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Special Determination S51: Subordinated Convertible Note in respect of a Limited Partnership Interest in a Public–Private Partnership

This determination may be cited as Special Determination S51: Subordinated Convertible Note in Respect of a Limited Partnership Interest in a Public–Private Partnership.

1. Explanation (which does not form part of the determination)

  1. This determination relates to the issue of subordinated convertible notes (Convertible Notes) by a limited partnership (the Partnership) to two of its limited partners (Limited Partner A and Limited Partner B – the Subscribers). The Convertible Notes will convert to a 40% partnership interest (for each of the Subscribers) at a single, or several, nominated date(s) in the future to match the partnership contributions by the other two limited partners in the Partnership (Limited Partner C and Limited Partner D).
  2. Limited Partner A is exempt from income tax. Limited Partner B is a limited partnership with multiple limited partners, some of whom are exempt from income tax. Limited Partner C and Limited Partner D are both limited liability companies. Limited Partner C, Limited Partner D, and each limited partner of Limited Partner B that is not exempt from income tax are together referred to as the Taxable Limited Partners. This determination only applies to the Taxable Limited Partners and does not apply to those limited partners that are exempt from income tax.
  3. The Convertible Notes will earn a fixed rate of interest that is payable monthly (Coupon Interest Payments) until the Convertible Notes are converted or repaid. The Coupon Interest Payments will be capitalised on each interest payment date. However, the additional Convertible Notes issued in satisfaction of the interest payments will not convert to a partnership interest, but will be repaid to the Subscribers over multiple distribution dates.
  4. The interest rate on the Convertible Notes will be a market rate determined under an agreed rate-set process. No fees are payable by the Partnership or the Subscribers in relation to the Convertible Notes.
  5. In accordance with s EW 6(2) an amount that is solely attributable to an excepted financial arrangement is not taken into account under the financial arrangements rules. An interest in a partnership is an excepted financial arrangement under s EW 5(11). Therefore, the Convertible Notes are a financial arrangement that includes an excepted financial arrangement.
  6. This Determination prescribes the method for determining the amounts that are solely attributable to the excepted financial arrangement, as well as the method for spreading the income and expenditure under the financial arrangements rules.

2. Reference

This determination is made under ss 90AC(1)(bb), 90AC(1)(d) and 90AC(1)(h) of the Tax Administration Act 1994.

3. Scope of determination

  1. This determination applies to the Convertible Notes issued by the Partnership to the Subscribers as part of a wider transaction entered into by the parties, which is the subject of Private Rulings BR Prv 16/64 and BR Prv 16/65, issued on 31 October 2016.
  2. The terms of the Convertibles Note are as follows:
    1. The Convertible Notes will be drawn in full at Financial Close and will have a face value equal to 40% (for each of the Subscribers) of the total equity requirement.
    2. The Convertible Notes will earn a fixed rate of interest that is capitalised monthly until conversion or repayment (the Coupon Interest Payments).
    3. The Coupon Interest Payments that are capitalised on each interest payment date will not convert to a partnership interest, but will be paid out to the limited partners over multiple partnership distribution dates.
    4. The interest rates payable to Limited Partner A and Limited Partner B under the convertible notes do not exceed the arm’s length rates that would have been agreed between wholly unrelated parties having regard to the terms of the convertible notes and applying orthodox pricing methodologies.
    5. No fees are payable by the Partnership or the Subscribers in relation to the Convertible Notes.

4. Principle

  1. The Convertible Notes are a financial arrangement (as defined in s EW 3). An interest in a partnership is an excepted financial arrangement (s EW 5(11)). Therefore, the Convertible Notes are a financial arrangement that includes an excepted financial arrangement.
  2. Under s EW 6(2), an amount that is solely attributable to an excepted financial arrangement is not taken into account under the financial arrangements rules.
  3. Any amount that is not solely attributable to an excepted financial arrangement is required to be taken into account under the financial arrangements rules and spread in accordance with those rules.
  4. Under s EW 14(3), an amount calculated for and allocated to an income year under a spreading method will either be expenditure incurred or income derived by the person.
  5. Determination G1A: Apportionment of Income and Expenditure on a Daily Basis sets out a method for calculating and allocating income and expenditure on the basis of daily apportionment.

5. Interpretation

In this determination, unless the context otherwise requires:

  • All legislative references in this determination are to the Income Tax Act 2007, unless otherwise stated.
  • Convertible Notes means the unsecured subordinated notes, in a denomination of $1.00 issued by the Partnership to the Subscribers.
  • means the monthly interest payable on the Convertible Notes in accordance with their terms.
  • IFRS means a New Zealand Equivalent International Financial Reporting Standard in effect under the Financial Reporting Act 2013 and as amended from time to time or an equivalent standard issued in its place.

6. Method

  1. Any change in the market value of the interest in the Partnership between the issue date of the Convertible Notes and conversion into the partnership interest will be solely attributable to the excepted financial arrangement.
  2. The Coupon Interest Payments are not solely attributable to an excepted financial arrangement, and therefore must be spread under the financial arrangements rules. There will be no other amounts of income or expenditure under the financial arrangements rules in relation to the Convertible Notes.
  3. Under s EW 14(3), the Coupon Interest Payments will be expenditure incurred by the Taxable Limited Partners and income derived by the limited partners of Limited Partner B that are not exempt from income tax.
  4. Income and expenditure in respect of the Convertible Notes will be calculated by daily apportionment of the Coupon Interest Payment to income years in accordance with Determination G1A: Apportionment of Income and Expenditure on a Daily Basis.

7. Example

This example illustrates the application of the method set out in this determination.

On 1 April 2017, Convertible Notes are issued to the Subscribers for $1,000. The Convertible Notes will mandatorily convert to a 40% interest in the Partnership for each Subscriber on 31 March 2022.

The Coupon Interest Payments will be set at the market interest rate of 8.5% and will be capitalised on each monthly interest payment date.

The annual sum of Coupon Interest Payments as at 31 March from 2018 to 2022 is:

31 March 2018 $88.39
31 March 2019 $96.20
31 March 2020 $104.71
31 March 2021 $113.96
31 March 2022 $124.04
  $527.30

On the date of issue, the market value of a 40% partnership interest in the Partnership is $1,000. Any change in the market value between the date of issue and 31 March 2022 will be solely attributable to an excepted financial arrangement.

The amounts that must be spread under the financial arrangements rules are the Coupon Interest Payments, which shall be apportioned using the method outlined in Determination G1A: Apportionment of Income and Expenditure on a Daily Basis.

This Determination is signed by me on the 31st day of October 2016.

Dinesh Gupta
Manager, Taxpayer Rulings