Private ruling: Capital Gains Tax - Tax relief for shareholders in listed investment companies
Date of advice: 26 February 2016
Published: April 2016
Ruling period: 1 July 20xx - 30 June 20xx
Date scheme commenced: 1 July 20xx

Ruling: Q1: If the taxpayer, as a listed investment company, includes in dividends to be paid to its shareholders amounts from its LIC capital account, would these be eligible to qualify for relief under Subdivision 115-D of the Income Tax Assessment Act 1997 ? | A1: Yes.

Relevant facts and circumstances: The taxpayer is an Australian resident incorporated in Australia in 20xx. It listed on the Australian Stock Exchange (ASX). The taxpayer has indicated in its Prospectus that it would primarily invest in ASX listed entities. It may also invest in unlisted securities, derivatives, and cash securities. In the first year of the operation, 90% of market value of taxpayer's CGT assets was permitted investments. It is intended that over 90% of the investment held by the taxpayer will be permitted investments. The taxpayer does not own (directly or indirectly) more than 10% of another company. The taxpayer has not received any discount capital gains distributions. The taxpayer is a long term investor. Its Prospectus states that the primary objective of the company is to provide long-term capital growth and income for shareholders. In the first year of operation, the taxpayer has invested a large portion of cash into long term equity investments. The taxpayer has adopted a buy and hold strategy. At the time of acquiring each investment, there is no exit point envisaged. It is intended that each investment be held indefinitely in order to generate income from interest and dividends. There is no intention at the time of acquisition to sell the investments with a view to making a profit. The annual turnover is intended to be low (i.e. less than 10%). In the first year of operation, the taxpayer had a less than 10% turnover of long term equity investments. As the taxpayer intends to hold investments long term, the annual turnover for future years is intended to remain low (i.e. less than 10%). The percentage of total income comprising of profits on disposal is intended to be low. In the first year of operation, profit on disposal in relation to total income was low. The taxpayer's percentage of total income comprising of profits on disposal is intended to remain low (I.e. less than 10%) for future income years. The disposals of investments are intended to be irregular. In the first year of operation, several investments were disposed of for various reasons. The disposals were outside the normal business operations of the taxpayer. The reasons for each of the disposals are provided. The market value percentage of the disposed investments out of the total investments is less than 10%. The disposals resulted in making both capital gains and losses. The gain was included in the net capital gain and it is calculated without indexation to the cost base. The taxpayer's 20xx tax return confirms the gain was included in the net capital gain. The net capital gains resulting from the disposals above in table x were from CGT assets that were held by the taxpayer for less than 12 months. These disposals for the year ended 30 June 20xx will not meet the definition of an LIC capital gain. At as 30 June 20xx, the balance of the LIC capital gains is nil. It is anticipated that a LIC capital gain dividend may be paid for the future income years. The taxpayer confirms that section 115-40 and 115-45 of the Income Tax Assessment Act 1997 (ITAA 1997) will not apply. Copies of the Prospectus and the taxpayer's income tax return are provided.

Relevant legislative provisions: Income Tax Assessment Act 1997 Section 115-20, | Income Tax Assessment Act 1997 Section 115-25, | Income Tax Assessment Act 1997 Section 115-30, | Income Tax Assessment Act 1997 Section 115-40, | Income Tax Assessment Act 1997 Section 115-45, | Income Tax Assessment Act 1997 Section 115-280, | Income Tax Assessment Act 1997 Section 115-285, | Income Tax Assessment Act 1997 Subsection 115-285(1), | Income Tax Assessment Act 1997 Section 115-290, | Income Tax Assessment Act 1997 Subsection 115-290(4), | Income Tax Assessment Act 1997 Section 115-295, and | Income Tax Assessment Act 1997 Section 118-20.

Reasons for decision: Summary: All references are to the Income Tax Assessment Act 1997 (ITAA 1997) unless otherwise specified. Section 115-280 of the ITAA 1997 provides a deduction to certain shareholders who are paid a dividend where all or some of the dividend is reasonably attributable to an LIC capital gain made by a listed investment company (LIC). | Detailed Reasoning - Listed investment company: Section 115-290 provides that a company that is an Australian resident is a LIC if: 1) at least 90% of the market value of its CGT assets consists of permitted investments, and 2) it is listed on ASX Ltd or another stock exchange approved under Corporations Act 2001 s 769 or it is a 100% subsidiary of a company that is so listed and is itself an LIC. A company that fails the 90% test in subsection 115-290(1) may nevertheless qualify as an LIC if the failure was temporary. The following investments are permitted investments pursuant to subsection 115-290(4): • equity-type interests such as shares, units, options and rights, but subject to the restriction that a company's interests in another company or trust are not counted as permitted investments if the company owns (directly or indirectly) more than 10% of that other company or trust; • any kind of financial instrument, such as loans, debts, debentures, bonds, promissory notes, futures contracts, forward contracts, currency swap contracts and rights or options in respect of shares, securities, loans or contracts; • any asset whose main use in the company's business is to derive interest, an annuity, rent (except where the main use for deriving rent was temporary), royalties or foreign exchange gains, unless the asset is an intangible one whose market value has been substantially enhanced by alterations to the asset; and • goodwill. The taxpayer is listed on the ASX. Its investment objectives, strategy and types of investment meet the requirements of a LIC. In the first year of operation, 90% of the market value of its CGT assets was permitted investments. It is intended that over 90% of the investment held by the taxpayer will be permitted investments. Therefore, it is considered that the taxpayer meets the definition of a LIC as defined under section 115-290. | Detailed Reasoning - LIC capital gain: Section 115-295 requires that a LIC must maintain records showing the balance of its LIC capital gains available for distribution. Therefore, the taxpayer is required to calculate a LIC capital gain. Section 115-285 provides that a LIC capital gain is a capital gain that is made by a LIC under section 115-290 and meets all of the following requirements set out in subsection 115-285(1): a) the capital gain must be made from a CGT event that happens on or after 1 July 2001; b) the capital gain must be made from a CGT asset which is a permitted investment as defined in subsection 115-290(4) and the market value of the permitted investments of the company must be at least 90% of the market value of the CGT assets of the company; c) the company must not choose to claim indexation under subsection 110-25(8) in respect of the CGT assets; d) the capital gain must result from a CGT event happening to a CGT asset owned by a listed investment company for at least 12 months; e) the anti-avoidance provisions relating to a discount capital gain in sections 115-40 and 115-45 must not be breached; and f) the capital gain must be included in both the net capital gain and taxable income of the company for the income year in which the capital gain was made. The taxpayer has meet all of the above requirements in the first year of operation except for paragraph 115-285(1)(d) that requires the investments that have been disposed of to have been held for at least 12 months. As such, the capital gains generated by the disposal of the investments in the first year of operation will not be LIC capital gains. The taxpayer accordingly has a LIC capital gains account of nil for the year ended 30 June 20xx. If the taxpayer meets all of the requirements in 115-285(1) in the following years it will have a LIC capital gain amount. It may then pay a dividend to shareholders that include an LIC capital gain amount. | Detailed Reasoning - Rule in section 118-20: If the CGT event causes the rule in section 118-20 to apply, for example because it gives rise to the inclusion of an amount as assessable income under section 6-5 as income according to ordinary concepts, or under section 26BB of the ITAA 1936, any capital gain will be reduced to the extent of that inclusion. That is, Subdivision 115-D applies only to those gains which are on capital account upon the disposal of investments of a listed investment company. Paragraph 8 of the Taxation Ruling TR 2005/23 Income Tax: listed investment companies provides that in determining whether gains on the disposal of investments are income on capital or revenue account, the decision in London Australia Investment Co. Ltd (1977) 138 CLR 106; 7 ATR 757; 77 ATC 4398 ( London Australia) is relevant. Paragraph 9 of the TR 2005/23 states: If on the facts the disposals of investments by a listed investment company are undertaken as part of carrying on a business of investment, the gains or losses on such disposals of investments will be on revenue account. That is, such gains will be income according to ordinary concepts and such losses will be deductible on revenue account. In these circumstances, the *listed investment company has not made *LIC capital gains from the disposal of those investments. On the other hand, where the disposal of investments amounts to no more than a mere realisation or change of investments, that is, the disposals have not been made as part of a business of investment, the gains or losses will be on capital account. Paragraph 80 of the TR 2005/23 provides that: The absence of an investment style which envisages an exit point is one indicator that the portfolio would be held on capital account, so that any disposals from that portfolio would be mere realisations of investments. The 'buy and hold' philosophy is an example of such a style. The relevant case law discloses other indicia which would contribute to a capital account conclusion. These may include: • a low average annual turnover (that is, less than London Australia, where the average turnover had been in the order of 10%); • a lack of regularity in sale activity (AGC (Investments) Limited v. FC of T 92 ATC 4239 ( AGC (Investments) ); Trent Investments Pty Ltd v. FC of T 76 ATC 4105); • a high proportion of stocks sold have been held for a significant number of years (see AGC (Investments) - 75% of stocks sold held more than 5 years). However, if a high proportion of the remainder are turned over, this tends to the opposite conclusion; • a low level of sales transactions compared to the number of stocks in the portfolio (see Milton Corporation v. FCT 85 ATC 4243); • profits on sale normally constitute a small percentage of total income; and • significant percentage of 'aged' stocks remains in the portfolio (AGC (Investments) - nearly 60% of stocks held more than 10 years). Applying these indicators to the taxpayer, the following indicate that the disposals of investments in the first year of operation were realisations of capital assets: • The taxpayer adopts a buy and hold strategy. At the time of acquiring each investment, there is no exit point envisaged; • Lack of regularity in sale activity; • The annual turnover is low i.e. less than 10%; • The percentage of total income comprising of profits on disposal is low; • From time to time, investments have been disposed of for various reasons; and • These disposals were all outside the normal business operations of the company. The Commissioner considers given the above factors that the disposal of investments by the taxpayer are on capital account. | Detailed Reasoning - Reflected in the taxable income of the company: Paragraph 21 of the TR 2005/23 explains that: The amount of a capital gain which is reflected in the taxable income of the company and therefore is a LIC capital gain is calculated as follows: • The deduction which is available under the Subdivision is worked out in respect of a capital gain which will bear tax in the year in which that capital gain is made. The following process is necessary to determine the amount of a capital gain which will bear tax: • the capital gain is required to be included in the listed investment company's net capital gain; • the capital gain is included in the net capital gain to the extent that it remains in the net capital gain after all of the company's capital losses and net capital losses have been allocated against its capital gains (subsection 102-5(1)); and • At least some part of the net capital gain must remain in the taxable income after losses and deductions are taken into account. Consequently, a capital gain which remains in the net capital gain may only be reflected in the company's taxable income up to the amount by which the taxable income has been increased by the inclusion of the amount of the net capital gain, but no more. Paragraph 113 of the TR 2005/23 provides that net capital gain is worked out under section 102-5 by (so far as relevant): Step 1: reducing the capital gains made during the income year by the capital losses (if any) made during the income year. Subsection 102-5(1) expressly (at Note 1 to Step 1) permits the taxpayer to choose the order in which the taxpayer reduces the capital gain; and Step 2: applying any previously unapplied net capital losses from earlier income years to reduce the amounts (if any) remaining after the reduction of capital gains under step 1. Subsection 102-5(1) expressly (at Note 2 to Step 2) permits the taxpayer to choose the order in which the taxpayer reduces the amounts. None of the taxpayer's net capital gain of for the financial year ended 30 June 20xx is an LIC capital gain. As such the question of whether the LIC capital gain is reflected in the taxpayer's taxable income for the year ended 30 June 20xx does not arise. | Detailed Reasoning - Conclusion: In the present case, section 115-285 is not satisfied for the year ended 30 June 20xx (with the CGT assets having not been held for 12 months prior to disposal). However it may be possible that the taxpayer satisfies section 115-285 in future years where: • The CGT event for the CGT assets happened after 1 July 2001; • The taxpayer incorporated after 1 July 2001 and all the CGT assets are acquired after 1July 2001; • The taxpayer is a LIC under section 115-290; • More than 90% of the market value of the taxpayer's CGT assets is permitted investments under section 115-290(4); • The CGT assets were acquired by the taxpayer before 12 months from the CGT event happened to them and is calculated without indexation to the cost base; • The anti-avoidance provisions relating to a discount capital gain in sections 115-40 and 115-45 is not breached; and • The capital gain is included in both the net capital gain and taxable income of the company for the income year. The ruling confirms that in future years a dividend paid by the taxpayer that includes an amount of a LIC capital gain (as defined in section 115-285) paid from a LIC capital gain account kept by the taxpayer is eligible for relief under Subdivision 115-D. The taxpayer will need to keep appropriate records to show that the amount is reasonably attributable to the LIC capital gain made by the taxpayer. Examples of LIC capital gains accounts which meet the record keeping requirements under Subdivision 115-D of the ITAA 1997 are provided at paragraph 217 to 223 of Taxation Ruling TR 2005/23 Taxation Ruling Income Tax: listed investment companies . The shareholders of the taxpayer receiving a dividend that includes an amount of LIC capital gain will each need to individually assess their own eligibility against the criteria in section 115-280 of the ITAA 1997.