Private ruling: Collar Strategy
Published: November 2014
Ruling period: Income year ended 30 June 2015 and future years (no end date)
Date scheme commenced: Scheme is yet to commence

Ruling: Q1: Will the payments made where either of the put or call options entered into by the Trust over dividends under the dividend collar strategy are exercised be related payments for the purposes of former section 160APHN of the Income Tax Assessment Act 1936 (ITAA 1936)? | A1: Yes

Relevant facts and circumstances: The Trust is an unregistered managed investment scheme. Of the direct and indirect investments entered into by the Trust, a significant asset is the Australian Equities Sector. The Investment Manager has been engaged by the Trust to develop a strategy to improve the excess return generated by the Australian equity portfolio compared to the market benchmark (the excess is also known as "alpha"). The strategy involves the use of variable put and call options in respect of shares and dividends in a particular company.

Relevant legislative provisions: former section 160APHD of the Income Tax Assessment Act 1936 | former section 160APHN of the Income Tax Assessment Act 1936

Reasons for decision: Summary: Pursuant to former subsection 160APHN(2) of the ITAA 1936, a related payment arises where: "The taxpayer or associate is taken, for the purposes of this Division, to have made, to be under an obligation to make, or to be likely to make, a related payment in respect of the dividend or distribution if, under an arrangement, the taxpayer or associate has done, is under an obligation to do, or may reasonably be expected to do, as the case may be, anything having the effect of passing the benefit of the dividend or distribution to one or more other persons." The purpose of the related payment rule, in the context of former Division 1A of the ITAA 1936, is to require additional testing of the 'at risk' position in the circumstances where the recipient of a dividend is not at risk in respect of the dividend (in the context that the receipt of a dividend is considered a common reward of share ownership in ordinary circumstances) as they are considered to have passed on the benefit of the dividend to a third party. Where the benefit of the dividend is 'passed on' to a third party, the recipient of the dividend is required to satisfy the holding period 'at risk' requirement for the 'secondary qualification period' as defined in former section 160APHD of the ITAA 1936, which is determined by reference to a discrete period around the ex-dividend date of the dividend the benefit of which has been passed on. This can be contrasted with the more usual 'primary qualification period', which generally runs from the day after the date of acquisition of a share or interest until a discrete period after the share or interest upon which the dividend has been paid first goes ex-dividend. Former section 160APHN of the ITAA 1936 provides some non-exhaustive examples as to what constitutes the concept of passing the benefit of a dividend to a third party. For example, if an owner of a share is under, or may reasonably become subject to, an obligation (former 160APHN(2)) to pay or credit an amount to another person (former 160APHN3(a) or (b)) and the amount is calculated by reference to the amount of the dividend the owner receives (former section 160APHN(4)(a) and (f)), then that owner would be considered to be passing on the benefit of the dividend to a third party. Such a scenario would be regarded as constituting a related payment for the purposes of former Division 1A of the ITAA 1936. The Explanatory Memorandum to Taxation Laws Amendment Bill (no. 2) 1999 (the EM) sets out the policy intent behind the related payment rule. The EM makes it clear that the rule is designed to apply in situations whereby the benefit of a dividend is transferred from a taxpayer to another party. Statements in the EM to this effect include: 4.97 A taxpayer or associate is taken for the purposes of the provisions to have made a related payment if the taxpayer or associate is under an obligation to pass the benefit of a dividend or distribution to other persons [emphasis added]. 4.104 …Generally, a correspondence between a share parcel and an index derivative which is sufficiently close to reduce risk materially in a qualification period will, if the index derivative requires a dividend equivalent benefit to pass to the holder of the derivative, also be sufficiently matched with the dividends on the parcel to constitute a related payment [emphasis added]; and 4.105 It is necessary for the related payments rule to apply to Share Price Index (SPI) future transactions where the seller of the future hedges by holding the physical stock (i.e. a share portfolio which is closely correlated with the All Ordinaries Index (AOI)) and effectively credits the buyer with the estimated dividends on the shares through the price against which the contract is agreed to be settled [emphasis added]. Former subsection 160APHN(4) of the ITAA 1936 lists the circumstances where an act that passes the benefit such as a payment will represent a related payment. These circumstances are: (a) the amount or the sum of the amounts paid, credited or applied... (d) is, or may reasonably be expected to be, equal to; or (e) approximates or may reasonably be expected to approximate; or (f) is calculated by reference to; the amount of the dividend or distribution. Under the arrangement the Trust will enter into put and call options in respect to shares in a particular company. They will also be obligated under the arrangement to pay an amount equal to the amount of the dividend to a third party. This entails the passing on the benefit of the dividend to that third party for the purposes of former Section 160APHN of the ITAA 1936 pursuant to the combined operation of former paragraph 160APHN(3)(a) and section 160APHN(4).