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Determination FDR 2008/12 - A type of interest in a foreign investment fund for which a person may not use the fair dividend rate method (Global Investment Service Super Yield Fund)

Reference

This determination is made under section 91AAO(1)(a) of the Tax Administration Act 1994. This power has been delegated by the Commissioner of Inland Revenue to the position of Policy Manager under section 7 of the Tax Administration Act 1994.

Discussion (which does not form part of the determination)

Units in the Global Investment Services Limited Super Yield Fund ("SYF") to which this determination applies are an attributing interest in a foreign investment fund ("FIF") for New Zealand resident investors.

New Zealand resident investors are required to apply the FIF rules to determine their tax liability in respect of their SYF investments each income year.

SYF 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 currency 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 the hedging arrangements are in place).

However, for the 2008/09 and subsequent income years, the broadening of section EX 46(8) of the Income Tax Act 2007 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 SYF should not qualify for the FDR method as the SYF 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 SYF were excluded from the FIF rules and were subject to tax on dividends due to the grey list exemption
  • For the 2007/08 income year the FIF rules apply and New Zealand resident investors would use the FDR method
  • For the 2008/09 year and later years the FIF rules apply and New Zealand resident investors would use the comparative value calculation method

It is clear the 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 being able to use the FDR method for their investments 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 investments 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 SYF.

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 6 December 2000, that commenced operation on 16 September 2002 (known as the Global Investment Services Limited Super Yield Fund ("SYF"));
  2. has as its trustee Global Investment Services Limited, a company resident in Australia;
  3. is managed by New Zealand Funds Management Limited ("NZ Funds");
  4. invests directly in a portfolio comprising of collateralised debt obligations ("CDOs") and New Zealand dollar denominated debt holdings;
  5. with respect to its holdings in CDOs, invests in instruments designed to provide a stable return at a predetermined level over their term based on the makeup of the CDO portfolio. The CDOs are managed within strict investment guidelines to achieve this return, rather than being actively managed to maximise returns;
  6. has a target rate of return (after fees) of 1% above the New Zealand 90 day bank bill rate over a rolling 12-month period;
  7. hedges 100% of its foreign currency exposure 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 typically 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. The debt tranches comprising a CDO are typically rated by external credit rating agencies.

"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 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 SYF unless that investor chooses for this determination to apply for that year.

Dated at Wellington this 17th day of April 2008

David Carrigan
Policy Manager
Inland Revenue

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Date published: 13 May 2008

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