NO.019

TAXATION OF CAPITAL PROTECTED PRODUCTS

Today the Government is announcing a measure relating to the taxation treatment

of the capital protection feature included in a capital protected product.

A typical capital protected product is a limited recourse loan facility to

fund the purchase of listed shares. The investor is protected from a fall in

the price of the shares as the loan facility includes a capital protection feature

that gives the investor the right to transfer the shares back to the lender

for the amount outstanding on the loan.

The Full Federal Court in Firth v Commissioner of Taxation ruled that

the component of `interest’ applicable to the cost of the capital protection

feature is deductible when paid. On 5 November 2002, the High Court refused

special leave for the Commissioner of Taxation to appeal this decision.

In response, the Government has decided to amend the Income Tax Assessment

Act 1997 to ensure that part of the expense on a capital protected product

is attributed to the cost of the capital protection feature, is not interest

and is not deductible where this cost is capital in nature.

Treating the cost of capital protection as separate and distinct from interest

on a loan is consistent with the approach taken in product rulings issued by

the Australian Taxation Office prior to the High Court’s refusal to allow special

leave.

The amendment applies to capital protected products that are used to acquire

listed shares, units and stapled securities. The capital gains tax (CGT) provisions

will ensure that the cost of capital protection is included in the cost base

of the relevant asset for CGT purposes.

This amendment is an integrity measure directed at protecting the revenue base.

The measure restores the general principle underpinning the current law that

any revenue loss or outgoing in producing assessable income is deductible, while

a capital loss or outgoing is not deductible.

The measure also ensures that all borrowers who utilise a capital protection

feature are treated in the same way for taxation purposes whether or not the

capital protection feature is purchased separately, or included within the `interest’

on the loan.

The amendment takes effect immediately, that is, it applies to arrangements,

including extensions of existing arrangements, entered into on or after 9.30

am Canberra time 16 April 2003.

CANBERRA

Contact: David Alexander

02 6277 7340

16 April 2003