Use of fair dividend rate method for a type of attributing interest in a foreign investment fund (ING Credit Opportunities Fund's interests in offshore credit opportunities funds)

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, Inland Revenue, under section 7 of the Tax Administration Act 1994.

Discussion (which does not form part of the determination)

The ING Credit Opportunities Fund ("INGNZ COF") invests in a number of offshore credit opportunities funds ("COFs"). INGNZ COF's portfolio of COF investments is fully hedged to the New Zealand dollar.

Shares/units in COFs, to which this determination applies, are attributing interests in a foreign investment fund ("FIF") for INGNZ COF. INGNZ COF is required to apply the FIF rules to determine its tax liability in respect of their investments in COFs each year.

COFs comprise interests in non-residents that hold assets of which 80% or more by value consist of financial arrangements that are hedged items having a value in New Zealand dollars governed by a hedging instrument that is highly effective. Therefore the fair dividend rate ("FDR") method under the FIF rules could not apply for the 2008-09 and subsequent income years to units/shares in COFs held by INGNZ COF, in the absence of a determination under section 91AAO of the Tax Administration Act 1994.

I consider that it is appropriate for INGNZ COF to use the FDR method in relation to COFs for the 2008-09 and subsequent income years. Although the assets of the COFs are entirely financial arrangements and the currency risk to INGNZ COF has been removed, I consider these investments (as described to me by the applicant) to be more akin to equity than debt. This is because they are designed to deliver above-average but volatile returns from trading on market opportunities. Much of the investment proposition is in the fund manager(s), rather than in the underlying debt assets themselves. It is therefore my view that, overall, INGNZ COF's investments are not akin to a New Zealand dollar-denominated financial arrangement.

Scope of determination

The following requirements need to be satisfied for this determination to apply for an income year to interests in COFs (not being fixed rate shares or non-participating redeemable shares) held by INGNZ COF:

• A COF must have a minimum "period turnover percentage" of 35% over the lesser of the following "measurement periods":
  
  
  1. a period of three accounting years of the COF ending on or before 28 February immediately before the start of the relevant income year; or
  2. a period from the commencement date of the COF, ending immediately on 28 February before the start of the relevant income year.
     
     (For clarification, "relevant income year" refers to INGNZ COF's income year beginning on 1 April and ending on 31 March.)
  
  The "period turnover percentage" is calculated as the average of the turnover percentages for each complete and incomplete accounting year of the COF in the relevant "measurement period":
  
  
  1. For each completed accounting year of the COF, the turnover percentage for that accounting year would be calculated as A / B x 100, where A is total sales plus total purchases in that year, divided by 2, and B is the average total market value of the COF's investment portfolio in the year; and
  2. For any incomplete accounting year of the COF, the turnover percentage would be calculated on an annualised basis as A / B x 100, where A is total annualised sales plus total annualised purchases for the relevant period, divided by 2, and B is the average total market value of the COF's investment portfolio in that period.

• INGNZ COF, in respect of an interest in a COF for which the requirements in (1) are met, will exercise no control or influence over the investment decisions of the relevant COF, including the "period turnover percentage" and the asset allocation decisions of the manager.

Interpretation

In this determination, unless the context otherwise requires -

"COFs" means non-New Zealand tax resident credit opportunities funds the units in which are held by the ING Credit Opportunities Fund (INGNZ COF). COFs 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;

"Fixed rate share" means a fixed rate share under section LF 2(3) of the Act;

"Non-participating redeemable share" means a non-participating redeemable share under section CD 14(9) of the Act;

"INGNZ COF" means the ING Credit Opportunities Fund, a New Zealand tax-resident unit trust that is a portfolio investment entity (as that term is defined in the Act). INGNZ COF holds units/shares in offshore credit opportunities funds (the subject of this determination);

"Measurement period" is defined in the Scope of determination;

"Period turnover percentage" is defined in the Scope of determination;

"Relevant income year" is defined in the Scope of determination;

"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 INGNZ COF may use the FDR method to calculate FIF income from the interest.

Application date

This determination applies for INGNZ COF's income years commencing on or after 1 April 2008.

Dated this 26th day of March 2008

David Carrigan
Policy Manager
Inland Revenue