX listed company and Taxpayer B and the ASX listed company will be will be drafted in a manner consistent with those terms listed above.

Relevant legislative provisions

Income Tax Assessment Act 1936 section 26BC

Income Tax Assessment Act 1936 subsection 26BC(1)

Income Tax Assessment Act 1936 subsection 26BC(3)

Income Tax Assessment Act 1936 paragraph 26BC(3)(a)

Income Tax Assessment Act 1936 paragraph 26BC(3)(b)

Income Tax Assessment Act 1936 subparagraph 26BC(3)(c)(i)

Income Tax Assessment Act 1936 subparagraph 26BC(3)(c)(iv)

Income Tax Assessment Act 1936 paragraph 26BC(3)(d)

Income Tax Assessment Act 1936 paragraph 26BC(3)(e)

Income Tax Assessment Act 1936 subsection 26BC(4)

Income Tax Assessment Act 1936 subsection 26BC(6)

Income Tax Assessment Act 1936 subsection 26BC(6A)

Income Tax Assessment Act 1936 subsection 26BC(6B)

Income Tax Assessment Act 1936 subsection 26BC(11A)

Income Tax Assessment Act 1936 subsection 26BC(11B)

Income Tax Assessment Act 1997 Subdivision 216-A

Income Tax Assessment Act 1997 subsection 216-10(1)

Income Tax Assessment Act 1997 subsection 216-10(2)

Income Tax Assessment Act 1997 section 216-30

Income Tax Assessment Act 1997 section 960-115

Income Tax Assessment Act 1997 section 960-130

Income Tax Assessment Act 1997 section 960-135

Reasons for decision

Question 1

Section 26BC of the ITAA 1936 provides automatic rollover relief to taxpayers who engage in eligible securities lending arrangements.

Relevantly, section 26BC of the ITAA 1936 will apply if the following conditions are satisfied:

● there is a written agreement of the kind known as a securities lending arrangement entered into after 9 May 1990 under which a taxpayer (referred to as 'the lender') disposes of an eligible security (referred to as 'the borrowed security') to another taxpayer (referred to as 'the borrower') and the lender acquires an identical security (referred to as a 'replacement security') within a period not exceeding 12 months of the time of disposal of the original security (paragraph 26BC(3)(a) of the ITAA 1936);

● both the borrower and lender were dealing with each other at arm's length in respect of the securities lending arrangement (paragraph 26BC(3)(b) of the ITAA 1936)

● if there is a making or a payment of a distribution in respect of the borrowed security during the borrowing period, then under the agreement the lender receives from the borrower a distribution (including a distribution in property) or a payment equal to the value of the distribution (referred to as a 'compensatory payment' (subparagraphs 26BC(3)(c)(i) and 26BC(3)(c)(iv) of the ITAA 1936)

● any consideration received by the lender from the borrower other than the replacement security, such as a fee, market value adjustments of the eligible securities or other consideration must be identified in the written agreement (paragraph 26BC(3)(d) of the ITAA 1936); and

● the lender does not dispose of the right to receive any part of the total consideration payable or to be given by the borrower under the securities lending arrangement (paragraph 26BC(3)(e) of the ITAA 1936).

The terms 'eligible security' and 'distribution' are defined in subsection 26BC(1) of the ITAA 1936. Relevantly, an eligible security means a share issued in a public company and a distribution includes interest or a dividend.

Where the above criteria are satisfied, the relevant following relief is available to the lenders in a securities lending agreement:

● the transaction is ignored with the effect that the lender is taken at all times to have held the replacement security for the purposes of determining the lender's assessable income (excluding CGT and fees payable under the SLA) or deductibility of an amount (subsection 26BC(4) of the ITAA 1936)

● any capital gain or loss from the disposal of the borrowed security by the lender is disregarded (subsection 26BC(6) of the ITAA 1936)

● where the lender acquired the borrowed securities before 20 September 1985, the lender is taken to have acquired any replacement security before that date (subsection 26BC(6A) of the ITAA 1936); and

● where the lender acquired the borrowed securities on or after 20 September 1985, the first element of the cost base (or reduced cost base) of the replacement security is the cost base of that security just before the acquisition of the replacement security (subsection 26BC(6B) of the ITAA 1936).

Subsection 26BC(11B) of the ITAA 1936 provides that where a lender receives a compensatory payment from the borrower under subparagraph 26BC(3)(c)(iv)(C) of the ITAA 1936 and an amount (referred to as the 'otherwise assessable amount') would have been included in the lender's assessable income for a particular year had the lender continued to hold the borrowed security, an amount equal to the otherwise assessable amount is included in the lender's assessable income.

Application

Under the proposed scheme:

● the SLAs will be in writing and entered into after 9 May 1990

● Taxpayers A and B will dispose of shares held in an ASX listed company to the trustee of the Trust

● within 12 months of the above disposal Taxpayers A and B will receive replacement securities from the trustee of the Trust

● Taxpayers A and B will be dealing with the trustee of the Trust at arm's length in respect of the securities lending agreement

● Taxpayers A and B will receive a compensatory payment equal to the value of any such amount received by the trustee of the Trust in respect of the ASX listed company shares

● consideration other than the replacement security is provided for in the written agreement, specifically interest payable and the compensatory payment; and

● neither Taxpayer A nor B will dispose of the right to receive any part of the total consideration payable or to be given by the trustee of the Trust under the respective SLAs.

As the requirements of subsection 26BC(3) of the ITAA 1936 are met, the following relief is available to both Taxpayers A and B in capacity as lenders under the proposed SLAs:

● no amount will be included in the assessable income of either Taxpayer A or B other than the interest paid and the compensatory payment

● any capital gain or loss from the disposal of the ASX listed company shares will be disregarded

● where replacement securities are provided in respect of pre-CGT ASX listed company shares, Taxpayers A and B will be taken to have acquired those replacement securities prior to 20 September 1985; and

● the first element of the cost base (and reduced cost base) of the replacement securities provided in respect of post-CGT ASX listed company shares will be the cost base of those securities just before acquisition of the replacement security.

Question 2

The issue of the CGT status of the replacement securities and the application of subsection 26BC(6A) of the ITAA 1936 have been previously discussed in the detailed reasoning in Question 1.

To summarise, Taxpayers A and B will be taken to have acquired the replacement securities prior to 20 September 1985 by virtue of subsection 26BC(6A) of the ITAA 1936.

Question 3

Subdivision 216-A of the ITAA 1997 deals with circumstances in which a distribution to a member of a corporate tax entity is treated as having been made to someone else.

Subsection 216-10(1) of the ITAA 1997 details the following specific situation in which this can occur:

● there is a corporate tax entity that makes a franked distribution to a member of the entity in respect of a membership interest in the entity

● the member was under an obligation to pay the distribution to another person under a SLA at the time the distribution was made

● the obligation was incurred in the member's capacity as the borrower under the SLA; and

● the distribution closing time occurred during the borrowing period

The term 'corporate tax entity' includes a company as stated in section 960-115 of the ITAA 1997. The phrase 'member of an entity' relevantly includes a member of the company or a stockholder in a company by virtue of section 960-130 of the ITAA 1997. The term 'membership interest in an entity' is each interest or right, or set of interests or rights a member of an entity has pursuant to section 960-135 of the ITAA 1997.

Where the requirements of subsection 216-10(1) of the ITAA 1997 are met, the distribution is taken to have been made to the other person as a member of the entity and not to the member under subsection 216-10(2) of the ITAA 1997.

The proposed scheme is on point with the specific situation detailed in subsection 216-10(1) of the ITAA 1997 as:

● the ASX listed company is a company and therefore a corporate tax entity that is expected to make franked distributions to (over the course of the proposed scheme) to the trustee of the Trust who will at that time be shareholder in ASX listed company

● the trustee of the Trust will be under an obligation to pay the distribution to both Taxpayer A and B under the proposed SLAs to be entered into at the time the distribution is made;

● the trustee of the Trust incurred this obligation in its capacity as the borrower under the SLA and

● any distribution made will have a closing time during the proposed borrowing period.

Therefore, by virtue of subsection 216-10(2) of the ITAA 1997, Taxpayers A and B are entitled to claim a tax offset for franking credits attached to the ASX listed company dividends.

It is worth noting that where section 216-30 of the ITAA 1997 applies, the borrower must give to the lender a statement in the approved form setting out such information in relation to the distribution as is required.

This requirement will be satisfied through the proposed use of the 'Transfer of Distribution Statement' form.