Edited version of private advice

Authorisation Number: 1051627699111

Date of advice: 10 February 2020

Ruling

Subject: Dividends and franking credits

Question 1

Are the dividends you receive assessable income within the meaning of section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

Yes

Question 2

Are the dividends assessable in the financial year relevant to the payment date?

Answer

Yes

Question 3

Are the imputation credits arising from the dividends assessable income within the meaning of section 6-5 of the ITAA 1997?

Answer

Yes

Question 4

Will Division 247 of the ITAA 1997 apply to the loan?

Answer

No

Question 5

Is the interest on the loan charged to you by the Product Issuer deductible under section 8-1 of the ITAA 1997?

Answer

Yes

Question 6

Are you eligible for a refund of any excess franking tax offsets arising from the imputation credits attached to the dividends?

Answer

Yes

This ruling applies for the following period:

1 July 20XX to 30 June 20XX

The scheme commences on:

1 July 20XX

Relevant facts and circumstances

You are resident of Australia for taxation purposes and intend to remain a resident for the whole of the relevant period.

On X April 20XX, you acquired a loan to purchase X fully paid ABC shares from XYZ Pty Ltd (the Product Issuer). The loan is a full recourse loan.

XYZ Pty Ltd is an Australian public company limited by shares listed on the Australian Securities Exchange.

You do not have a direct or indirect shareholding in the Product issuer.

In order to purchase the shares in ABC, you executed an agreement.

The agreement is a loan facility which enables eligible investors to purchase securities with borrowed funds loaned from XYZ Pty Ltd. You must pay interest to the Product Issuer at the variable interest rate determined by the Product Issuer.

The shares are held in the name of the Product Issuer's nominee (the Trustee) and you retain a beneficial ownership in the shares.

You are absolutely entitled to the shares as against the Trustee, and at the Maturity Date or Early Maturity Date of each Loan and you may elect to transfer the shares into your name.

The Trustee is the registered shareholder of the shares for the sole benefit of yourself.

You are not entitled to elect to use a dividend reinvestment plan offered by a company.

You have granted a security interest to the Product Issuer over the shares and other entitlements and benefits relating to the shares purchased.

You have elected to have an Upside Cap applicable to the shares of X%.

You are not wholly or partly protected against a fall in the market value of the shares in the Company as you have elected to forego a Put Option on the shares.

During the relevant period, the ABC is expected to declare fully franked dividends for all shareholders who were fully paid ordinary shareholders on the record date.

Within a reasonable period of time following receipt of each relevant cash dividend paid by the Product Issuer to the Trustee, the Trustee will pay you the cash dividend amount.

The arrangement of the loan is at arm's length and you are not an associate of the Product issuer.

The Agreement provides that the Trustee must pay the full amount of the dividends received by the Trustee to the Taxpayer for the following reasons:

a.    A resulting trust arises from the relationship between the Taxpayer and the Trustee for the following reasons:

                                          i.    The shares purchased by the Taxpayer were paid for by the Taxpayer and no contribution to the purchase price was made by the Trustee;

                                         ii.    The Taxpayer pays interest on the loan to the Product Issuer and the Trustee makes no contribution to the amount of interest paid; and

                                        iii.    There is nothing to indicate from the Agreement that the Taxpayer intended to make a gift of any of the shares to the Trustee.

Clause 35 of the Agreement provides the following:

"Trustee" means XYZ Pty Ltd or its nominee which will hold the Secured Property as trustee for the Borrower(s). This definition of Trustee ensures that the relationship between the Trustee and the Taxpayer is a trustee/beneficiary relationship. As referred to above, the circumstances arising from a purchase of property by the Taxpayer and that property being held by a trustee gives rise to a resulting trust. The circumstances do not indicate that the trust established under the Agreement is a bare trust because the Trustee cannot convey the shares into the name of the Taxpayer at the election of the Taxpayer without the consent of the Product Issuer. See the Commissioner's ruling GSTR 2008/3 at [29] to [44] for the Commissioner's position of the general principles which apply to bare trusts.

Clause 1.7 of the Agreement provides the following:

If required by XYA Pty Ltd (the Product Issuer), the Trustee will hold the Secured Property as trustee for your benefit. This clause grants a discretionary power to the Product Issuer and this clause gave rise to the holding of the Secured Property by the Trustee.

Clause 1.8 of the Agreement provides the following:

If required by XYZ Pty Ltd (the Product Issuer), the Trustee will receive all your dividends and distributions into a segregated bank account nominated and operated by the Trustee. Subject to this Agreement and any other direction made by you, the Trustee will forward the dividend or distribution to your nominated bank account. This clause 1.8 ensures that the Trustee has a legal obligation to pay all of the amounts of any dividends or distributions to the Taxpayer.

Clause 4.5 of the Agreement provides the following:

You (the Taxpayer) agree that the Trustee will hold securities on your behalf. The Trustee will execute as Trustee any documents it thinks appropriate in relation to the agreements. The Trustee may do, or refrain from doing, anything it determines including (i) arranging for the lodgment of documents of title for any securities, (ii) appointing any director, officer or employee as its attorney and (iii) applying any money held by it in or towards the satisfaction of any amount that you owe to XYZ Pty Ltd under the agreement. Clause 4.5 ensures that the Taxpayer consents to the Trustee holding any shares on their behalf arising from the Product Issuer's discretionary power under clause 1.7.

The Taxpayer has not entered into any stock borrowing arrangements with the Trustee and accordingly, the Trustee has not at any time acquired any beneficial interest in the shares.

Relevant legislative provisions

Income Tax Assessment Act 1936 subsection 6(1)

Income Tax Assessment Act 1936 subsection 44(1)

Income Tax Assessment Act 1997 section 6-5

Income Tax Assessment Act 1997 subsection 6-5(2)

Income Tax Assessment Act 1997 section 8-1

Income Tax Assessment Act 1997 Division 67

Income Tax Assessment Act 1997 subsection 67-25

Income Tax Assessment Act 1997 Division 207

Income Tax Assessment Act 1997 subsection 207-20(1)

Income Tax Assessment Act 1997 Division 247

Reasons for Decision

Question 1

Section 6-5 of the ITAA 1997 provides that your assessable income includes income according to ordinary concepts, which is called ordinary income. Subsection 6-5(2) of the ITAA 1997 provides that if you are an Australian resident, your assessable income includes the ordinary income you derived directly or indirectly from all sources, whether in or out of Australia during the year.

Ordinary income has generally been held to include three categories, namely, income from rendering personal services, income from property and income from carrying on a business.

Other characteristics of ordinary income that have evolved from case law include receipts that:

·         are earned

·         are expected

·         are relied upon, and

·         have an element of periodicity, recurrence or regularity.

Dividend income you received is classed as ordinary income and assessable under section 6-5 of the ITAA 1997.

Question 2

Subsection 6(1) of the Income Tax Assessment Act 1936 (ITAA 1936) defines a dividend to include any distribution made by the company to any of its shareholders, whether in money or other property, and any amount credited by a company to any of its shareholders as shareholders.

As per subsection 44(1) of the ITAA 1936, an Australian resident shareholder (the registered holder of shares) is assessable on all dividends paid (to the shareholder) by a company (whether the company is a resident or non-resident) out of profits derived from any source.

The term 'paid' in relation to a dividend as defined in subsection 6(1) of the ITAA 1936 includes 'credited' or 'distributed. The declaration of a dividend creates a debt owing to the shareholders and the payment, crediting or distribution of the dividend discharges that debt. The posting of a dividend cheque or money represents a payment for these purposes.

In your case, the conditions in subsection 44(1) of the ITAA 1936 are satisfied. You are a shareholder of ABC and you expect payments to be made to you of the dividend for the purposes of subsection 44(1) of the ITAA 1936.

Accordingly, the dividends you receive are assessable to you in the income year the dividends are paid and credited by the company.

Question 3

Subsection 207-20(1) of the ITAA 1997 provides that if an entity makes a franked distribution to another entity, the assessable income of the receiving entity, for the income year in which the distribution is made, includes the amount of the franking credit on the distribution. This is in addition to any other amount included in the receiving entity's assessable income in relation to the distribution under any other provision of this Act

Question 4

Division 247 of the ITAA 1997 outlines the taxation provisions applicable to capital protected borrowing and only applies to borrowers with respect to capital protected borrowings entered into on or after 9:30 am by legal time in the ACT, on 16 April 2003.

The purpose of Division 247 of the ITAA 1997 is to separately identify an appropriate portion of the total consideration paid by a borrower as the premium paid for "capital protection". This premium is treated for CGT purposes as the price paid for a put option, whether or not a put option is actually granted to the borrower: If the financing agreement allows the borrower to invoke capital protection on more than one occasion, the borrower is taken to have acquired a put option for each relevant period for which capital protection may be invoked.

In your case, you have not elected to acquire a put option under the terms of the agreement and the loan is a full recourse loan. You are not wholly or partly protected against a fall in the market value of the shares.

Question 5

Section 8-1 of the ITAA 1997 allows a deduction for all losses and outgoings to the extent to which they are incurred in gaining or producing assessable income, except where the outgoings are of a capital, private or domestic nature, or relate to the earning of exempt income.

Taxation Ruling TR 95/25 Income tax: deductions for interest under section 8-1 of the Income Tax Assessment Act 1997 following FC of T v. Roberts; FC of T v. Smith provides the Commissioner's view regarding the deductibility of interest expenses. As outlined in TR 95/25, there must be a sufficient connection between the interest expense and the activities which produce assessable income. TR 95/25 specifies that to determine whether the associated interest expenses are deductible, it is necessary to examine the purpose of the borrowing and the use to which the borrowed funds are put.

The 'use' test, established in the High Court case Federal Commissioner of Taxation v. Munro (1926) 38 CLR 153, (1926) 32 ALR 339 is the basic test for the deductibility of interest, and looks at the application of the borrowed funds as the main criterion.

Accordingly, it follows that if a loan is used for investment purposes from which income is to be derived, the interest incurred on the loan will be deductible. However, where a loan relates to private purposes, no deduction is allowed.

In your case you borrowed money to purchase shares in ABC. The associated interest expenses incurred are for your investment loan and as a result the interest expense is considered to be an allowable deduction.

Question 6

Under the general rule in section 207-20 of the ITAA 1997, an entity which receives a franked distribution is entitled to a tax offset for the income year in which the distribution is made. Holders who are entitled to a tax offset under Division 207, in respect of franking credits received, will also be subject to the refundable tax offset rules in Division 67, unless specifically excluded from the refundable tax offset rules under section 67-25 of the ITAA 1997.

In your circumstances, section 67-25 of the TIAA 1997 does not apply to your situation as you do not meet any of the criteria for the refundable tax offset rules to not apply. Accordingly, you are entitled to a tax offset equal to the franking credit on the distribution.