Private ruling: RBA capital indexed bonds
Published: January 2013
Ruling period: Year ending 30 June 2013
Date scheme commenced: On or after 1 January 2012

Ruling: Q1: Is your loss on face value made, when you disposed of your Reserve Bank of Australia (RBA) capital indexed bond, deductible against your assessable income? | A1: Yes.

Relevant facts and circumstances: Late in the relevant financial year you purchased a capital indexed bond from the RBA. Early in the subsequent financial year, you sold your capital indexed bond back to the RBA, making a loss on its face value on disposal. The bond was due to mature in 20XX. You are an Australian resident. You have not made any tax-timing method elections under Division 230 of the Income Tax Assessment Act 1997 (ITAA 1997).

Relevant legislative provisions: Income Tax Assessment Act 1936 Section 159GP | Income Tax Assessment Act 1936 Section 26BB | Income Tax Assessment Act 1997 Section 295-85 | Income Tax Assessment Act 1997 S ection 230-5 | Income Tax Assessment Act 1997 Section 230-10 | Income Tax Assessment Act 1997 Section 230-15 | Income Tax Assessment Act 1997 Section 230-90 | Income Tax Assessment Act 1997 Section 230-100 | Income Tax Assessment Act 1997 Section 230-115 | Income Tax Assessment Act 1997 Section 230-130 | Income Tax Assessment Act 1997 Section 230-135 | Income Tax Assessment Act 1997 Section 230-175 | Income Tax Assessment Act 1997 Section 230-455

Reasons for decision: Detailed Reasoning - Taxation of superannuation entities: Division 295 of the ITAA 1997 contains rules for the taxation of complying superannuation funds. Section 295-85 of the ITAA 1997 makes the CGT rules the primary code for determining the tax treatment of the gains or losses generated on the disposal of an asset. Paragraph 295-85(2)(a) of the ITAA 1997 modifies the normal CGT rules so that a CGT event happening to a CGT asset of a complying superannuation fund is not affected by the following provisions: § section 6-5 of the ITAA 1997 (ordinary income), § section 8-1 of the ITAA 1997 (amounts you can deduct), and § sections 15-15 and 25-40 of the ITAA 1997 (profit-making undertakings or plans); § section 230-15 (about financial arrangements). Exceptions to this treatment are contained in paragraph 295-85(3)(b) of the ITAA 1997 for CGT assets, which includes for a bond. In your case, the provisions in Division 295 of the ITAA 1997 will not apply because your asset is a bond. | Detailed Reasoning - Qualifying securities: Section 26BB of the ITAA 1936 defines the term 'traditional security' as: traditional security , in relation to a taxpayer, means a security held by the taxpayer that: (a) is or was acquired by the taxpayer after 10 May 1989; (b) either: (i) does not have an eligible return; or (ii) has an eligible return, where: (A) the precise amount of the eligible return is able to be ascertained at the time of issue of the security; and (B) that amount is not greater than 1½% of the amount calculated in accordance with the formula: Payments × Term where: Payments is the amount of the payment or of the sum of the payments (excluding any periodic interest) liable to be made under the security when held by any person; and Term is the number (including any fraction) of years in the term of the security; (c) is not a prescribed security within the meaning of section 26C; and (d) is not trading stock of the taxpayer. Section 159GP of the ITAA 1936 defines a 'qualifying security' as: "qualifying security" means any security: (a) that is issued after 16 December 1984; (b) that is not a prescribed security within the meaning of section 26C; (ba) that is not part of an exempt series (see subsection (9A)); (c) the term of which, ascertained as at the time of issue of the security will, or is reasonably likely to, exceed 1 year; (d) that has an eligible return; and (e) where the precise amount of the eligible return is able to be ascertained at the time of issue of the security - in relation to which the amount of the eligible return is greater than 1½% of the amount ascertained by multiplying the amount of the payment or the sum of the payments (excluding any periodic interest) liable to be made under the security by the number (including any fraction) of years in the term of the security; but does not, except as provided by subsection (10), include an annuity. For the purposes of this Division, there shall be taken to be an eligible return in relation to a security if at the time when the security is issued it is reasonably likely, by reason that the security was issued at a discount, bears deferred interest or is capital indexed or for any other reason, having regard to the terms of the security, for the sum of all payments (other than periodic interest payments) under the security to exceed the issue price of the security, and the amount of the eligible return is the amount of the excess. In your case, your capital indexed bond was a qualifying security because it had an eligible return, due to being capital indexed, and because, due to being capital indexed, the precise amount of the eligible return was not able to be ascertained at the time of issue of the security (given future indexation amounts remained unknown). | Detailed Reasoning - Taxation of financial arrangements (TOFA) provisions: From 1 July 2010, the rules contained in the TOFA provisions of Division 230 of the ITAA 1997 apply to the taxation of certain qualifying securities. Section 230-5 of the ITAA 1997 provides Division 230 does not apply to financial arrangements where you are: · …a superannuation entity or fund…with assets of less than $100 million… · and either: · the arrangement is to end not more than 12 months after you start to have it; or · the arrangement is not a qualifying security… For clarity, paragraph 1.22 of the Explanatory Memorandum to the Tax Laws Amendment (Taxation of Financial Arrangements) Act 2009 explains: This legislation does not apply to…financial arrangements of superannuation funds (both regulated and self managed)…where the value of the entity's assets are less than $100 million except where the arrangement is a qualifying security and its remaining life after acquisition is more than 12 months… Also, the exception under subsection 230-455(1) for certain taxpayers (about where there is no significant deferral) does not apply to capital indexed bonds, as the arrangement is a qualifying security and the arrangement was to end more than 12 months after you started to have it. In your case, your capital indexed bond had a remaining life after acquisition of more than X months. Therefore, the TOFA provisions contained in Division 230 of the ITAA 1997 apply to your case. | Detailed Reasoning - Taxation treatment of qualifying securities: Section 230-15 of the ITAA 1997 provides, in general, subject to its exceptions, gains are assessable and losses are deductible in relation to a financial arrangement. Subsection 230-15(1) states your assessable income includes a gain you make from a financial arrangement. Subsection 230-15(2) states you can deduct a loss you make from a financial arrangement, but only to the extent that: § you make it in gaining or producing your assessable income, or § you necessarily make it carrying on a business for the purpose of gaining or producing assessable income. Under subsection 230-100(2) of the ITAA 1997, the accruals method applies to a gain or loss you make on the index bonds as it is a financial arrangement under section 230-45 and there is a sufficiently certain overall gain from the arrangement. Although the amount of the face value is adjusted to inflation, subsection 230-115(4) states that you must assume that the inflation rate remains the same. Subsection 230-130(1) of the ITAA 1997 provides the period over which the gain or loss is to be spread is the period that: (i) starts when you start to have the arrangement; and (ii) ends when you will cease to have the arrangement. Section 230-135 of the ITAA 1997 explains the gain or loss is to be spread, as follows: The intervals to which parts of the gain or loss are allocated must: (a) not exceed 12 months; and (b) all be of the same length. Paragraph (b) does not apply to the first and last intervals. These may be shorter than the other intervals. For each interval: (a) determine a rate of return; and (b) determine an amount to which you apply the rate of return. …in determining the amount to which you apply the rate of return for an interval, have regard to: (a) the amount or value; and (b) the timing; of financial benefits that are to be taken into account in working out the amount of the gain or loss, and were provided or received by you during the interval. An example of how the gain or loss is to be spread was provided. Subsections 230-175(1) and 230-175(2) of the ITAA 1997 provide running balancing adjustments must be made if the financial benefit received or to be received is less or more than the amount estimated under section 230-135. Section 230-90 of ITAA 1997 explains the 'accruals method' is applied to determine the amount and timing of gains and losses from a financial arrangement if they are sufficiently certain for such accrual to be done. If the accruals method is applied to a gain or loss on the basis of an estimate of a financial benefit and the benefit when received or provided is more or less than the estimate, a balancing adjustment is made to correct for the underestimate or overestimate. | Detailed Reasoning - Conclusion: In your case, there will be two accrual periods, one in the relevant financial year and one in the subsequent financial year. You are to determine a rate of return for the first accrual period. Then you are to apply that rate of return to the second accrual period and make any necessary balancing adjustments. In short, your loss on face value on disposal will form part of your balancing adjustment and fall into the subsequent financial year.

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