Private ruling: Investment by managed investment trust in a forward sale agreement
Published: October 2014
Ruling period: Years ended 30 June 2015 to 30 June 2018
Date scheme commenced: The issue date of this ruling

Ruling: Q1: Is the arrangement a 'security' as defined in subsection 159GP(1) of the Income Tax Assessment Act 1936 (ITAA 1936) such that it could be considered a qualifying security or traditional security, and an exchangeable interest? | A1: No | Q2: Is the arrangement a 'financial arrangement' under section 230-45 of the Income Tax Assessment Act 1997 ? | A2: Yes | Q3: Is the arrangement a 'financial arrangement' under section 230-50? | A3: No | Q4: Is the arrangement a 'Division 230 financial arrangement' as defined in section 995-1? | A4: No | Q5: Is the arrangement a 'debt interest' as defined in Division 974? | A5: Yes | Q6: If the arrangement is neither a 'Division 230 financial arrangement' nor a 'debt interest', will section 275-100 apply such that any gain from the arrangement will be subject to tax under the capital gains tax provisions? | A6: This question is not applicable as the arrangement is a 'debt interest' as defined in Division 974 | Q7: If the arrangement is a 'Division 230 financial arrangement' or a 'debt interest' such that it is not an asset covered by section 275-105, will any gain or loss made upon the delivery of the shares be on revenue account and subject to section 6-5 or section 8-1 accordingly? | A7: No | Q8: If the arrangement is not a 'Division 230 financial arrangement', will a CGT event C2 under section 104-25 occur upon the delivery of the shares to the trust? | A8: Yes | Q9: If the arrangement is a 'Division 230 financial arrangement', will any gain on the arrangement be assessable at the date of the delivery of the shares in accordance with section 230-100 and paragraph 230-180(2)(a)? | A9: This question is not applicable as the arrangement is not a 'Division 230 financial arrangement' as defined in section 995-1 | Q10: Where the value of the index on the maturity date exceeds the predetermined capped price and the trust is required to pay the amount of the excess to the bank, is the excess amount paid by the trust included in the cost base of the trust's rights under the arrangement, as determined under Part 3-1? | A10: Yes | Q11: For the purposes of Division 115, will the shares that are acquired under the arrangement be considered to be acquired at the date of entering into the arrangement? | A11: No | Q12: Will the first element of the cost base of the shares delivered at the end of the arrangement, as determined under Part 3-1, be the market value of the shares at the date of delivery? | A12: Yes | Q13: For the purpose of determining under Part 3-1 the first element of the cost base of the shares delivered, will the Commissioner accept as the relevant market value of the shares the closing price of those shares on the relevant stock exchange as at the date of delivery? | A13: Yes | Q14: Will Part IVA of the ITAA 1936 apply to the arrangement? | A14: No

Relevant facts and circumstances: The trust is a unit trust, established during the year ended 30 June 20XX and formed with the intention of raising funds from investors for the purposes of investment with a bank in a forward sale agreement. The investors in the trust (the unit holders) will be wholesale clients as per section 761G of the Corporations Act 2001 and are expected to be Australian residents for taxation purposes. The forward sale agreement, to be entered into during the year ended 30 June 20YY, constitutes an agreement by the trust to purchase from the bank and for the bank to deliver (or procure delivery of) to the trust a predetermined number of shares. Where the value of a nominated index does not breach the 'barrier' by falling below a predetermined level, the forward sale agreement provides the trust with a guaranteed exposure to that index (subject to a predetermined cap). The 'guaranteed' exposure to the index refers to the fact that the value of the trust's investment, where held to maturity, is 100% capital protected such that, where the value of its investment has decreased over the term of the agreement, the trust is ensured to receive the amount it invested (comprised of a combination of the market value of the shares to which the trust is entitled as at maturity and a payment made to it from the bank). Where, on the other hand, the barrier is breached, the trust's investment in the forward sale agreement is no longer guaranteed and the trust stands to generate either a gain or loss depending on the performance of the index over the term of the investment. The trust's level of participation under the forward sale agreement varies depending on the performance of the index. The targeted date for delivery of the shares to the trust is shortly after maturity (likely to be three years after entry into the contract, but may differ). Delivery of the shares to the trust shall constitute full and effective performance of the forward sale agreement in respect of those shares so delivered. Where the unit holders choose to redeem their units in the trust immediately following delivery of the shares, the trust will sell the shares on the market to satisfy the redemption price. Unit holders may retain their interest in the trust after the delivery of the shares to the trust. In this respect the sale of the shares by the trust after they are delivered is purely to be determined by the redemption demands of the unit holders. Assumptions 1. The trust will be a managed investment trust pursuant to section 12-400 of Schedule 1 to the Taxation Administration Act 1953 . 2. The trustee of the trust will make a choice in the approved form under section 275-115 (on or before the day it is required to lodge its income tax return in the income year in which it became a managed investment trust, or as otherwise allowed by the Commissioner) such that, subject to its satisfaction of all other requirements of subsection 275-100(1), the trust will be afforded deemed capital account treatment on covered assets for the income year in which the trust became a managed investment trust and all subsequent income years. 3. If Division 230 does not apply to the trust in relation to its gains or losses from the arrangement for any year (because of the operation of subsections 230-455(1) and (2)), the trust will not make an election under subsection 230-455(7) to have Division 230 apply. 4. The forward sale agreement is a 'financing arrangement' under section 974-130 for the bank. 5. The barrier will be set at below, or possibly slightly higher than, X% of the index level on the Commencement Date. 6. All dealings between the trust and the bank will be at arm's length.

Relevant legislative provisions: Corporations Act 2001 section 9 | Corporations Act 2001 section 761G | Income Tax Assessment Act 1936 section 26BB | Income Tax Assessment Act 1936 subsection 26BB(1) | Income Tax Assessment Act 1936 section 70B | Income Tax Assessment Act 1936 Part III Division 6C | Income Tax Assessment Act 1936 Division 16E | Income Tax Assessment Act 1936 subsection 159GP(1) | Income Tax Assessment Act 1936 paragraph 159GP(1)(a) | Income Tax Assessment Act 1936 paragraph 159GP(1)(b) | Income Tax Assessment Act 1936 paragraph 159GP(1)(c) | Income Tax Assessment Act 1936 paragraph 159GP(1)(d) | Income Tax Assessment Act 1936 Part IVA | Income Tax Assessment Act 1997 section 6-5 | Income Tax Assessment Act 1997 section 8-1 | Income Tax Assessment Act 1997 Part 3-1 | Income Tax Assessment Act 1997 section 103-15 | Income Tax Assessment Act 1997 section 104-10 | Income Tax Assessment Act 1997 subsection 104-10(4) | Income Tax Assessment Act 1997 section 104-25 | Income Tax Assessment Act 1997 paragraph 104-25(1)(b) | Income Tax Assessment Act 1997 subsection 104-25(3) | Income Tax Assessment Act 1997 subsection 108-5(1) | Income Tax Assessment Act 1997 subsection 109-5(1) | Income Tax Assessment Act 1997 subsection 110-25(2) | Income Tax Assessment Act 1997 subsection 110-25(3) | Income Tax Assessment Act 1997 subsection 110-55(2) | Income Tax Assessment Act 1997 subsection 112-20(1) | Income Tax Assessment Act 1997 Division 115 | Income Tax Assessment Act 1997 section 115-5 | Income Tax Assessment Act 1997 Subdivision 130-E | Income Tax Assessment Act 1997 section 130-100 | Income Tax Assessment Act 1997 Division 230 | Income Tax Assessment Act 1997 subsection 230-15(1) | Income Tax Assessment Act 1997 section 230-45 | Income Tax Assessment Act 1997 subsection 230-45(1) | Income Tax Assessment Act 1997 paragraph 230-45(1)(d) | Income Tax Assessment Act 1997 paragraph 230-45(1)(e) | Income Tax Assessment Act 1997 paragraph 230-45(1)(f) | Income Tax Assessment Act 1997 subsection 230-45(2) | Income Tax Assessment Act 1997 paragraph 230-45(2)(a) | Income Tax Assessment Act 1997 subsection 230-45(3) | Income Tax Assessment Act 1997 paragraph 230-45(3)(a) | Income Tax Assessment Act 1997 paragraph 230-45(3)(b) | Income Tax Assessment Act 1997 paragraph 230-45(3)(c) | Income Tax Assessment Act 1997 subsection 230-45(5) | Income Tax Assessment Act 1997 paragraph 230-45(5)(a) | Income Tax Assessment Act 1997 section 230-50 | Income Tax Assessment Act 1997 paragraph 230-50(2)(b) | Income Tax Assessment Act 1997 section 230-100 | Income Tax Assessment Act 1997 paragraph 230-180(2)(a) | Income Tax Assessment Act 1997 section 230-455 | Income Tax Assessment Act 1997 subsection 230-455(1) | Income Tax Assessment Act 1997 subsection 230-455(2) | Income Tax Assessment Act 1997 paragraph 230-455(2)(b) | Income Tax Assessment Act 1997 subsection 230-455(7) | Income Tax Assessment Act 1997 section 275-100 | Income Tax Assessment Act 1997 subsection 275-100(1) | Income Tax Assessment Act 1997 paragraph 275-100(1)(d) | Income Tax Assessment Act 1997 section 275-105 | Income Tax Assessment Act 1997 paragraph 275-105(2)(b) | Income Tax Assessment Act 1997 section 275-115 | Income Tax Assessment Act 1997 Division 974 | Income Tax Assessment Act 1997 subsection 974-15(1) | Income Tax Assessment Act 1997 subsection 974-20(1) | Income Tax Assessment Act 1997 paragraph 974-20(1)(a) | Income Tax Assessment Act 1997 paragraph 974-20(1)(b) | Income Tax Assessment Act 1997 paragraph 974-20(1)(c) | Income Tax Assessment Act 1997 paragraph 974-20(1)(d) | Income Tax Assessment Act 1997 paragraph 974-20(1)(e) | Income Tax Assessment Act 1997 section 974-130 | Income Tax Assessment Act 1997 section 995-1 | Taxation Administration Act 1953 section 12-400 of Schedule 1

Reasons for decision: Summary: Under subsection 159GP(1) of Division 16E of the ITAA 1936, 'security' means: (a) stock, a bond, debenture, certificate of entitlement, bill of exchange, promissory note or other security; (b) a deposit at bank or other financial institution; (c) a secured or unsecured loan; or (d) any other contract, whether or not in writing, under which a person is liable to pay an amount or amounts, whether or not the liability is secured. The forward sale agreement is not considered to have sufficient debt like obligations to be a contract to which paragraph (d) of the definition of security in subsection 159GP(1) of the ITAA 1936 applies, nor does it fall within paragraphs (a), (b) or (c) of that definition. The forward sale agreement therefore does not meet the definition of security under subsection 159GP(1) of the ITAA 1936. For the purposes of determining whether an arrangement is a qualifying security (defined in subsection 159GP(1) of Division 16E of the ITAA 1936) or a traditional security (defined in subsection 26BB(1) of the ITAA 1936), that arrangement must be a security, as defined in subsection 159GP(1) of the ITAA 1936 (see above). As the forward sale agreement does not meet the definition of security under subsection 159GP(1) of the ITAA 1936, it is not a qualifying security for the purposes of Division 16E of the ITAA 1936, nor a traditional security for the purposes of sections 26BB and 70B of the ITAA 1936. For the purposes of determining whether an arrangement is an exchangeable interest (defined in section 130-100), that arrangement must be either a traditional security or a qualifying security. As the forward sale agreement is neither a traditional security nor qualifying security, it is not an exchangeable interest for the purposes of Subdivision 130-E. Division 230 sets out the tax treatment of gains or losses from a 'financial arrangement'. Generally, an entity will have a financial arrangement if they have under an arrangement, a cash settlable legal or equitable right to receive a financial benefit, a cash settlable legal or equitable obligation to provide such benefit, or a combination of one or more such right and/or obligations, and paragraphs 230-45(1)(d) to (f) do not apply (subsection 230-45(1)). A right to receive or obligation to provide a financial benefit can be cash settlable under subsection 230-45(2) if, inter alia, the benefit is money, it is a right you intend to satisfy or settle by receiving money, it is an obligation that you intend to satisfy or settle by providing money, or you satisfy subsection 230-45(3). Subsection 230-45(3) reads: | Detailed Reasoning - 230-45(3): You satisfy this subsection if: (a) the *financial benefit is readily convertible into money or a *money equivalent; and (b) there is a market for the financial benefit that has a high degree of liquidity; and (c) subsection (4) or (5) is satisfied. Subsection 230-45(5) is satisfied if your purpose, or one of your purposes for entering into the arrangement under which you are to receive the financial benefit is to receive or deliver the financial benefit to raise or provide finance. Addressing each of the relevant components of subsection 230-45(3) separately: • the shares (being the relevant financial benefit) will be able to be sold by the trust on the relevant share market index or indices following their delivery by the bank, and therefore will be able to be readily convertible into money (thereby satisfying paragraph 230-45(3)(a)); • the relevant share market index or indices on which the shares may be sold by the trust following their delivery by the bank is/are a highly liquid market (thereby satisfying paragraph 230-45(3)(b)); and • for the purposes of paragraph 230-45(5)(a), one of the trust's purposes for entering into the forward sale agreement is to provide finance to the bank (thereby satisfying paragraph 230-45(3)(c)). As the trust satisfies subsection 230-45(3), its right to receive the shares is cash settlable. This cash settlable right, in conjunction with the trust's other rights and obligations which are cash settlable financial benefits pursuant to paragraph 230-45(2)(a), constitute a financial arrangement under section 230-45. | Detailed Reasoning - Question 3: A legal or equitable right or obligation to receive or provide an equity interest, or a combination of one or more such rights and/or obligations, is deemed to be a financial arrangement provided that the right, obligation or combination does not constitute, or does not form part of, a cash settlable financial arrangement under subsection 230-45(1) (paragraph 230-50(2)(b)). As the forward sale agreement constitutes a cash settlable financial arrangement under section 230-45 (see question 2), a right or obligation of the trust to receive or provide an equity interest under the forward sale agreement (if any) will not be a financial arrangement under section 230-50. | Detailed Reasoning - Question 4: Section 995-1 defines a 'Division 230 financial arrangement' as a financial arrangement to which Division 230 applies in relation to your gains and losses from the arrangement. Where an arrangement is not a qualifying security for the purposes of Division 16E of the ITAA 1936 and an election under subsection 230-455(7) to have Division 230 apply to financial arrangements has not been made, then pursuant to section 230-455, Division 230 does not apply in relation to gains or losses from a financial arrangement if it is held by a managed investment scheme (within the meaning of the Corporations Act 2001 ) and the managed investment scheme satisfies subsection 230-455(2) for the income year in which it starts to have the arrangement. As the income year in which the trust (a managed investment scheme) starts to have the arrangement (i.e. 2015) is an income year after the one in which the trust comes into existence (i.e. 2014), the relevant paragraph to be applied in subsection 230-455(2) is (b). The trust will satisfy paragraph 230-455(2)(b) for the year ended 30 June 20YY as the value of its assets for the year ended 30 June 20XX, being the immediately preceding income year (worked out at the end of that immediately preceding income year) was less than $100 million. Pursuant to the assumption that the trust will not make an election under subsection 230-455(7) to have Division 230 apply, and on the basis that the forward sale agreement is not a qualifying security (see question 1), Division 230 (for the reasons set out above) will not apply in relation to its gains and losses from the forward sale agreement. The forward sale agreement is therefore not a Division 230 financial arrangement as defined in section 995-1. | Detailed Reasoning - Question 5: A scheme gives rise to a debt interest in an entity if the scheme, when it comes into existence, satisfies the debt test in subsection 974-20(1) (subsection 974-15(1)). Subsection 974-20(1) provides: | Detailed Reasoning - 974-20(1): A *scheme satisfies the debt test in this subsection in relation to an entity if: (a) the scheme is a *financing arrangement for the entity; and (b) the entity, or a *connected entity of the entity, receives, or will receive, a *financial benefit or benefits under the scheme; and (c) the entity has, or the entity and a connected entity of the entity each has, an *effectively non-contingent obligation under the scheme to provide a financial benefit or benefits to one or more entities after the time when: (i) the financial benefit referred to in paragraph (b) is received if there is only one; or (ii) the first of the financial benefits referred to in paragraph (b) is received if there are more than one; and (d) it is substantially more likely than not that the value provided (worked out under subsection (2)) will be at least equal to the value received (worked out under subsection (3)); and (e) the value provided (worked out under subsection (2)) and the value received (worked out under subsection (3)) are not both nil. The classification of a scheme as giving rise to a debt interest is done from the perspective of the issuer of the interest, in this instance the bank. Addressing each component of subsection 974-20(1) separately: • the forward sale agreement will be a financing arrangement for the bank, as per assumption 4 of this ruling (thereby satisfying paragraph 974-20(1)(a)); • the bank will receive a financial benefit under the forward sale agreement in the form of the trust's initial investment amount (thereby satisfying paragraph 974-20(1)(b)); • the bank has an effectively non-contingent obligation to provide a financial benefit under the forward sale agreement in the form of the shares, together with any cash payment at maturity (thereby satisfying paragraph 974-20(1)(c)); • because the trust's investment is 100% capital protected in the event that the barrier is not breached, it is substantially more likely than not that the value of the shares, together with any cash payment, provided by the bank to the trust under the forward sale agreement will be at least equal to the value the trust's initial investment amount received by the bank under the same agreement (thereby satisfying paragraph 974-20(1)(d)); and • the value of the shares, together with any cash payment, and the trust's initial investment amount are not both nil (thereby satisfying paragraph 974-20(1)(e)). As such, the forward sale agreement satisfies the debt test in subsection 974-20(1) and is a debt interest as defined in Division 974. | Detailed Reasoning - Question 6: For capital account treatment under section 275-100 to apply to a CGT asset of a managed investment trust, it must be an asset covered by section 275-105 (paragraph 275-100(1)(d)). An asset is not covered by section 275-105 if it is a debt interest (paragraph 275-105(2)(b)). The forward sale agreement is a debt interest as defined in Division 974 (see question 5) and section 275-100 will not apply. | Detailed Reasoning - Question 7: The trust is not a trader in the shares or in forward sale agreements and is not treated for taxation purposes as trading in the shares or in forward sale agreements, or carrying on a business of investing in the shares or forward sale agreements. Such personal circumstances of the trust, in addition to the specific terms of the forward sale agreement, indicate that any gain or loss made by the trust upon delivery of the shares by the bank will not be on revenue account and subject to section 6-5 or section 8-1 accordingly. Rather, the trust will hold its investment in the forward sale agreement on capital account and any gain or loss it makes upon delivery of the shares will be assessed under the CGT provisions (see question 8). | Detailed Reasoning - Question 8: Under subsection 108-5(1) a CGT asset is any kind of property or a legal or equitable right that is not property. The rights of the trust under the forward sale agreement are legally enforceable rights and therefore, in their totality, a CGT asset according to the definition in subsection 108-5(1). Where the shares are delivered to the trust following maturity, the trust's ownership of the contractual rights under the forward sale agreement comes to an end by reason of those rights being discharged or satisfied. This discharge or satisfaction of the contractual rights gives rise to CGT event C2 (paragraph 104-25(1)(b)). The trust will make a capital gain from this CGT event if the capital proceeds from the ending of the trust's ownership of the asset are more than the asset's cost base or, alternatively, a capital loss from this CGT event if those capital proceeds are less than the asset's reduced cost base (subsection 104-25(3)). Division 115 allows a taxpayer a discount on capital gains in certain circumstances. In accordance with section 115-5, any capital gain realised by the trust upon satisfaction of the trust's rights under the forward sale agreement will be treated as a discount capital gain where the trust has held those rights for at least 12 months (excluding the days of acquisition and disposal). | Detailed Reasoning - Question 9: Gains made from a financial arrangement are included in assessable income (subsection 230-15(1)). However, Division 230 does not apply to assess gains made from a financial arrangement for any income year if the financial arrangement is not a Division 230 financial arrangement. The forward sale agreement is not a Division 230 financial arrangement (see question 4) and Division 230 does not apply in relation to any gains made by the trust from the arrangement. | Detailed Reasoning - Question 10: As confirmed in response to question 8 of this ruling, the rights of the trust under the forward sale agreement are legally enforceable rights and, in their totality, a CGT asset according to the definition in subsection 108-5(1). Any excess amount representing the difference between the value of the index on the maturity date and the predetermined capped price, and paid by the trust to the bank under the terms of the forward sale agreement, is capital expenditure made to acquire the contractual rights referred to above. For the purposes of calculating any capital gain or capital loss under section 104-25 upon delivery of the shares, this amount will be included (as part of the first element) in the trust's cost base (or reduced cost base) in that CGT asset (subsections 110-25(2) and 110-55(2)). Section 103-15 states that Part 3-1 (including the cost base and reduced cost base provisions) applies to you as if you are required to pay money even if you don't have to pay it until a later time. | Detailed Reasoning - Question 11: The shares to be received by the trust under the forward sale agreement are CGT assets according to the definition in subsection 108-5(1). Each share will be taken to have been acquired by the trust at the time it is delivered to the trust (subsection 109-5(1)). A subsequent sale of a share by the trust after their delivery by the bank will give rise to a CGT event A1 (section 104-10). The trust will make a capital gain from this CGT event if the capital proceeds from the disposal of the trust's asset are more than the asset's cost base or, alternatively, a capital loss from this CGT event if those capital proceeds are less than the asset's reduced cost base (subsection 104-10(4)). In accordance with section 115-5, any capital gain realised by the trust from the disposal of the shares will be treated as a discount capital gain where the trust has held those shares for at least 12 months (excluding the days of acquisition and disposal). | Detailed Reasoning - Question 12: The first element of the cost base (or reduced cost base) of the shares to be delivered to the trust will be their market value at the time of acquisition, i.e. on the date of delivery to the trust (subsections 110-25(2), 110-55(2) and 112-20(1)). The cost base (or reduced cost base) of the trust's shares will also include, as its second element, any incidental costs incurred by the trust in acquiring the shares (subsections 110-25(3) and 110-55(2)). | Detailed Reasoning - Question 13: In calculating the first element of the cost base (or reduced cost base) of the shares delivered to the trust, and in establishing the market value of the shares as at the date of delivery to that end, the value to be used is the closing price of the shares on the relevant stock exchange on which they are traded on the date of their delivery. | Detailed Reasoning - Question 14: Provided that the arrangement ruled on is entered into and carried out as disclosed in this ruling, it is accepted that the forward sale agreement is an ordinary commercial transaction and Part IVA of the ITAA 1936 will not apply.