ATO ID 2009/142: Taxation of Financial Arrangements: financial arrangement - is a forward purchase contract 'cash settlable' under paragraph 230-45(2)(e) of the Income Tax Assessment Act 1997
Date of decision: 16 November 2009
Year of income: Year ended 30 June 2011
Business line: Finance and Investment Centre of Expertise

Issue
Does a forward purchase contract under which a taxpayer receives physical delivery of a commodity and which incorporates a 'dealer's margin' meet the definition of 'cash settlable' under paragraph 230-45(2)(e) of the Income Tax Assessment Act 1997 (ITAA 1997)?

Decision
No. The words 'you deal with the right or obligation, or with similar rights or obligations' in paragraph 230-45(2)(e) of the ITAA 1997 require that a taxpayer must deal with the rights and/or obligations in relation to the commodity rather than deal with the commodity itself. The fact that the taxpayer receives a dealer's margin so described is not relevant because the taxpayer does not deal with the rights and/or obligations themselves in order to generate a profit from a dealer's margin.

Facts
The taxpayer's operation includes entering into a forward purchase contract with a supplier to procure a commodity. The calculation of the purchase price incorporates a fixed amount known as a 'dealer's margin'. The date of the agreement is usually up to three years before the date of delivery. The taxpayer will then enter into a forward sale contract with a buyer to sell the same commodity. The date of the agreement is usually up to one and a half years before the date that the commodity is expected to be received from the supplier. At all times, the taxpayer will receive physical delivery of the commodity from the supplier under the forward purchase contract before delivering the same to the buyer under the forward sale contract.

Reasons for decision
Summary: Division 230 of the ITAA 1997 applies to financial arrangements. For the purposes of this analysis it is considered that, having regard to the factors in subsection 230-55(4) of the ITAA 1997, the forward purchase contract will constitute a single arrangement. A 'financial arrangement' is defined in subsection 995-1(1) of the ITAA 1997 by reference to sections 230-45 to 230-55 of the ITAA 1997. Specifically, paragraphs 230-45(1)(a) and (b) of the ITAA 1997 state that you have a financial arrangement, if you have, under an arrangement, a cash settlable legal or equitable right to receive a financial benefit or an obligation to provide a financial benefit. Whether a right to receive or obligation to provide a financial benefit is cash settlable is specified in subsection 230-45(2) of the ITAA 1997. Relevantly, paragraph 230-45(2)(a) of the ITAA 1997 states that 'a right you have to receive, or an obligation you have to provide, a financial benefit is cash settlable if...the benefit is money or a money equivalent'. Paragraph 230-45(2)(e) of the ITAA 1997 further provides that 'a right you have to receive, or an obligation you have to provide, a financial benefit is cash settlable if, and only if, you deal with the right or obligation, or with similar rights or obligations, in order to generate a profit from short-term fluctuations in price, from a dealer's margin, or from both...' Under the forward purchase contract, the taxpayer has a right to receive the commodity from the supplier and an obligation to pay the contracted price. Both the commodity and the contracted price satisfy the definition of financial benefit (defined in subsection 955-1(1) of the ITAA 1997 by reference to subsection 974-160(1) of the ITAA 1997 as, amongst other things, 'anything of economic value'). It is then relevant to consider whether the right to receive the commodity and the obligation to pay the contracted price are a cash settlable right and obligation as defined in subsection 230-45(2) of the ITAA 1997. The taxpayer's obligation to pay the contracted price under the forward purchase contract satisfies the definition of cash settlable pursuant to paragraph 230-45(2)(a) of the ITAA 1997 as the obligation is in relation to a financial benefit that is a sum of money. However, the taxpayer's right to receive the commodity from the supplier under the forward purchase contract will not satisfy paragraph 230-45(2)(a) of the ITAA 1997. The right to receive the commodity under the forward purchase contract is not money or a money equivalent as defined. The issue is whether the right to receive the commodity satisfies the requirements of paragraph 230-45(2)(e) of the ITAA 1997 on the basis that, under the forward purchase contract, the taxpayer deals with the right in order to generate a profit from short-term fluctuations in price, from a 'dealer's margin', or from both. The phrase 'deal with the right or obligation' is not defined; therefore it will take its ordinary meaning. The phrase clearly requires you to deal with the 'right or obligation' rather than deal with the commodity itself. In order to satisfy the requirements of paragraph 230-45(2)(e) of the ITAA 1997, what has to be dealt with in the relevant sense is the actual right(s) and obligation(s) themselves, that is, the intangible right(s) and obligation(s), as distinct from the physical piece of property represented by the commodity. This interpretation is consistent with paragraph 2 81 of the Explanatory Memorandum to the Tax Laws Amendment (Taxation of Financial Arrangements) Bill 2008 which states: The sort of dealer's margin in view in paragraph 230-45(2)(e) of the ITAA 1997 is a reference to the sort of margin that someone who deals in the right or obligation has, rather than to the sort of margin that someone who deals in the commodity itself has. In this case, the taxpayer is not dealing in the relevant right to the commodity itself in order to generate a profit. That there is an amount which is called a 'dealer's margin', paid as part of a transaction dealing in 'the commodity' to generate a profit, does not satisfy paragraph 230-45(2)(e) of the ITAA 1997. Accordingly, the financial benefit constituted by the taxpayer's right to receive the commodity under the forward purchase contract does not meet the definition of 'cash settlable' under paragraph 230-45(2)(e).

Legislative references: Income Tax Assessment Act 1997 section 230-45 paragraph 230-45(1)(a) paragraph 230-45(1)(b) subsection 230-45(2) paragraph 230-45(2)(a) paragraph 230-45(2)(e) section 230-50 section 230-55 subsection 230-55(4) subsection 974-160(1) subsection 995-1(1)
Related ATO interpretative decisions: ATO ID 2009/115
Other references: Explanatory Memorandum to the Tax Laws Amendment (Taxation of Financial Arrangements) Bill 2008