Holding period rule

In determining whether a Fund has a materially diminished risk of loss or opportunity for gain in respect of a particular share, can the Fund deconstruct the SPI 200 Futures contracts in order to determine its net position in respect of the particular share?

Yes.

A particular Fund has a long investment in shares in ABC Pty Ltd, a public listed company included in the ASX 200 index. During its period of ownership, the Fund receives a franked dividend from ABC Pty Ltd.

As part of its investment strategy, the Fund enters into short positions in respect of the ASX 200 through SPI 200 Futures contracts.

No associates of the Fund hold a position in ABC shares under an arrangement with the Fund.

A taxpayer's 'net position' is determined by reference to its long and short positions. Former subsection 160APHJ(2) of the Income Tax Assessment Act 1936 (ITAA1936) provides that a position in relation to shares or an interest in shares is anything that has a 'delta' in relation to the shares or interest.

The 'net position' of the Fund in relation to the ABC shares is defined in former subsection 160APHJ(5)of the ITAA 1936 as the sum of the Fund's long positions in the shares (calculated on the basis of their delta) and short positions in the shares (also calculated on the basis of their delta).

Pursuant to former subsection 160APHJ(4) of the ITAA 1936, a long position in relation to shares, or an interest in shares, is a position that has a positive delta in relation to the shares or interest. For example, the purchase of ABC shares viewed in isolation would have a delta of +1.

Pursuant to former subsection 160APHJ(3) of the ITAA 1936, a short position in relation to shares, or an interest in shares is a position that has a negative delta in relation to the shares or interest.

It is stated that there are no associates of the Fund which held ABC shares under an arrangement with the Fund. Therefore, the issue of whether an associate of the Fund, pursuant to former subsection 160APHJ(9) of the ITAA 1936, has a short position or an interest in relation to ABC shares is not relevant.

Former subsection 160APHJ(2) of the ITAA 1936 defines a 'position' in relation to shares as anything that has a delta in relation to the shares and includes a non exhaustive list of potential positions. In this instance, the position is the short sale of SPI Futures Contracts.

'Delta' is a financial concept that measures the relative change in the price of an option or other derivative for a given small change in the price of the underlying asset. The concept of delta is not defined in the tax legislation, but former subsection 160APHM(3) of the ITAA 1936 provides by way of example that an option to sell a share with a delta of minus 0.5 in relation to the share reduces the risks of loss and opportunities for gain by 50%.

Former subsection 160APHJ(2) of the ITAA 1936 lists some examples of positions which, because they relate to "substantially similar or related property", will have a delta in relation to the underlying shares held by the taxpayer. Substantially similar or related property is considered to refer to property sufficiently similar to the underlying shares so as to exhibit a correlation in price movements.

This correlation is between shares, interests in shares or property that the taxpayer is connected to. In defining the scope of this correlation it is essential to restrict the analysis to factors that are not too remote.

The SPI Futures contract is an instrument that is not too remote because the SPI Futures contract is made up of many stocks, including ABC shares. Therefore, the holding necessary to take into account when determining the net position of the Fund in relation to the ABC shares, is the short position taken on the ABC shares through the SPI Futures contracts.

For the purposes of the 'holding period' rule pursuant to subsection 160APHO of the ITAA 1936, where neither a taxpayer nor an associate of the taxpayer has made, is under an obligation to make, or is likely to make a related payment in respect of the dividend, the taxpayer will be a qualified person if the shares are held 'at risk' for at least 45 days (for ordinary shares) or 90 days (in the case of preference shares).

Where the taxpayer has made, is under an obligation to make, or is likely to make a related payment in respect of the dividend, the relevant qualification period will be the secondary qualification period. As no related payments have been made, the relevant primary qualification period, defined in section 160APHD of the ITAA 1936 will be the period commencing on the day after the day on which the taxpayer acquired the shares or interest, and ending on the 45th day after the day on which the shares or interests become ex-dividend.

Pursuant to subsection 160APHO(2) of the ITAA 1936, a taxpayer is taken to have 'materially diminished' the risks of loss or opportunities for gain on a particular day in respect of shares held by the taxpayer or in respect of an interest in shares held by the taxpayer, if the taxpayer's 'net position' on that day in relation to the shares or interest in shares has less than 30% of those risks or opportunities.

The facts presented above shows that the Fund's net position is comprised of the long stock position in ABC shares (on which dividends are received) and the short position on the SPI Futures contract.

The Fund has formulated a methodology for establishing whether the fund has materially diminished its risk of loss or opportunities for gain in respect of the ABC shares.

Essentially, the SPI futures contract is deconstructed into its open (short) component stock positions. The net position of a particular stock is then determined by offsetting the decomposed component of the SPI futures contract relating to the stock against the +1 delta of the particular share. If the net position is greater than 30%, it is concluded that all of those particular shares are held sufficiently 'at risk' during the qualification period.

Because the net long/short position calculated in accordance with the methodology is greater than 30%, it can be concluded that during the qualification period, the Fund has not materially diminished its risk of loss or opportunities for gain in respect to its holdings of ABC shares. Consequently, the Fund will be eligible for a tax offset in respect of the franking credits attached to the dividends on the ABC shares.