Private ruling: TOFA - Contracts for difference (CFD)
Published: May 2012
Ruling period: Year ending 30 June 2011 | Year ending 30 June 2012 | Year ending 30 June 2013 | Year ending 30 June 2014 | Year ending 30 June 2015
Date scheme commenced: 1 July 2010

Ruling: Q1: I s the CFD that the company has entered into with its sole director a financial arrangement for the purpose of Division 230 of the ITAA 1997? | A1: Yes, the CFD that the company has entered into with its sole director is a financial arrangement for the purpose of Division 230 of the ITAA 1997. | Q2: Is a payment made or received under clause 6 a gain or loss made (as the case requires) for the purposes of section 230-15(1) and (2) of the ITAA 1997? | A2: No, a payment made or received under clause 6 is not a gain or loss made for the purposes of section 230-15(1) and (2) of the ITAA 1997.

Relevant facts and circumstances: BACKGROUND The company is an Australian private limited company, controlled by a sole director. The company is developing a business plan to acquire an Australian Financial Services Licence and provide Contracts for Difference (CFD) within the Australian market place. The company's business model is to earn a margin over its costs. The company has entered into a CFD with its sole director. The rights and obligations under the CFD The legal and equitable rights and obligations under the terms of the CFD can broadly be separated into: · primary rights and obligations representing the fundamental terms which are the reason each party has entered into the CFD; and · supplementary rights and obligations, reflecting those terms of the CFD which facilitate or support the fundamental terms. Under clause xx of the terms of the CFD, an investor may offer to enter into a new CFD by placing an order with the company. This may be to either open a new CFD or close-out an existing CFD. The investor may be either the Long Party (notionally purchasing the underlying) or the Short Party (notionally selling the underlying). The order can be of a number of varieties (set out in clauses x to y). The Reference Securities to which the CFD relates will be those of major banks, unless the company determines otherwise (clause xx). For administrative purposes, each investor maintains a 'company account' in which the investor deposits funds. This account has a number of sub-accounts such as the 'Collateral Sub-account' and the 'Blocked Funds Sub-account'. Primary rights and obligations The CFD constitutes an obligation of the investor to pay the company: · any interest on an open CFD if the investor is the Long Party; · any Shortfall on the close-out date; · any Dividend Amounts if the investor is the Short Party; and · any Trading Fees; (clause xx) The 'Shortfall', if the investor is the Long Party, means the greater of: · the Initial CFD Face Value less the Close-out CFD Face Value; and · nil. The 'Shortfall', if the investor is the Short Party, means the greater of: · the Close-out CFD Face Value less the Initial CFD Face Value; and · nil. The CFD constitutes an obligation of the company to pay the investor: · any interest on an open CFD if the company is the Long Party; · any Surplus on the close out date; and · any Dividend Amounts if the company is the Short Party; (clause xx) The 'Surplus', if the investor is the Long Party, means the greater of: · the Close-out CFD Face Value less the Initial CFD Face Value; and · nil. The 'Surplus', if the investor is the Short Party, means the greater of: · the Initial CFD Face Value less the Close-out CFD Face Value; and · nil. The 'Dividend Amount' means an amount equivalent to the payment of any dividends paid on the Reference Security - this may include an amount reflecting franking credits where the company is the Long Party (clause xx). The interest is calculated by applying the relevant rate to the CFD Face Value as it is at the time the interest is payable (clause xx). The CFD Face Value is determined by the company by reference to the market value of the Reference Security (clauses xx). This is done at each Valuation Time (clause xx). Each party may also be required to make 'Mark-To-Market Payments': · if, at any Valuation Time the CFD Face Value is greater than the previous value, the Short Party must pay the Long Party the excess; · vice versa, if the CFD Face Value is less, the Long Party must pay the Short Party the excess; · any Mark-To-Market Payment, where paid by the company, will be treated as a refund of any prepaid Shortfall and where paid by the investor will be treated as a refund of any prepaid Surplus; and · to the extent the Mark-To-Market Payment exceeds any prepaid Shortfall or Surplus respectively, it will be treated as a prepayment of the Shortfall or Surplus respectively; (clause xx). The company has sole discretion to charge fees and charges from time to time (clause xx). In addition to the payments set out above, the company may also charge - as an independent obligation - the investor default interest where the investor fails to make a payment on the due date (Annexure x). Supplementary rights and obligations In addition to the primary rights and obligations set out above, the following supplementary rights and obligations, which are essentially administrative in nature, are set out under the terms of the CFD: · The company has the discretion to reject an order, to determine which Reference Securities the CFD may relate to, to determine the market value of the Reference Securities and other administrative functions under the CFD. · The company has powers to set-off the various accounts of the investor (Annexure x clause xx). · The investor indemnifies the company for all costs (including taxes) incurred by the investor in association with the company Account and transaction documents, as well as law suits etc. (Annexure x clauses xx). · Each party is required to comply with obligations in relation to deduction and remitting tax from payments made to or from the other party (Annexure x clause xx). · The company may assign its rights and obligations under the CFD (Annexure x clause xx). There are also a number of rights and obligations setting out the security interest arrangements the investor is expected to provide: · The investor must maintain in its company Account and the sub-accounts sufficient cash or collateral (including Reference Securities themselves) to discharge the investor's obligation under the CFD (clause x). If the investor allows the margin (cash or collateral) to dip below the required level, this is an Event of Default and the shortfall is a debt owing to the company (clause xx). · The collateral is subject to a mortgage and other security requirements, including investor's being obliged to maintain the amount of collateral (or margin) in the account - if there is an Event of Default, the company may have recourse to the collateral (i.e. sell or deal with for cash) or cash margin to discharge the obligations of the investor (clause x). · Until there is an Event of Default, the investor retains the usual rights of an owner of property in respect of the collateral (clause 9.13). If there is an Event of Default, the company may deal with the collateral as needed (clause xx). · The investor must not create a security interest over the collateral which ranks ahead of the company's interest (clause xx). · The company has wide powers to close out the investor's CFD, as well as to terminate the investor's rights to trade, where circumstances require it and there has been an Event of Default (clause xx). In such circumstances any accrued interest, Surplus, Shortfall and Mark-To-Market payments become payable and the company may have recourse to the margin or collateral. · The company may appoint a Receiver upon an Event of Default (clause xx). · The investor is required to take all reasonable steps to avoid an Event of Default, and to inform the company of any Events of Default (clause xx). Events of Default include essentially anything which could jeopardise the investor's ability to discharge its obligations under the CFD and include, among other things: o an inability to pay an amount due under the terms of the CFD; o granting a security interest over the collateral which ranks in from of the company's security interest; and o any other failure to perform obligations which have a material impact on the company's rights or interest under the CFD.

Relevant legislative provisions: Income Tax Assessment Act 1997 Division 230. | Subdivision 230-A | Section 230-15 | Subsection 230-15(1) | Subsection 230-15(2) | Subsection 230-40(1) | Section 230-45 | Subsection 230-45(1) | Paragraph 230-45(1)(d) | Paragraph 230-45(1)(e) | Paragraph 230-45(1)(f) | Subsection 230-45(2) | Paragraph 230-45(2)(a) | Section 230-50 | Section 230-55 | Section 230-70 | Section 230-75 | Subdivision 230-B | Subsection 230-100(2) | Subsection 230-100(3) | Subsection 230-100(5) | Section 230-105 | Section 230-115 | Subsection 230-115(1) | Subsection 230-115(2) | Section 230-180 | Subsection 230-180(2) | Subdivision 230-C | Subsection 230-210(2) | Subsection 230-220(1) | Section 230-230 | Subsection 230-230(1) | Subdivision 230-G | Section 230-435 | Section 995-1

Reasons for decision: Summary: The CFD that the company has entered into with its sole director is a financial arrangement for the purpose of Division 230 of the ITAA 1997. | Detailed Reasoning - Detailed reasoning: The definition of 'financial arrangement' determines the unit of taxation in respect of which gains and losses are recognised under Division 230 of the ITAA 1997. In order to determine whether gains and losses arise under a financial arrangement, it is first necessary to establish whether the rights and obligations under the agreement give rise to an 'arrangement' that in turn meets the definition of a financial arrangement. The term 'arrangement' is defined in section 995-1 of the ITAA 1997 to mean any arrangement, agreement, understanding, promise or undertaking, whether express or implied, and whether or not enforceable (or intended to be enforceable) by legal proceedings. Paragraph 2.47 of the Explanatory Memorandum to the Taxation Laws Amendment (Taxation of Financial Arrangements) Bill 2008 states that: "The various rights and obligations subsisting under a contract will typically constitute the relevant arrangement for the purposes of Division 230. That is, the contract is typically viewed on a 'stand-alone' basis. In this context, the contract is neither aggregated with another contact (or contracts), nor disaggregated into component parts, when determining the relevant arrangement to be considered under Division 230." Section 230-55 of the ITAA 1997 modifies this broad concept of 'an arrangement' by providing guidance as to which specific rights and obligations will constitute the relevant arrangement for the purposes of Division 230 of the ITAA 1997. Having regard to section 230-55 of the ITAA 1997, broadly, the rights and obligations under the CFD entered into between the company and its sole director will constitute a single arrangement. Subdivision 230-A of the ITAA 1997 provides the test for determining whether an arrangement is a financial arrangement. Broadly, an arrangement will be a financial arrangement if it satisfies the definition of a financial arrangement under section 230-45 of the ITAA 1997, or the definition of a financial arrangement under section 230-50 of the ITAA 1997 (relating to equity interests). Relevantly, subsection 230-45(1) of the ITAA 1997 provides: "You have a financial arrangement if you have, under an arrangement: a) a cash settlable legal or equitable right to receive a financial benefit; or b) a cash settlable legal or equitable obligation to provide a financial benefit; or c) a combination of one or more such rights and/or one or more such obligations;unless: d) you also have under the arrangement one or more legal and equitable rights to receive something and/or one or more legal or equitable obligations to provide something; and e) for one or more of the rights and/or obligations covered by paragraph (d): i. the thing that you have the right to receive, or the obligation to provide, is not a financial benefit; or ii. the right or obligation is not cash settlable; and f) the one or more rights and/or obligations covered by paragraph (e) are not insignificant in comparison with the right, obligation or combination covered by paragraph (a), (b) or (c). The right, obligation or combination covered by paragraph (a), (b) or (c) constitutes the financial arrangement." It is noted that the definition of a financial arrangement in subsection 230-50 of the ITAA 1997 does not apply in the present circumstances. To determine whether the CFD will be a financial arrangement, we must first determine the rights and obligations under the CFD. The rights and obligations under the CFD can be broadly separated into 'primary' and 'supplementary' rights and obligations. The primary rights to receive and obligations to provide under the CFD are: · the rights to receive and corresponding obligations to provide the Mark-to-Market payments; · the rights to receive and corresponding obligations to provide the Surplus and Shortfall payments; · the rights to receive and corresponding obligations to provide the interest payments; · the rights to receive and corresponding obligations to provide the Dividend Amount payments; · the rights to receive and corresponding obligations to provide any fees; and · the rights to receive and corresponding obligations to provide any penalty interest. The supplementary rights to receive and obligations to provide under the CFD terms relate primarily to administrative functions, the establishment and maintenance of the security interest provided to the company by the investor, and other indemnities. The primary rights and obligations are rights to receive and obligations to provide financial benefits which, being money, are cash settlable for the purposes of paragraph 230-45(2)(a) of the ITAA 1997. Broadly, the supplementary rights and obligations relating to the security interest, the administration of the CFD and other indemnities are either non-cash settlable, or do not relate to a 'financial benefit' as defined. Where there are one or more legal or equitable rights to receive, or obligations to provide something which is either not a financial benefit, or if the right or obligation is not cash settlable, the arrangement may not be a 'financial arrangement' for the purposes of section 230-45 of the ITAA 1997 if that right or obligation is 'not insignificant' in comparison to the rights and obligation referred to in paragraphs 230-45(1)(a) to (c) of the ITAA 1997. Accordingly, we must consider whether the supplementary rights and obligations are 'not insignificant' when compared to the primary rights and obligations, for the purposes of paragraph 230-45(1)(f) of the ITAA 1997. In relation to the supplementary rights and obligations giving rise to the security interests, these are considered insignificant in comparison with the primary rights and obligations. The various rights and obligations exist for the purpose of ensuring or facilitating the discharge of the primary rights and obligations. The interest does not in itself provide an additional right to property. It will only have any effect where the primary rights and obligations presently exist (and have not been discharged giving rise to an Event of Default). Similarly with any administrative legal rights to receive or obligations to provide such as the company's obligation to determine the face value of the CFD or the investor's obligation to indemnify the company, these are in place only to facilitate the primary rights and obligations. They have no separate importance to the primary rights and obligations and are as such are appropriately considered relatively insignificant. Accordingly, the rights and obligations under the arrangement which are not cash-settlable or which do not relate to 'financial benefits' as defined are not 'not insignificant' compared to the cash settlable rights and obligations under the arrangement. There is therefore no right within the meaning of paragraphs 230-45(1)(d) to (e) of the ITAA 1997. The primary rights and obligations under the CFD will be a financial arrangement for the purposes of section 230-45 of the ITAA 1997. | Summary: A payment made or received under clause 6 is not a gain or loss made for the purposes of section 230-15(1) and (2) of the ITAA 1997. | Detailed Reasoning - Detailed reasoning: As per the CFD entered into between the company and its sole director, clause 6 provides that an investor must comply with margin obligations which arise in relation to the CFD. Under this clause, the investor may be required to provide cash or collateral to the company to satisfy the margin obligations. The margin rates are determined by the company in its sole discretion. As explained in the response to question 1, the rights and obligations under a CFD will be a single arrangement pursuant to section 230-55 of the ITAA 1997, and this arrangement is a financial arrangement for the purposes of section 230-45 of the ITAA 1997. As explained in the guidance provided to question 6, the realisation method will apply to bring gains and losses from a CFD to account. Relevantly, section 230-180 of the ITAA 1997 provides: "(1) If a gain or loss is to be taken into account using the realisation method, you are taken, for the purposes of section 230-15, to make the gain or loss for the income year in which the gain or loss occurs. (3) For the purposes of subsection (1), a gain or loss from a financial arrangement is taken to occur at the time at which the last of the financial benefits taken into account in determining the amount of the gain or loss: a. is provided; or b. if the financial benefit is not provided at the time when it is due to be provided under the arrangement and it is reasonable to expect that the financial benefit will be provided - is due to be provided. …" A payment under clause 6 is a financial benefit received under the financial arrangement. However, a payment under this clause does not, in and of itself, constitute a loss from the financial arrangement. Section 230-70 provides: "(1) Apply subsection (2) in working out whether you make, or will make, a gain or loss (and the amount of the gain or loss) at a time when: · you receive a particular financial benefit under a financial arrangement; or · one of your rights under a financial arrangement ceases. The gain or loss is to be calculated in nominal (and not present value) terms. (3) You must have regard to the extent to which the financial benefits that you have provided, or are to provide, under the financial arrangement are reasonably attributable, at the time mentioned in subsection (1), to the benefit or right referred to in paragraph (1)(a) or (b)." Section 230-75 of the ITAA 1997 provides: "(1) Apply subsection (2) in working out whether you make, or will make, a gain or loss (and the amount of the gain or loss) at a time when: · you provide a particular financial benefit under the financial arrangement; or · one of your obligations under a financial arrangement ceases. The gain or loss is to be calculated in nominal (and not present value) terms. (2) You must have regard to the extent to which the financial benefits that you have received, or are to receive, under the financial arrangement Accordingly, we must determine whether there are financial benefits provided, or financial benefits which are to be provided, which are 'reasonably attributable', to the financial benefit received (being the payment of margin amounts under clause 6). Under the terms of the CFD, the company will repay funds to the Investor where the funds are 'Available Funds.' The term 'Available Funds' is defined under the CFD to mean the balance of the Deposit Sub Account in excess of the margin requirements. Accordingly, the company has a contingent obligation to provide a financial benefit, being the repayment of margin funds not applied. It should be noted that, under section 230-85 of the ITAA 1997, a contingent obligation is treated as an obligation for the purposes of Division 230 of the ITAA 1997. The obligation of the company to repay these amounts is 'reasonably attributable' to the right to receive the margin funds. Therefore, a payment made or received under clause 6 is not, in and of itself, a loss from a financial arrangement brought to account under section 230-15 of the ITAA 1997. Rather the gain or loss requires a comparison between financial benefits received and provided which are reasonably attributable to each other.

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