Edited version of your written advice

Authorisation Number: 1051439646015

Date of advice: 12 October 2018

Ruling

Subject: Bond redemption

Question 1

Do the 19XX Bonds fall within the category of ‘traditional securities’ as outlined in section 26BB of the Income Tax Assessment Act 1936 (ITAA 1936)?

Answer:

No.

Question 2

Do the 19YY Bonds fall within the category of ‘traditional securities’ as outlined in section 26BB of the ITAA 1936?

Answer:

No.

Question 3

Do the 19XX Bonds fall within the category of ‘qualifying securities’ as outlined in Division 16E of the ITAA 1936?

Answer:

Yes.

Question 4

Do the 19YY Bonds fall within the category of ‘qualifying securities’ as outlined in Division 16E of the ITAA 1936?

Answer:

Yes.

Question 5

Will the proceeds of redemption of both the Bonds be assessable as a capital gain?

Answer:

Yes however the gain will be reduced for the amounts assessable under Division 16E.

This ruling applies for the following periods

Year ended 30 June 2018

The scheme commenced on

1 July 2017

Relevant facts and circumstances

You obtained savings bonds issued by the Country X Treasury Department in 19XX (“the 19XX Bonds”).

The bonds are non-marketable, interest-bearing government savings bonds that are guaranteed to at least double in value over the initial term of the bond, typically 20 years. They earn interest semi-annually and redemption value jumps at such time to reflect the additional accrued interest.

Paper bonds are sold at 50% of face value. You paid $5,000 in Country Y currency for your $10,000 paper bonds which were denominated in that foreign currency. The bonds are not worth their face value until they mature. Each of your 19XX bonds were denominated $10,000 and were issued at the price of $5,000.

Country Y citizens, official Country Y residents and Country Y government employees (regardless of their citizenship status) can buy and own these Bonds. Minors can also own these Bonds.

On maturity, you receive the face value of your bonds plus accrued interest.

The guaranteed original rate of return and the original maturity date for your bonds were:

A bond with an issue date in the time period from November 1982 through April 1995 earns interest either

● at a guaranteed rate or guaranteed rates; or

● at a market-based rate (85% of 6-month averages of 5-year Treasury securities yields)

whichever category of rates, separately, by itself, over the entire period from date of issue, produces the higher redemption value for the bond.

When it changes a guaranteed rate, Treasury must announce the rate before the extended period starts. For all bonds issued before May 1995, the guaranteed rate for extension periods entered on or after March 1993 has been 4%.

When electronic Bonds in a Treasury Direct account stop earning interest, they are automatically redeemed and the interest earned is reported to the government revenue authority.

You converted your paper Bonds to electronic format in Winter 2016.

You were a Country Y citizen at the time of issue of the 19XX bonds and you were not a resident of Australia.

You obtained more bonds issued by the Country Y Treasury Department in Summer 19YY (“the 19YY Bonds”).

They also were converted to electronic format in Winter 2016.

Each of these three 19YY Bonds were denominated $10,000 in the Country Y currency and were issued at the price of $5,000 in the Country Y Currency.

You became a resident of Australia in Winter 1995.

You renounced your Country Y citizenship in 2016.

Both the Bonds were redeemed on or about Autumn 2018.

You did not obtain the bonds as trading stock, nor as a profit-making undertaking or scheme; merely to hold until maturity as a capital investment.

The 19XX Bonds were held to maturity on that basis.

The 19YY Bonds were required by the Country Y Treasury to be redeemed at the time of redemption of the 19XX bonds because you were no longer a Country Y citizen.

You had a choice of reporting the interest accrued and you chose to defer until redemption/maturity.

Relevant legislative provisions

Income Tax Assessment Act 1936 Division 16E

Income Tax Assessment Act 1936 Section 26BB

Income Tax Assessment Act 1936 Part IIIA

Income Tax Assessment Act 1936 Subsection 160AF(1)

Income Tax Assessment Act 1997 Section 6-5

Income Tax Assessment Act 1997 Section 108-5

Reasons for decision

Section 6-10 of the Income Tax Assessment Act 1997 (ITAA 1997) provides that a taxpayer’s assessable income includes statutory income amounts that are not ordinary income but are included in assessable income by another provision. As you are an Australian resident, your assessable income includes your statutory income from all sources, whether in or out of Australia: section 6-10(4).

Section 10-5 of the ITAA 1997 lists provisions which include, in some circumstances, gains on redemption of bonds as assessable income:

● section 26BB of the Income Tax Assessment Act 1936 (ITAA 1936);

● sections 159GQ and 159GW of the ITAA 1936; and

● section 102-5 of the ITAA 1997.

Question 1 and 2: Traditional Securities

In determining whether the bonds constitute “traditional securities”, it is necessary to first consider whether the bonds are a “security” for the purposes of section 26BB of the ITAA 1936.

Section 26BB

Subsection 26BB(1) defines a ‘security’ to have the same meaning as in Division 16E of the ITAA 1936. Subsection 159GP(1) within Division 16E defines a “security” to mean:

(a) stock, a bond, debenture, certificate of entitlement, bill of exchange, promissory note or other security;

(b) a deposit at bank or other financial institution;

(c) a secured or unsecured loan; or

(d) any other contract, whether or not in writing, under which a person is liable to pay an amount or amounts, whether or not the liability is secured.

You acquired Country Y Savings Bonds. Accordingly it is considered that the bonds constitute ‘securities’ by reason of paragraph 159GP(1)(a) of the ITAA 1936.

Traditional security

To have gains on redemption of bonds classed as assessable income, they need to constitute traditional securities.

The term ‘traditional security’ is defined under subsection 26BB(1) of the ITAA 1936 to mean a security held by a taxpayer that:

(a) is or was acquired by the taxpayer after 10 May 1989;

(b) either:

(i) does not have an eligible return; or

(ii) has an eligible return, where:

(A) the precise amount of the eligible return is able to be ascertained at the time of issue of the security; and

(B) that amount is not greater than 1.5% of the amount calculated in accordance with the formula:

Payments x Term

where:

Payments is the amount of the payment or of the sum of the payments (excluding any periodic interest) liable to be made under the security when held by any person; and

Term is the number (including any fraction) of years in the term of the security;

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

(d) is not trading stock of the taxpayer.

The definition or ‘eligible return is given by subsection 159GP(3). It states:

“For the purposes of this Division, 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 refers to interest that is payable no later than one year from the commencement of the period to which it relates. Typically, an eligible return will exist where the security is issued at a discount, bears deferred interest or is capital indexed. Where the return on the security is positive, the accrual provisions include amounts in assessable income over the term of the security. If the return is negative, a deduction may be obtained.

Application to your circumstances

19XX Bonds

You acquired the 19XX Bonds before 10 May 1989. Therefore this section would have no application. This outcome is not altered by the fact that you became resident in Australia in 1995. Section 855-45 of the ITAA 1997 can apply to certain assets that are owned by a person who becomes an Australian resident as if that person had acquired those assets at the time he or she become an Australian resident. However section 26BB is not within the provisions that are affected by section 855-45.

One issue with your circumstances is the fact that you converted your bonds from paper form to electronic. However this process merely involves converting your paper based bonds into an electronic version that is easier to keep track of. You still have the same holdings and you receive no additional bonuses or interests for doing this. The asset retains the same value and has the same characteristics. Therefore it will be considered that the same asset exists post electronic version and no CGT event has occurred at that time.

19YY Bonds

You acquired the 19YY bonds after 10 May 1989. Therefore section 26BB can apply.

The 19YY Bonds on the facts are guaranteed to double in value if held to the bond maturity period given. It is considered that these bonds have an eligible return as they were issued at a discount and it is reasonably likely that the sum of the payments (other than periodic interest) would exceed the issue price of the security.

However they are not considered to satisfy the other requirements of the section. The eligible return will be considered to be greater than 1.5% of the amount calculated in accordance with the formula in sub-subsection 26BB(1)(b)(ii)(B) detailed above.

Putting in the figures that represent your situation, this provides the following calculation:

$5000 x 30 = $150,000

The eligible return would be $5000.

The eligible return would be greater than 1.5% of the amount calculated under this formula.

Therefore the 19YY bonds will not be considered to be traditional securities.

Question 3 & 4: Qualifying securities

Qualifying securities are regulated by Division 16E to the exclusion of any other provision of the Act, except where the securities constitute trading stock. You have stated you did not obtain the bonds as trading stock, nor as a profit-making undertaking or scheme; merely to hold until maturity as a capital investment.

Section 159GP of the ITAA 1936 defines a ‘qualifying security’ as:

"qualifying security" means any security:

(a) that is issued after 16 December 1984;

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

(‘prescribed security’ means:

(i) a seasonal security as defined by section 4 of the Loan (Short-term Borrowings) Act 1959; or

(ii) any stock or other security issued by the Commonwealth that does not bear interest;

and includes an interest in any such seasonal security, stock or other security. Stock means Commonwealth Government Inscribed Stock or Australian Consolidated Inscribed Stock.

(ba) that is not part of an exempt series (see subsection (9A)) (That is, where the first security in a series is not a qualifying security, later securities issued with the same terms will not be treated as securities assessable in accordance with Div 16E.);

(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 1½% 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.

Application to your circumstances

Your 19XX and 19YY bonds fulfil the characterisation of qualifying securities:

● they issued after 16 December 1984;

● they are not prescribed securities within the meaning of section 26C;

● they are not part of an exempt series;

● the term of the bonds were reasonably expected to exceed one year;

● they have an eligible return; and

● the payments made under the security (other than ‘periodic interest’) are reasonably likely to exceed the issue price of the security.

Division 16E does not apply to non-residents who hold qualifying securities nor to qualifying securities held as trading stock. When you became a resident of Australia in 1995, Division 16E became applicable to your Country Y savings bonds.

Tax treatment of qualifying securities for Australian residents

Where Division 16E applies to a security, you are required to divide the term of the security into ‘accrual periods’ (usually periods of six months) and calculate the ‘accrual amount’ for each period according to a formula contained in section 159GQB(1):

[Implicit interest rate x Opening balance] – Periodic interest

This accrual amount is then brought to account under section 159GQ.

You requested that the interest be paid upon redemption instead of on an annual basis. The effect of this is the amount of interest payable upon redemption would not constitute ‘periodic interest’ as given by section 159GP(6). The interest would be assessable as ordinary income in the year in which it is payable. This result is relevant to the formula above.

The eligible return from qualifying securities issued before 28 January 1994 is separated into its fixed (non-varying) and varying elements. The fixed element is brought to account on a straight line basis, that is, an equal amount of the fixed element of the return is brought to account in each income year during the term of the security.

Where the security is held for only part of an income year, an apportioned amount is brought to account in that year.

The varying element is brought to account on an attribution basis, that is, so much of the varying element as is attributable to the relevant income year, or which the Commissioner considers may reasonably be attributed to the year, is included in the assessable income of the holder of the security.

Question 5: Capital gains tax

You may make a capital gain or capital loss when a capital gains tax (CGT) event happens to a CGT asset. A CGT asset is any kind of property or a legal or equitable right that is not property.

Your CGT assets were the rights you received when you acquired your US Savings Bonds.

Subsection 104-25(1) says that CGT event C2 happens if your ownership of an intangible CGT asset ends by being redeemed, cancelled, released, discharged, satisfied, expired, abandoned, surrendered or forfeited, among other things.

Receipt of a lump sum payment may give rise to a capital gain, the cancellation or surrendering of such a right is a CGT event. The time of the event is when a contract is entered into that results in the asset ending, or, if there is no contract, when the asset ends.

You make a capital gain if the capital proceeds from the ending of the asset are more than the asset’s cost base.

Section 102-5 will bring into your assessable income any capital gain which arose on redemption of the bonds, worked out from acquisition date on commencement of your Australian residency.

As a result of renouncing your Country Y citizenship you were required to redeem your Country Y savings bonds. The first series of bonds had fully matured however the second series were redeemed before maturity.

The amount you received from redemption of the bonds will be assessable as capital gains. When calculating your net capital gain, you will need to establish the cost base of the bonds which has been affected as a result of becoming an Australian resident.

160M(12) Becoming an Australian resident

Former section 160M(12) of the ITAA 1936 explained that where a non-resident becomes a resident of Australia on or after 20 September 1985, every asset that was owned by that person immediately before becoming a resident, other than:

(a) a taxable Australian asset;

(b) any other asset that was acquired by the taxpayer before 20 September 1985; or

(c) an asset to which subsection 13, 14 (relating to trusts) or 15 (omitted in 1991) applies;

shall be deemed to have been acquired by them at the time of becoming a resident for a consideration equal to the market value of the asset at that time.

Accordingly, for CGT purposes, you are taken to have acquired your Country Y Savings Bonds on the date you became an Australian resident and the first element of your cost base will be their market value as at that date.

Any change of value between purchase and deemed acquisition date does not fall under any consideration within the Australian taxation system as you are not considered to have held the assets for taxation purposes in Australia until the deemed acquisition date.

Note that amounts assessed under Div 16E will reduce any capital gain that is assessed upon redemption (section 118-20 ITAA 1997).