Use of fair dividend rate method for a type of attributing interest in a foreign investment fund (PIMCO Cayman Global Bond (NZD Hedged) 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, Inland Revenue under section 7 of the Tax Administration Act 1994.

Discussion (which does not form part of the determination)

Units in the non-resident issuer (PIMCO Cayman Global Bond (NZD Hedged) Fund) to which this determination applies held by New Zealand resident investors, including TOWER Asset Management International Bond Fund, are an attributing interest in a foreign investment fund.

New Zealand resident investors are required to apply the foreign investment fund rules to determine their tax liability in respect of their units in the non-resident issuer each year.

As the non-resident issuer invests solely in financial arrangements and due to the presence of hedging arrangements that would be highly effective in terms of hedging the underlying foreign currency financial arrangements, section EX 46(10)(c) of the Act would apply to units in the non-resident issuer to prevent the use of the fair dividend rate (FDR) method in the absence of a determination made under section 91AAO of the Tax Administration Act 1994.

Despite the non-resident issuer having assets which 80% or more by value consist of financial arrangements effectively hedged to New Zealand dollars, I consider that it is appropriate for a New Zealand resident investor in this arrangement to use the FDR method. I would normally have concerns about using the FDR method for such investments. However, I consider that an investment in an actively traded debt portfolio can be more akin to equity than debt. This can be the case, for example, if the portfolio is designed to deliver above-normal but volatile returns from trading on market opportunities. If the investment proposition to the New Zealand resident investor is sufficiently in the ability of the fund manager, rather than only in the underlying debt assets themselves, then from a policy perspective it is appropriate for the FDR method to be used for the investment.

Scope of determination

This determination applies to units held by New Zealand resident investors, including TOWER Asset Management International Bond Fund, a portfolio investment entity, in a non-resident issuer.

1. The non-resident issuer:
   1. is a unit trust that is established in the Cayman Islands as a series trust of PIMCO Cayman Trust;
   2. is known as the PIMCO Cayman Global Bond ( NZD-Hedged) Fund;
   3. issues New Zealand dollar denominated units (not being fixed rate shares, non-participating redeemable shares or guaranteed return shares) directly to the New Zealand investors;
   4. invests in a global bond portfolio using a trading strategy based on the benchmark index;
   5. actively manages the global bond portfolio;
   6. has a minimum turnover percentage target;
   7. seeks to hedge 95% to 105% of the value of the global bond portfolio to the New Zealand dollar;
   8. is managed against a global currency index and is permitted to have currency exposure to plus or minus 25% of the Fund's benchmark index on a per currency basis and is permitted to purchase currencies not represented in the index;
   9. has a target tracking error measured against the benchmark index.
   
   
2. TOWER Asset Management International Bond Fund will exercise no control or influence over the investment decisions of the non-resident issuer including the target minimum annual turnover percentage, asset allocation decisions and the target tracking error.

Interpretation

In this determination unless the context otherwise requires:

"Benchmark index" means the index that at the date of this determination is called the Lehman Brothers Global Aggregate Bond Index, or a replacement index with substantially the same features;

"PIMCO Cayman Trust" means a unit trust established in Cayman Islands pursuant to a declaration of trust;

"Series trust" means a separate and distinct unit trust established in the Cayman Islands as a series trust of PIMCO Cayman Trust;

"Fixed rate share" means a fixed rate share under section LL 9 of the Act;

"Non-participating redeemable share" means a non-participating share under section CD 22 of the Act;

"Guaranteed return share" means a share involving an obligation under section EX 46(10)(d) of the Act;

"The Act" means the Income Tax Act 2007;

"Minimum turnover percentage target" means the target percentage agreed with and disclosed before this determination is made to the Policy Manager, Inland Revenue who makes this determination;

"Target tracking error" means the target percentage agreed with and disclosed before this determination is made to the Policy Manager, Inland Revenue who makes this determination.

Determination

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

Application Date

This determination applies for the 2008-2009 and subsequent income years.

Dated at Wellington this 16^th day of September 2008.

David Carrigan
Policy Manager
Inland Revenue Department