Spreading Method to be applied by Bank, valuation of shares issued by Bank on Conversion and solely attributable

This Determination may be cited as Special Determination S48: Spreading Method to be applied by Bank, valuation of shares issued by Bank on Conversion and solely attributable.

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

1. This determination relates to a funding transaction involving the issue of Notes by Bank to Parent pursuant to a Deed Poll. The Notes will contain a conversion mechanism to allow them to be recognised as Additional Tier 1 capital for the purposes of the Reserve Bank of New Zealand framework relating to the capital adequacy of banks.
2. The funding transaction is the subject of private ruling BR Prv 16/53, issued on 18 October 2016 and is fully described in that ruling.
3. The agreement to subscribe for shares provided for in the Deed Poll is a financial arrangement (as defined in s EW 3) and an “agreement for the sale and purchase of property or services” (as defined in s YA 1). The Notes, the Deed Poll and the ordinary shares in Bank issued on Conversion are, together, part of a wider financial arrangement. That wider financial arrangement includes excepted financial arrangements being the ordinary shares in Bank.

2. Reference

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

3. Scope of determination

1. This determination applies to a funding transaction involving the issue of Notes by Bank to Parent pursuant to a Deed Poll.
2. If a Conversion occurs, the relevant number of Notes must be immediately and irrevocably converted. In summary, the steps for the conversion of the Notes will be as follows:
   1. Bank will issue a specified number of ordinary shares in Bank to Parent for each Note to be converted.
   2. Parent's rights in relation to each Note to be converted will be immediately and irrevocably terminated for an amount equal to the Issue Price of the Note to be converted. Bank will apply this amount by way of payment for the subscription of the ordinary shares referred to in paragraph (a).
   3. Immediately following the transfer referred to in (a), the Notes will become immediately due and payable and Bank will be required to repay the Face Value of the Notes to HoldCo as assignee. Under the terms of the Co Ordination Agreement, the Face Value owed to HoldCo will be repaid by being applied on HoldCo’s behalf to subscribe for ordinary shares in Bank. The number of ordinary shares in Bank to be subscribed for will be calculated in accordance with a formula in the Co-Ordination Agreement.
3. This determination applies:
   1. if shares are issued by Bank on a Conversion of the Notes, to determine the value of the shares for the purposes of the financial arrangements rules;
   2. to determine the spreading method to be used in respect of the Notes; and
   3. to determine whether any amounts are solely attributable to the ordinary shares in Bank.

4. Principle

1. The Notes and the subscription for shares are, together, part of a financial arrangement (as defined in s EW 3). The agreement to subscribe for shares in Bank by Parent is an “agreement for the sale and purchase of property and services” (as defined in s YA 1), because it is a conditional agreement to acquire property. The shares in Bank are excepted financial arrangements (as defined in s EW 5(13)).
2. The agreement to subscribe for shares is not a “short-term agreement for sale and purchase” (as defined in s YA 1), because settlement is not required to occur within 93 days. Therefore, the agreement to subscribe for shares is not an excepted financial arrangement under s EW 5.
3. For the purposes of determining the consideration paid or payable under the financial arrangements rules, the value of the shares issued by Bank must be established under s EW 32. None of subs (2B) to (5) of s EW 32 apply to the share subscription.
4. Under s EW 32(6), the Commissioner is required to determine the value of the property. Bank is required to use this amount.
5. A person who uses IFRS to prepare financial statements and to report for financial arrangements can use the IFRS financial reporting method in s EW 15D. Bank uses IFRS to prepare financial statements and to report for financial arrangements.
6. Under s EW 15I, because the financial arrangement includes in part an excepted financial arrangement, s EW 15C(1) does not apply and Bank must use one of the methods in s EW 15I(2) to allocate an amount of income or expenditure to an income year. One of the methods available under s EW 15I(2) is a determination made by the Commissioner.
7. Under s EW 6(2), an amount that is "solely attributable" to an excepted financial arrangement described in any of ss EW 5(2) to EW 5(16) is not an amount that is taken into account under the financial arrangements rules.

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.
• Bank means the bank issuing the Notes.
• Conversion has the meaning set out in the terms of the Notes, as described in private ruling BR Prv 16/53, issued on 18 October 2016.
• Deed Poll has the same meaning as described in private ruling BR Prv 16/53, issued on 18 October 2016.
• 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.
• Notes means the Notes issued to Parent pursuant to a Deed Poll.
• Parent means the parent company of Bank.

6. Method

1. The funding transaction does not involve the advancement or deferral of income or expenditure.
2. The IFRS financial reporting method in s EW 15D (as modified by s EW 15D(2)) must be used to allocate income and expenditure over the term of the Notes, provided none of the restrictions for application of the IFRS financial reporting method in s EW 15D(2B) apply to the Notes.
3. For the purposes of s EW 32(6), the value of the shares issued by Bank is equal to the amount Parent paid for those shares.
4. No amount of consideration paid or payable under the Notes or the share subscription is "solely attributable" to an excepted financial arrangement.

7. Example

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

Bank issues Notes having a face value of $100. Prior to the Notes being redeemed or converted, Bank will use the IFRS financial reporting method to allocate income and expenditure over the term of the Notes.

On a Conversion, Notes having an Issue Price of $100 are to be converted into ordinary shares in Bank.

Bank immediately pays an amount equal to the Issue Price of the Notes to Parent for termination of Parent's rights under the Notes. This amount is automatically applied on Parent’s behalf to subscribe for ordinary shares in Bank. Bank issues the number of shares to Parent calculated in accordance with the formula in the terms of the Notes. The value of the shares, for the purposes of s EW 32, is $100.

None of these amounts are solely attributable to an excepted financial arrangement.

This Determination is signed by me on the 18th day of October 2016.

Fiona Heiford

Manager, Taxpayer Rulings