Use of fair dividend rate method for a type of attributing interest in a foreign investment fund

Reference

This determination is made under section 91AAO(1)(a) of the Tax Administration Act 1994 (the Act). This power has been delegated by the Commissioner of Inland Revenue to the position of Investigations Manager, Investigations and Advice, under section 7 of the Act.

Discussion (which does not form part of the determination)

Shares in the Kynikos Global Capital Partners Limited (the "Kynikos Fund") to which this determination applies, are attributing interests in a foreign investment fund ("FIF") for New Zealand resident investors.

The Kynikos Fund's investment objective is capital appreciation derived from a managed portfolio. The Fund will have the ability to trade in any market or any security in which it thinks it can trade profitably, including but not restricted to equities, preferred equities, debt, distressed debt, swaps, put options, call options, multiple option strategies, stock index futures, single stock futures and private placements.

The investments held by Kynikos Fund are predominantly financial arrangements. In addition, some resident investors may hedge their attributing interests in the Kynikos Fund back to New Zealand dollars. Therefore, section EX 46(10)(cb) of the Income Tax Act 2007 (ITA) could apply to prevent investors from using the fair dividend rate method in the absence of a determination under section 91AAO of the Act.

Despite the Kynikos Fund having assets predominantly comprising financial arrangements and the presence of the hedging arrangements, the overall arrangement contains sufficient risk so that it is not akin to a New Zealand dollar-denominated debt instrument. Accordingly, I consider it is appropriate for resident investors to use the fair dividend rate method to calculate FIF income from their attributing interest in the Kynikos Fund.

Scope of determination

This determination applies to Class B and Class C share investments in the Kynikos Fund held by New Zealand resident investors.

The Kynikos Fund:

• is organised under the laws of the Cayman Islands as a limited liability company
• is an open-ended investment company
• invests primarily in equity derivatives through its prime brokers.

The determination is subject to the following conditions:

1. The investment in Kynikos Fund is not part of an overall arrangement that seeks to provide investors a return that is equivalent to an effective New Zealand dollar denominated interest exposure.
2. As it is an actively managed fund, the Kynikos Fund may temporarily close out its derivative investments. This may result in the Kynikos Fund having a notional derivative position of less than 20% of its net assets value (NAV).
   
   Should this reduction in the value of derivative exposure occur, it is expected that the level of NAV of at least 20% would be restored within 45 days. Failure to restore the investment to this level would result in this determination ceasing to apply from the first day of the following Quarter.
3. If the Kynikos Fund ceases to trade continuously in derivative instruments or there is a reduction of investment holdings in favour of an investment that provides a New Zealand-resident investor with a return akin to a New Zealand dollar denominated debt investment, then this determination will cease to apply from the first day of the following Quarter unless corrective action is undertaken within a continuous period of 45 days.

Interpretation

In this determination unless the context otherwise requires:

"Kynikos Fund" means the Kynikos Global Capital Partners Limited;

"Fair dividend rate method" means fair dividend rate method under section YA 1 of the Income Tax Act 2007;

"Financial arrangement" means financial arrangement under section EW 3 of the Income Tax Act 2007;

"Foreign investment fund" means foreign investment fund under section YA 1 of the Income Tax Act 2007;

"The investor" means the person who has a share in the Kynikos Fund.

Determination

This determination applies to an attributing interest in a FIF, being a direct income interest in the Kynikos Fund. This is a type of attributing interest for which the investor may use the fair dividend rate method to calculate FIF income from the interest.

Application Date

This determination applies for the 2016 and subsequent income years.

However, under section 91AAO(3B) of the Act, this determination also applies for an income year beginning before the date of this determination for a person who invests in the Kynikos Fund and who chooses that the determination applies for that income year.

Dated, this 19th day of September 2016.

John Trezise
Investigations Manager, Investigations and Advice
Inland Revenue