Issue
Does an Australian resident taxpayer have an interest in a Foreign Investment Fund (FIF) at the end of the income year for the purposes of subsection 485(3) of the ITAA 1936, where the taxpayer redeems all of its shares in the FIF on the last day of the income year and acquires shares in the same FIF at the beginning of the next income year?
Decision
No. The taxpayer does not have an interest in a FIF at the end of the income year for the purposes of subsection 485(3) of the ITAA 1936 as the taxpayer does not have a share or an entitlement to a share in the FIF at the end of the income year.
Facts
The taxpayer acquired shares in a foreign company that is a FIF.
On the last day of the income year the taxpayer completed and submitted a redemption request in respect of all its shares in the FIF.
Before the end of the income year the redemption request is accepted by the FIF and confirmation of the redemption is issued by the FIF to the taxpayer. The shares are cancelled and the register of shareholders is updated accordingly.
The taxpayer executed a standing application before the end of the income year for the subscription of shares in the FIF to be issued at the beginning of the next income year.
The FIF does not accept the standing application before the end of the income year and is under no obligation to issue shares to the taxpayer.
The taxpayer subsequently acquires shares in the FIF at the beginning of the next income year.
Reasons for Decision
Subsection 485(3) of the ITAA 1936 provides that section 529 of the ITAA 1936 will apply to include an amount in the taxpayer's assessable income where FIF income has been accrued if: • the taxpayer had an interest or interests in a FIF at the end of the income year • the income year is 1992-1993 or later; and • the taxpayer was an Australian resident under Part XI of the ITAA 1936.
An interest in a FIF that is a foreign company is either a share in the foreign company (paragraph 483(1)(a) of the ITAA 1936) or 'an option, convertible note, or other instrument, that confers an entitlement to acquire such a share' (paragraph 483(1)(b) of the ITAA 1936). The relevant time for determining whether such an interest exists is 'at the end of the income year' (paragraph 485(3)(a) of the ITAA 1936).
Section 488 of the ITAA 1936 sets out what constitutes a disposal or acquisition of an interest in a FIF. To constitute a disposal of an interest in a FIF, subsection 488(3) of the ITAA 1936 requires that there is a change in beneficial ownership.
When the redemption is executed and submitted by the taxpayer to the FIF and it is accepted with confirmation issued by the FIF, the taxpayer will then have the right to demand payment of the redemption amount. The taxpayer will not have any other rights against the FIF in respect of the shares (other than the right to receive a dividend if a dividend is declared before the redemption). Therefore, the taxpayer will no longer have beneficial ownership of the shares in the FIF at the end of the year of income.
In relation to standing applications for shares in a FIF, a taxpayer will have an interest in a FIF in terms of paragraph 483(1)(a) of the ITAA 1936 if the taxpayer acquires shares in the same FIF before the end of the income year. If a taxpayer has a contract to acquire an interest in a FIF, the time of acquisition, in terms of section 489 of the ITAA 1936, is the time of making of the contract. If a contract to acquire shares is made as at the end of the income year, the taxpayer will have an interest in a FIF at the end of the income year.
For a valid contract to exist there must be offer and acceptance, consideration, intention to assume legal obligations and certainty of terms (Seddon NC, Ellinghaus MP 1997, Cheshire & Fifoot's Law of Contract 7th edn, Butterworths, Sydney, paragraph 1.16). The standing application made by the taxpayer represents an offer. As the offer is not accepted by the FIF until the beginning of the next income year a contract to acquire shares in the FIF does not exist at the end of the income year.
The taxpayer will have an interest in the FIF in terms of paragraph 483(1)(b) of the ITAA 1936 if the taxpayer has an option, convertible note, or other instrument that confers an entitlement (within the meaning of section 475 of the ITAA 1936) to acquire a share in the FIF at the end of the income year (paragraph 483(1)(b) of the ITAA 1936).
Any right that confers an entitlement to acquire a share in the FIF must be embodied in an 'instrument' to fall within paragraph 483(1)(b) of the ITAA 1936. 'Instrument' is not defined in the legislation and as such is given its ordinary meaning. The Macquarie Dictionary , 2001, rev. 3rd edn, The Macquarie Library Pty Ltd, NSW, defines the term 'instrument' as 'a formal legal document, as a contract, promissory note, deed, grant, etc.'.
The term was also discussed by French J in Azevedo v. Secretary, Department of Primary Industries & Energy (1992) 35 FCR 284 quoting from the Shorter English Oxford Dictionary : The ordinary English meaning ....is "a formal legal document whereby a right is created or confirmed, or a fact recorded; a formal writing of any kind, as an agreement, deed, charter, record, drawn up and executed in technical form".
In these particular circumstances, the taxpayer does not hold an 'instrument' which confers on them an 'entitlement to acquire' a share in the FIF at the end of the income year.
The standing application made by the taxpayer grants the FIF the right to order the taxpayer to acquire the shares upon acceptance of the application. Such a right is in the form of a put option. Taxation Ruling TR 2002/3 states that a put option does not constitute an entitlement to acquire in terms of section 475 of the ITAA 1936, but constitutes a right by the holder to impose an obligation on another.
Therefore, the standing application does not constitute an 'entitlement to acquire' shares in the FIF at the end of the income year. The FIF is under no obligation to issue shares to the taxpayer. The taxpayer does not have an absolute or contingent entitlement to acquire shares prior to the FIF accepting the application.
Given that the taxpayer does not have a share or an entitlement to acquire a share in the FIF at the end of the year of income, they do not have an interest in a FIF at the end of the year of income for the purposes of section 485 of the ITAA 1936.
Note: the taxpayer will return on revenue account so much of the redemption price as exceeds the amount debited to the share capital account as an assessable dividend. The redemption price is based on the market value of the shares on the day of the redemption.