Private ruling: Calculation methodology for CGT
Date of advice: 17 December 2015
Published: March 2016
Ruling period: 1 July 2015 to 30 June 2019.
Date scheme commenced: 1 July 2015.

Ruling: Q1: Will the Commissioner confirm that the manner in which the capital gain or capital loss is calculated by the taxpayer for the purposes of section 102-5 of the Income Tax Assessment Act 1997 (ITAA 1997) by nominating the specific shares (that is, the parcel of shares) from the taxpayer's aggregated portfolio is allowable in determining the taxpayer's overall net capital gain or loss for a particular year and satisfies the requirements of subsection 121-20(1) of the ITAA 1997? | A1: Yes. Issue 2 | Q2: Will the Commissioner confirm that Part IVA of the Income Tax Assessment Act 1936 (ITAA 1936) does not apply to the proposed arrangement? | A2: Yes.

Relevant facts and circumstances: The taxpayer is a complying superannuation fund. The taxpayer is managed by a trustee company (the Trustee). The taxpayer invests its members' superannuation money and offers its members a range of investment options. Each of the taxpayer's six investment options invest across more than one asset class. To manage these assets, the taxpayer engages Australian and international investment managers. Each investment manager is responsible for a specific amount of the taxpayer's assets. The role of the investment manager is to: • maintain a portfolio of assets on behalf of the Trustee within the guidelines set out in the investment management agreement, which sets out certain criteria such as limits of exposure to a single asset; • use the funds allocated to it by the Trustee to make all the investment decisions; • instruct a broker to sell the shares (when an investment manager decides to sell some of the Trustee's shares); • be an authorised representative of the Trustee. The investment manager can instruct the broker to make the sale using the Master Custodian's account to settle the transaction; and • make the decision to what securities to buy, hold or sell, and in what quantities, and instruct the Master Custodian to carry out its decisions. The investment manager does not buy, hold or sell the shares. Nor does it select which parcel of shares is to be sold. Instead, the investment manager instructs the broker to sell a certain number of a type of shares from the Master Custodian's account. Master Custodian's roles The Trustee engages XYZ as its Master Custodian, to hold all shares as nominee for the taxpayer and to settle all trades instructed by the investment managers. When the Master Custodian receives instructions to settle a trade, its role is to: • be responsible for recording the buying and selling of shares in its records on behalf of the Trustee; • select which parcel of shares is to be disposed of - this is because it is the Master Custodian which keeps the records relating to the buying and selling of shares on behalf of the Trustee; • allocate specific share parcels to be disposed of in accordance with the methodology determined by the taxpayer; and maintain the taxpayer's accounting and tax records and calculations, so that it can assist the Trustee in meeting its tax and regulatory obligations. Master Custodian's existing system Under the Master Custodian's existing system, where shares are to be disposed of, the system utilises a 'maximise loss' tax inventory method. This means that share parcels to be disposed of are selected on a portfolio-per-portfolio basis to achieve an optimal capital gains tax ("CGT") outcome at the individual portfolio level. This is described in further detail below: • CGT records are maintained by the Master Custodian on an investment manager by investment manager basis. This means that the purchases and sales of shares by a particular investment manager are recorded separately for each investment manager (i.e. on a single portfolio of assets); • When an investment manager sells shares on behalf of the Trustee, the Master Custodian's system automatically identifies the parcel of shares sold based on a predetermined parcel selection methodology (e.g. "maximise loss" tax inventory method) in order to calculate the capital gain or loss arising to the Trustee; • the selection of share parcels is restricted to the parcels available in the portfolio in which the disposal was initiated; • the parcel of shares with the highest cost base for CGT purposes is selected so that the outcome is the smallest possible capital gain or the biggest possible capital loss; and • the taxpayer's overall CGT position is determined by adding up all the capital gains and losses from each of the portfolios, before offsetting the capital losses against the capital gains, and then claiming the CGT discount to the extent that it is applicable. Master Custodian's proposed system From 1 July 2015, the Master Custodian is offering an enhanced system (the System) to the taxpayer. The features of the System are as follows: • Data of share acquisitions and disposals will continue to be entered into the portfolios established for each investment manager (sub-portfolio) and processed at this level. • This data will also be automatically replicated in an aggregated portfolio created by the Master Custodian. • The information in the aggregated portfolio will not be distinguished by sub-portfolio. • Where an investment manager sells a parcel of shares, parcel selection will be performed by the System at the sub-portfolio level and also at the aggregated portfolio level. • The parcel selection will occur across the aggregated portfolio using a 'maximise loss' tax inventory method which prioritises parcels of shares that generates the smallest gain or largest loss on disposal. • The parcel selection criteria can be enhanced by switching on an adjustment factor function to adjust the tax value on parcels held for less than 12 months. The adjustment factor has the effect of putting a greater emphasis or bias towards selling parcels that are further away from accessing the CGT discount than those parcels which are in a closer position. • An adjustment factor can be set between 0.1 and 0.9. An adjustment factor closer to 0.9 means that the System will place a greater value in disposing share parcels that are furthest away from qualifying for the CGT discount. • The method of selecting the nominated shares subject to the CGT event is automated within the proposed system. This is likely to result in different parcels being selected at the sub-portfolio levels and aggregated portfolio level. • Calculations at the aggregated portfolio level will be used for calculating the taxpayer's tax position. • Calculations at the sub-portfolio level will continue to be used by the Master Custodian to solely monitor an investment manager's after tax performance. • Once a parcel of shares has been selected as the nominated parcel of shares, that selection is final. With respect to the assets supporting pensions, the taxpayer uses an actuarial approach to determine the exemption for the assets supporting current pensions. The proposed system will not change this process. System capabilities The Master Custodian's system is designed at the individual investment manager level to record the: • date that an investment manager entered into a contract to buy or dispose of a parcel of shares. • name and security identifier (for example, ISIN) of the assets acquired. • type and class of asset (e.g. ordinary shares). • number of assets (e.g. the number of shares in the parcel) that have been acquired or disposed. • cost elements of the parcel of shares including of any incidental costs (e.g. brokerage), in the case of an acquisition. • reduced cost base when a tax deferred distribution is received. • 'frozen indexed' cost base where relevant. • impact of corporate actions including bonus issues, return of capital, share splits, takeovers, etc. • proceeds received and any incidental costs incurred (e.g. brokerage) in case of a disposal. • notional nominated parcel of assets that was subject to the CGT event. • remaining balance of the parcel where it has been partially disposed. Each transaction is allocated a system generated unique transaction ID number. Transactions in a foreign currency are converted to Australian Dollars at the exchange rate on the contract date. Under the System, the same information listed above is replicated in the aggregated portfolio. The Master Custodian also performs the following reconciliations: • The realised CGT position between the aggregated portfolio and the sub-portfolio is according to the "maximise loss" tax inventory method; and • Accounting to tax (realised and unrealised) movements between the aggregated portfolio and the sub-portfolio are in line with the previous corresponding period. • Non-propagated income items (such as dividends, interest received, etc) between the aggregated portfolio and sub-portfolio are consistent. Records are kept electronically and the Master Custodian's existing system and the System meet the record keeping requirements set out in paragraph 37 of the Taxation Ruling TR 2005/9 Income Tax: Record keeping - electronic records (TR 2005/9), with respect to: • record retention; • data security and integrity; • system documentation; • retaining archival copies; and accessibility.

Relevant legislative provisions: Income Tax Assessment Act 1997 Section 100-45 | Income Tax Assessment Act 1997 Section 102-5 | Income Tax Assessment Act 1997 Section 121-20 | Income Tax Assessment Act 1997 Subsection 121-20(1) | Income Tax Assessment Act 1997 Section 121-25 | Income Tax Assessment Act 1936 Part IVA | Income Tax Assessment Act 1936 Subsection 177A(1) | Income Tax Assessment Act 1936 Subsection 177C(1) | Income Tax Assessment Act 1936 Subsection 177C(4) | Income Tax Assessment Act 1936 Section 177CB | Income Tax Assessment Act 1936 Subsection 177D(2) | Income Tax Assessment Act 1936 Section 177F

Reasons for decision: Summary: The manner in which the capital gain or capital loss is calculated by the taxpayer for the purposes of section 102-5 of the ITAA 1997 by nominating the specific shares (that is, the parcel of shares) from the taxpayer's aggregated portfolio is acceptable in determining the taxpayer's overall net capital gain or loss for a particular year and will satisfy the requirements of subsection 121-20(1) of the ITAA 1997. | Detailed Reasoning - Detailed reasoning: The method of nominating parcel of shares The taxpayer's assessable income includes any capital gain made by the taxpayer in the income year pursuant to section 102-5 of the ITAA 1997. For CGT purposes, where a disposal of a CGT asset (e.g. a parcel of shares) occurs, a capital gain or loss for most capital gains events is worked out in accordance with section 100-45 of the ITAA 1997. Where the shares can be individually distinguished, a capital gain or loss can be determined by reference to the capital proceeds, cost base and the acquisition date of the shares. Where the disposal of shares form part of a holding of identical shares which are acquired over time, it may not always be possible to distinguish or identify the particular shares that have been disposed of. In these situations, the taxpayer will need to decide which particular shares are being disposed of. For CGT purposes, the Commissioner will accept the taxpayer's selection of the identity of shares that have been disposed of. CGT Determination TD 33 Capital Gains: How do you identify individual shares within a holding of identical shares? (TD 33), paragraphs 3 and 4 provide: 3. In these circumstances, the taxpayer will need to decide which particular shares are being disposed of. Taxpayers in this situation will need to keep adequate records of the transaction so that the decision can be supported should the income tax return be subject to Tax Office scrutiny at a later date. 4. In the past, where unidentifiable shares have been disposed of, the Commissioner has accepted 'first-in first-out' as a reasonable basis of identification. For CGT purposes, the Commissioner will also accept the taxpayer's selection of the identity of shares disposed of. Under the System, the taxpayer must keep detailed records of the assets sold and this must be used in determining any capital gain or loss. The Master Custodian maintains the accounting and tax records to enable the taxpayer to determine its capital gain or loss. The tax records are currently kept separately on the sub-portfolio basis. Under the System, all relevant information will continue to be recorded in the sub-portfolio and the aggregated portfolio levels. The information in the aggregated portfolio reflects the actual ownership of all the parcels of shares held by the taxpayer. The Master Custodian performs the parcel selection at the sub-portfolio level and also at the aggregated portfolio level and decides which particular parcel of shares from the aggregated portfolio that have been disposed of for CGT purposes. Gains or losses at the aggregated level will be used to determine the taxpayer's CGT position. On the basis that the taxpayer maintains sufficient records to specifically identify the shares that have been disposed of, the Commissioner will accept the taxpayer's selection of specific shares, that is, a nominated parcel of shares, for the CGT event, from the aggregated portfolio in order to determine the taxpayer's overall capital gain or loss for the income year. Record keeping requirements Section 121-20 of the ITAA 1997 deals with the records that must be kept to determine the capital gain or a capital loss from a CGT event. Subsection 121-20(1) of the ITAA 1997 provides that: You must keep records of every act, transaction, event or circumstance that can reasonably be expected to be relevant to working out whether you have made a *capital gain or capital loss from a CGT event. (It does not matter whether the CGT event has already happened or may happen in the future.) Section 121-20 also specifies that records that are relevant to determine the taxpayer's capital gain or loss are records that: • identify the date on which the assets are bought or sold; • identify the price at which the assets are purchased and sold; • record the details of every act, transaction, event or circumstance that is relevant to work out the capital gain or capital loss from a CGT event; and • are in English or readily accessible and convertible into English. Further, section 121-25 of the ITAA 1997 deals with the retention of such records to substantiate the taxpayer's capital gain or loss. Where electronic records are kept, TR 2005/9 provides at paragraph 22: Advances in technology (including the internet) have meant that many taxpayers who carry on a business now process and keep their records electronically rather than through a paper based system. This includes encrypted records. The Tax Office requires that records, whether kept on paper or electronically, must be kept accurately so as to enable that person's tax liability to be readily ascertained. The records must be in a form which Tax Office staff can access and understand in order to ascertain that person's taxation liability. Based on the information provided by the taxpayer regarding the System, the taxpayer will have sufficient records to enable it to identify the shares that have been disposed of (at the aggregated portfolio level), and calculate the capital gain or loss in respect of the disposal of the shares. Accordingly, the Commissioner confirms that the records the taxpayer has stated will be maintained by the System satisfy the requirements of subsection 121-20(1) of the ITAA 1997. | Summary: The Commissioner confirms that Part IVA of the ITAA 1936 will not apply to the proposed arrangement. | Detailed Reasoning - Detailed reasoning: Part IVA is the general anti-avoidance provision which gives the Commissioner the discretion to cancel a 'tax benefit' that has been obtained, or would, but for section 177F of the ITAA 1936, be obtained by a taxpayer in connection with a scheme to which Part IVA applies. The conditions for the application of Part IVA are: • a scheme within the meaning of subsection 177A(1) of the ITAA 1936; • a tax benefit arises that was obtained or would be obtained in connection with the scheme but for Part IVA; and • having regard to the matters in subsection 177D(2) of the ITAA 1936, the scheme is one to which Part IVA applies. The scheme In the present case, the broad definition of 'scheme' would encompass the System. The scheme includes the use of the System, the creation of the aggregated portfolio, the selection of parcels of shares from the aggregated portfolio rather than from the sub-portfolios, the use of the adjustment factor to adjust the tax value on parcels held for less than 12 months and the utilisation of the "maximise loss" method. The tax benefit Based on the information provided, it is considered that there would be a tax benefit as defined in subsection 177C(4) of the ITAA 1936. After the System is put in place, the likely benefit would be the enhanced capacity to select the share parcels with highest cost base for CGT purposes from the aggregated portfolio. The System utilises the 'maximise loss' tax inventory method which aims to generate the smallest gain or largest loss on disposal, thus, resulting in a more favourable tax outcome than that which may have been achieved using the existing system. It is likely that the following tax benefits would arise: • reduction of capital gains for a year of income; or • capital losses rather than capital gains for a year of income; or • discount capital gains rather than non-discount capital gains for a year of income. Purpose of the scheme For Part IVA to apply to a scheme, it must be concluded that, having regard to certain matters in subsection 177D(2) of the ITAA 1936, the person, or one of the persons who entered into or carried out the scheme or any part of the scheme did so for the purpose of enabling the relevant taxpayer to obtain a tax benefit in connection with the scheme. The matters listed in subsection 177D(2) of the ITAA 1936 are: (a) the manner in which the scheme was entered into or carried out; (b) the form and substance of the scheme; (c) the time at which the scheme was entered into and the length of the period during which the scheme was carried out; (d) the result in relation to the operation of this Act that, but for this Part, would be achieved by the scheme; (e) any change in the financial position of the relevant taxpayer that has resulted, will result, or may reasonably be expected to result, from the scheme; (f) any change in the financial position of any person who has, or has had, any connection (whether of a business, family or other nature) with the relevant taxpayer, being a change that has resulted, will result or may reasonably be expected to result, from the scheme; (g) any other consequence for the relevant taxpayer, or for any person referred to in paragraph (f), of the scheme having been entered into or carried out; (h) the nature of any connection (whether of a business, family or other nature) between the relevant taxpayer and any person referred to in paragraph (f). Conclusion In the present case, having regard to the relevant factors in subsection 177D(2) of the ITAA 1936, it is considered that the scheme would not be entered into for the dominant purpose of obtaining a tax benefit in connection with the scheme. This leads to the conclusion that the tax benefit arising from the scheme will not be one to which Part IVA applies. Accordingly, the Commissioner confirms that Part IVA will not apply to the proposed arrangement.