Use of fair dividend rate method for a type of attributing interest in a foreign investment fund
FDR 2016/07 covers the use of fair dividend rate method for a type of attributing interest in a FIF (K2 Alternative Strategies NZ Portfolio).
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)
Class A shares in the K2 Alternative Strategies NZ Portfolio Limited (“K2”), to which this determination applies, are attributing interests in a foreign investment fund (“FIF”) for New Zealand resident investors.
New Zealand resident investors are required to apply the FIF rules to determine their tax liability in respect of their investment in shares in K2 each year.
K2 invests, directly and indirectly (via a broadly diversified portfolio of underlying hedge funds) in a mix of asset types, including cash, equities, debt securities and derivatives. Its investment objective provides exposure to equity, credit, currency and commodity markets. K2 enters into foreign currency hedging arrangements to provide investors with New Zealand dollar denominated exposure.
Section EX 46(10)(c) of the Income Tax Act 2007 (ITA) could potentially apply to prevent investors from using the fair dividend rate method in the absence of a determination under section 91AAO of the Act.
Notwithstanding that K2 may have assets predominantly comprising financial arrangements and the presence of any 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 K2.
Scope of determination
This determination applies to Class A share investments in K2 held by New Zealand resident investors.
K2 Alternative Strategies NZ Portfolio Limited:
- is a company incorporated under the laws of the Cayman Islands;
- issues Class A shares, which are denominated in New Zealand dollars;
- invests in underlying assets predominantly consisting of cash and cash equivalents, derivative instruments, equity and debt securities, which provide exposure to a range of equity, credit, currency and commodity markets.
The investment in the Class A shares are subject to foreign currency hedging arrangements undertaken by K2 for the purposes of mitigating exchange rate risk for New Zealand investors.
These currency hedging arrangements are targeted to be highly effective (80-125%).
The determination is subject to the following conditions:
- The investment in K2 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.
- In the event K2 directly holds equities offering a fixed rate of return or financial arrangements that provide funds to another person of an amount that is equal to or greater than 80% of K2’s net asset value (NAV), it is expected that the level of such financial arrangements will be restored within 45 days (to less than 80%). Failure to restore the investment to this level would result in this determination ceasing to apply from the first day of the following Quarter.
- K2 must be a foreign PIE equivalent in terms of section HM 3 of the ITA at all times. In the event that K2 ceases to meet the requirements set out in section HM 3 at the end of two consecutive quarters, this determination will cease to apply from the first day of the following quarter.
In this determination unless the context otherwise requires:
“Controlled foreign company” means controlled foreign company under section EX 1 of the Income Tax Act 2007;
“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;
“Foreign PIE equivalent” means foreign PIE equivalent as defined under section HM 3 of the Income Tax Act 2007;
“K2” means K2 Alternative Strategies NZ Portfolio Limited;
“PIE” means a portfolio investment entity as set out in subpart HM of the Income Tax Act 2007;
“The investor” means the person who has a share in K2.
This determination applies to an attributing interest in a FIF, being a direct income interest in K2. 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.
This determination applies for the 2017 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 K2 and who chooses that the determination applies for that income year.
Dated this 22nd day of December 2016.
Investigations Manager, Investigations and Advice