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Determination FDR 2008/05 - A type of attributing interest in a foreign investment fund for which a person may not use the fair dividend rate method (ING Diversified Yield Fund)

Reference

This determination is made under section 91AAO(1)(b) of the Tax Administration Act 1994. This power has been delegated by the Commissioner of Inland Revenue to the Deputy Commissioner, Policy Advice Division, under section 7 of the Tax Administration Act 1994.

Discussion (which does not form part of the determination)

Units in the non-resident issuer to which this determination applies (the ING Diversified Yield Fund ('DYF')) are an attributing interest in a foreign investment fund ('FIF') for primarily New Zealand resident investors. New Zealand resident investors are required to apply the FIF rules to determine their tax liability in respect of their units in the non-resident issuer each year.

The non-resident issuer invests predominantly in financial arrangements (at least 80% of the investment mix) which, while not directly denominated in New Zealand dollars, provide a New Zealand Dollar equivalent return through the use of hedging arrangements. For the 2007-08 income year, section EX 40(9)(d) of the Income Tax Act 2004 ('the Act') does not exclude New Zealand resident investors from using the fair dividend rate ('FDR') method to determine their tax liability under the FIF rules, since the financial arrangements are not denominated in New Zealand dollars (although there are hedging arrangements in place). However, for the 2008-09 and subsequent income years the broadening of section EX 40(9)(d) under the Taxation (Business Taxation and Remedial Matters) Act 2007, means the New Zealand resident investors will be excluded from using the FDR method due to the hedging arrangements.

The policy intention is that investments in the DYF should not qualify for the FDR method as the DYF's investments are akin to New Zealand dollar denominated debt investments. However, in the absence of this determination, most New Zealand resident investors will be required to use the FDR method for the 2007-08 income year. This result is inconsistent with the policy intention of the FIF rules.

In addition, New Zealand resident investors would have to apply three tax methods in three income years, as follows:

  • Before the 2007-08 income year, investments in the DYF were excluded from the FIF rules due to its residence status in a 'grey list' country;
  • For the 2007-08 income year the FIF rules apply and New Zealand resident investors would use the FDR method; and
  • For the 2008-09 and later income years the FIF rules apply and New Zealand resident investors would use the comparative value calculation method.

It is clear that New Zealand resident investors will incur greater compliance costs than if only one of the FIF calculation methods was used uniformly over the term of their investment.

Despite investors in the non-resident issuer prima facie being able to use the FDR method to their investment for the 2007-08 income year, I consider that it is appropriate for New Zealand resident investors in this arrangement to be excluded from using the FDR method for the 2007-08 and subsequent income years. The overall arrangement (as described to me by the applicant) contains predominantly investment in debt securities and is sufficiently hedged so that it is akin to a New Zealand dollar denominated debt investment. Accordingly, it is appropriate that the FDR method not be used by New Zealand resident investors in the non-resident issuer.

Scope of determination

The investments to which this determination applies are units in a non-resident issuer which:

  1. is an Australian unitised trust established on 1 July 2003 (known as the ING Diversified Yield Fund);
  2. is managed by ING (NZ) Administration Pty Limited ('ING Administration'), a company incorporated and tax resident in Australia, or an entity which is associated with ING Administration;
  3. invests through a Cook Islands company in a portfolio of Collateralised Debt Obligations ('CDOs'), Credit Opportunity Funds ('COFs') and New Zealand Dollar denominated cash holdings;
  4. has a target rate of return (after fees) of 2% above the New Zealand 90-day bank bill rate;
  5. hedges 100% of its investments on a total portfolio market value basis to the New Zealand dollar.

Interpretation

In this determination, unless the context otherwise requires -

"CDOs" means Collateralised Debt Obligations which are high-yielding international interest bearing securities issued by offshore special purpose vehicles. The special purpose vehicles use the proceeds from the securitisation to invest in corporate debt and mortgage-backed securities and other credit products. Collateralised Debt Obligation securities are typically rated by external credit rating agencies;

"COFs" means Credit Opportunity Funds which are structured credit funds that invest in a diverse range of corporate debt securities including senior secured bank loans, unsecured investment grade bonds, non investment grade bonds, second-ranking corporate bonds, mezzanine loans and distressed corporate bonds. Credit Opportunity Funds invested into by the non-resident issuer include both rated and non rated credit funds;

"Financial arrangement" means financial arrangement under section EW 3 of the Act;

"Non-resident" means a person that is not resident in New Zealand for the purposes of the Act;

"The Act" means the Income Tax Act 2004, or any equivalent provision in the Income Tax Act 2007, as applicable.

Determination

An attributing interest in a FIF to which this determination applies is a type of attributing interest for which a person may not use the fair dividend rate method to calculate FIF income from the interest.

Application date

This determination applies for the 2007-08 and subsequent income years.

However, under section 91AAO(3B) of the Tax Administration Act 1994, this determination does not apply for the 2007-08 income year for an investor in the DYF unless that investor chooses for this determination to apply for that year.

Dated this 10th day of March 2008

Robin Oliver
Deputy Commissioner, Policy
Inland Revenue

 

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Date published: 11 Mar 2008

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