ATO ID 2011/91: Taxation of financial arrangements: meaning of 'premium' in section 230-165 of the Income Tax Assessment Act 1997
Date of decision: 24 October 2011
Year of income: Year ended 30 June 2012
Business line: Finance and Investment Centre of Expertise

Issue
Will an amount reflecting the difference between the consideration paid for acquiring a portfolio of loans and the face value of the portfolio be a 'premium' for the purposes of section 230-165 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Decision
Yes. Where the consideration paid for acquiring a portfolio of loans is greater than the face value of the portfolio, this is a premium for the purposes of section 230-165 of the ITAA 1997.

Facts
The taxpayer is a financial institution which has made a valid election under section 230-150 of the ITAA 1997. The taxpayer subsequently acquired a portfolio of similar loans from another company. Gains and losses from these loans will be brought to account under the accruals tax timing methodology in Subdivision 230-B of the ITAA 1997. The consideration paid for acquiring the portfolio was greater than the outstanding principal of the loans in the portfolio at the time of acquisition (that is, the face value or nominal value of the loan book). The difference between the face value of the portfolio at the time of acquisition and the consideration paid is calculated with reference to the portfolio as a whole, rather than being attributable to particular financial arrangements within the portfolio. The difference between the face value of the portfolio at the time of acquisition and the consideration paid is not considered to be significant relative to the overall gain/loss from the portfolio.

Reasons for decision
Summary: All legislative references are to the ITAA 1997 unless otherwise indicated. Section 230-165 essentially requires the identification of any discount or premium which arises from the acquisition of a portfolio of similar financial arrangements in order that, to the extent that a gain or loss from a financial arrangement within that portfolio is attributable to the discount or premium (the 'premium/discount gain or loss'), it may accrue over the expected life of the portfolio. The 'premium' which is to be spread under section 230-165 is not a defined term for the purposes of Division 230. The Macquarie Dictionary includes in the definition of 'premium': '...a sum above the nominal or par value of a thing.' This can be contrasted its definition of 'discount', being: '...any deduction from the nominal value.' Where it is open to do so, particularly where the meaning of a term is ambiguous, provisions are to be construed in a way that is 'consistent with the language and purpose of all the provisions of the statute' ( Project Blue Sky Inc & Others v Australian Broadcasting Authority (1998) 194 CLR 355 at 381). A fundamental aspect of Division 230 is that traditional taxation of gross receipts and outgoings is replaced with the taxation of a net gain or loss made from a financial arrangement. Although not specifically defined, it is clear from the structure and operation of Division 230 that the concept of a gain or loss connotes the appropriate offsetting of the costs (broadly financial benefits provided) against proceeds (broadly, financial benefits received) (Explanatory Memorandum (EM) to the Tax Laws Amendment (Taxation of Financial Arrangements) Bill 2008 paragraphs 3.3 to 3.9, 3.20, 3.32, 3.33, 4.126, 4.127, among others). A gain or loss is to be calculated in nominal terms (as indicated by subsections 230-70(1) and 230-75(1), and the EM at paragraphs 3.20, 3.58, 3.60 and 4.143). Except as provided for under sections 230-60 and 230-505, a financial benefit under a financial arrangement is also to be measured in nominal rather than net present value terms - that is, its value at the time it is (or is to be) provided (EM paragraphs 3.20, 3.58, 3.59, 4.6 and 4.7). Where applicable, sections 230-150 and 230-165 overlay the ordinary accruals rules in Subdivision 230-B, to apply specific treatment for portfolio premiums and discounts (see subsection 230-165(5)). To the extent that a gain or loss under the accruals method arises in part from a premium or discount, paragraph 230-165(2)(a) treats that part of the gain or loss attributable to the discount or premium to be a particular gain or loss to which the accruals method applies. To the extent that the gain or loss does not arise from the premium or discount, it will be treated as a separate gain or loss from the financial arrangement to which the accruals method applies. The term 'premium' in paragraphs 230-165(1)(d) and 230-165(2)(a) appears as an alternative, or in contrast, to the term 'discount'. To the extent that a discount constitutes a gain from the acquisition of an entire portfolio, it follows that a premium should therefore constitute a loss. It is consistent with the structure of Division 230 to calculate the discount or premium which arises due to the acquisition of the entire portfolio (rather than being attributable to any specific financial arrangement within that portfolio) in the same manner that a gain or loss referrable to an individual financial arrangement would ordinarily be calculated. That is the net gain or loss in nominal terms is determined by comparing the difference between the outgoings (consideration paid) and receipts (principal outstanding at the time of acquisition). In determining a 'discount', an approach which offsets the cost of a portfolio against its face value is consistent with the statement in paragraph 4.155 of the EM: 'A portfolio of loans purchased for an amount less than its face value may represent a portfolio discount to which the modified accruals rule may also apply.' The same approach is therefore appropriate in determining a 'premium'. Example 4.6 in the EM identifies a premium as the difference between the consideration for the portfolio and its market value (in terms of net present value) at the time of acquisition. This appears to be inconsistent with the ordinary meaning of the term in the context of financial arrangements, the overall approach of Division 230 in determining a gain or loss, and the approach to determining a gain from a portfolio discount under section 230-165. In Brooks & Anor v FC of T 2000 ATC 4362 at 4376, the full Federal Court noted 'there have been cases where the law as stated in the Explanatory Memorandum has been held to be wrong.' To the extent that Example 4.6 in the EM is inconsistent with other statements in the EM and the structure of Division 230 as set out above, the example is not considered to accurately reflect the law.

Legislative references: Income Tax Assessment Act 1997 Division 230 section 230-60 subsection 230-70(1) subsection 230-75(1) Subdivision 230-B section 230-150 section 230-165 subsection 230-165(1)(d) paragraph 230-165(2)(a) subsection 230-165(5) section 230-505
Case references: Project Blue Sky Inc & Others v Australian Broadcasting Authority (1998) 194 CLR 355
Other references: Explanatory Memorandum to the Tax Laws Amendment (Taxation of Financial Arrangements) Bill 2008 The Macquarie Dictionary, 5th Edn, The Macquarie Library Pty Ltd, NSW, 2009
Subject references: Income tax Taxation of Financial Arrangements (CoE)