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Determination FDR 2009/5: Use of fair dividend rate method for a type of attributing interest in a foreign investment fund that is a derivative income trust

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 a non-resident issuer ("the issuer") to which this determination applies are attributing interests in a foreign investment fund (FIF) for portfolio investment entities (PIE) managed by New Zealand Funds Management Limited (NZFM). Each PIE is required to apply the FIF rules to determine its tax liability in respect of units in the nonresident issuer each year.

As the issuer holds New Zealand denominated cash, the balance of which may in exceptional circumstances exceed 80% or more by value of its assets, section EX 46(10)(cb) of the Act could apply to prevent the PIE from using the fair dividend rate method in the absence of a determination under section 91AAO of the Tax Administration Act 1994. Despite the fact that the issuer may hold assets which 80% or more by value consist of financial arrangements denominated in New Zealand dollars, I consider that it is appropriate for New Zealand-resident investors in this arrangement to use the fair dividend rate method. The overall arrangement (as described to me by the applicant) contains sufficient risk so that it is not akin to a New Zealand dollar-denominated debt instrument.

Scope of determination

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

  1. is a unit trust that is established and tax-resident in Australia;
  2. has appointed, as Investment Manager, NZFM (a company incorporated and tax-resident in New Zealand) or an entity which is associated with NZFM;
  3. issues New Zealand dollar denominated units (not being fixed rate shares or non-participating redeemable shares) to a PIE (or PIEs) for which NZFM is the Investment Manager;
  4. has been established to hold derivative contracts to take or hedge equity or commodity risk by a single investor that is the PIE;
  5. invests proceeds from the issue of units in assets which are foreign currency accounts, New Zealand dollar accounts and financial arrangements that do not provide funds to the issuer;
  6. to the extent to which it invests in foreign currency accounts (or other financial arrangements that provide funds to the issuer, in relation to which the return is determined by reference in any way to underlying non-New Zealand dollar-denominated fixedinterest securities), does not invest in any currency arrangements which provide an overall economic return as if the securities were denominated in New Zealand dollars;
  7. has investment guidelines that prohibit the investment manager from entering into currency arrangements (whether in the issuer itself or through any associated, or commonly controlled, entity) that are intended by the investment manager to achieve an effective hedge of more than 80% of the issuer's foreign currency exposure;
  8. may make distributions to the unit holders on a regular basis, but does not guarantee that any income will be derived or that a distribution will be made;
  9. may pay to the PIE an amount exceeding the issue price of the unit on redemption, but does not guarantee that the redemption price of a unit will exceed its issue price;
  10. the PIE has removed no more than 80% of the foreign currency risk associated with the units.

It is a further condition of this determination that the investment in the issuer is not part of an overall arrangement that seeks to provide the PIE with a return that is equivalent to an effective New Zealand dollardenominated interest exposure.

Interpretation

In this determination, unless the context otherwise requires:

"Associated" means associated within the meaning of subpart YB of the Act;

"Financial arrangement" means a fixed-rate share under section LL 9 of the Act;

"Investment Manager" means the person or entity appointed by the trustee to carry out the investment activities of the trustee;

"Non-participating redeemable share" means a nonparticipating redeemable share under section CD 22(9) 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 2007.

Determination

An attributing interest in a FIF to which this determination applies is a type of attributing interest for which a person may use the fair dividend rate method to calculate FIF income from the interest.

Application date

This determination applies for the 2009-10 and subsequent income years. However, under section 91AAO(3B) of the Tax Administration Act 1994, this determination does not apply for an income year beginning before the date of this determination for an investor in the issuer unless that investor chooses for this determination to apply for that year.

Dated at Wellington this 24th day of September 2009

David Carrigan
Policy Manager, Policy Advice Division

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Date published: 01 Feb 2010

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