Instalment warrant information

Instalment warrants allow a client to invest in securities and, at the time of making the investment, only pay part of the value of those securities. The client may obtain a non-recourse loan from the issuer for the remaining value of the securities. A non-recourse loan means that the client has no obligation to repay the loan upon maturity of the warrant.

There are two ways in which an instalment warrant can be purchased.

  1. Primary market application (purchasing directly from the issuer at the time of an instalment warrant issue). If purchasing via the primary market, the client
    can make a:
    • cash application – where the client will make an investment through a disclosure document before trading of the warrant commences on the Australian Securities Exchange (ASX)
    • shareholder application – where a shareholder will convert existing shares they hold into an instalment warrant
    • rollover application – where the client will roll from an existing series of instalment warrants into a new instalment series over the same underlying securities.
  2. Secondary market application which is where an instalment warrant is purchased through the ASX.

 

  • Vanilla instalment warrants – these are standard warrants where investors are issued with a non-recourse loan which they use to finance the purchase of underlying assets
  • Rolling instalment warrants – these are warrants that will roll on a reset date if the investor elects to roll the warrant into the next series. The issuer recalculates the components of the warrant and notifies the client. If a client does not specifically elect to roll or sell their warrant then they may be deemed to have accepted the conditions of the next series and the issuer will, in this case, automatically roll their existing warrant into the next series
  • Resetting instalment warrants – these are warrants that have an annual reset feature which allows an investor to restructure their warrant or change their gearing levels. At the annual reset date, the client may maintain their current holding, end their investment or roll into another series
  • Self-funding instalment warrants – the investor pays a portion of the value of the underlying securities upfront and any dividends paid under the terms of the warrant are retained by the issuer to reduce the loan amount. Interest on the loan is added to the amount outstanding each year.

The main components of an instalment warrant are:

  • an underlying security
  • a completion payment amount
  • a holder’s put option
  • a deductible borrowing fee
  • prepaid interest.

We deem instalment warrants to be held on capital account. All disposals are considered to be subject to capital gains tax (CGT) and all dividends and distributions received on the underlying securities are assessable.

Any dividends, distributions and associated credits distributed under the terms of the warrant should be treated as assessable income in the year in which they were paid or declared (as relevant).

An instalment warrant investor must hold their warrant at risk for a period of 45 days during the qualification period. The qualification period commences on the day after the warrant was acquired and ends 45 days after the share arising on the underlying security becomes ex dividend. This rule will deny franking credits attached to the dividends received where this qualification period has not been met.

We assume that interest paid on borrowings used to acquire income producing assets (such as instalment warrants) is deductible for income tax purposes as it is expected that assessable income will be derived from the holding of instalment warrants.

On this basis, we report interest amounts as deductible. We do not take into account whether any interest becomes non-deductible due to the fact that the interest rate used is in excess of the relevant RBA interest rate benchmark (and hence becomes a cost associated with capital protection and non-deductible).

To this end, we rely on disclosure from the product issuers.

We recommend that investors seek independent taxation advice in order to determine the deductibility (or otherwise) of these interest payments.

A borrowing fee is made up of two components. The first component comprises a borrowing fee for the purchase of the instalment warrant. As the predominant purpose of obtaining the loan is to produce assessable income from the instalment warrant, the Australian Taxation Office (ATO) recognises that this amount should be deductible over the period of the borrowing. The second element relates to the holder’s put option (HPO) and has historically not been accepted by the ATO as being deductible.

The HPO will have differing tax attributes depending on whether the option to purchase the underlying securities is exercised. Where the put option is not exercised, the amount relating to the purchase of the put option should represent the cost base of the option. 

Generally speaking, a capital loss will arise where the put option lapses (as the proceeds received for CGT purposes are nil). Where the put option is exercised, this amount should be added to the cost base of the underlying securities at the time the option is exercised.

A taxable event does not arise when the completion payment is made. Instead, a taxable event arises once the underlying securities are ultimately disposed.

We report the warrant cost base (as calculated by reference to the underlying security price) as the total of the warrant price less deductible prepaid interest and borrowing expenses. We rely on the information provided by the issuer of the instalment warrant. We recommend that independent taxation advice be sought as to the correct calculation of an instalment warrant cost base.

Where this occurs there may be a refund of prepaid interest. This refunded amount should be included in the assessable income of the investor. A capital gain or loss will arise to the investor, being the difference between the sale proceeds and the cost base of the instalment warrant.

In this situation the warrant issuer will exercise its power of sale of the underlying securities and may transfer a portion of the net proceeds to the holder. The holder will be treated for CGT purposes as having disposed of the underlying securities. A capital gain or loss will arise, being the difference between proceeds received and the cost base of the underlying securities. In the case of a capital loss, the proceeds from the sale are insufficient to meet the final instalment. Generally speaking, investors are not required to make up this deficit.

The Issuer Instalment Warrant Tax Report – Summary and Issuer Instalment Warrant Tax Report – Detailed outline relevant information on an investor’s instalment warrant holdings as provided by the instalment warrant issuer.

The Issuer Instalment Warrant Tax Report – Summary provides a summary of:

  • prepaid interest amounts
  • interest refund amounts
  • borrowing fee amounts

as provided by the instalment warrant issuers for an individual and self managed superannuation fund.

The Issuer Instalment Warrant Tax Report – Detailed provides detailed information for each instalment warrant held in an investor’s account as provided by the issuer.

The expense recognition rules associated with instalment warrants may differ between warrant issuers and may depend upon the entity type of the taxpayer.  Investor’s and their accountant should read the footnotes to the reports and undertake independent calculations to determine which amounts (if any) of the expenses reported are deductible in the current financial year.