Investor return adjustment in section HL 7 can apply for an investor's interest in a portfolio investor class or their interest in a different class

Section HL 7 has been amended to allow a portfolio tax rate entity to perform an investor return adjustment to reflect the effect of the investor's portfolio investor rate as a member of a portfolio investor class.  Previously, the investor return adjustment had to be performed for the investor's interest in the entity as a whole.

It should be noted, however, that a portfolio tax rate entity still has the flexibility to perform the investor return adjustment to whatever portfolio investor interest of the investor that the entity considers is required.  This is because, under the amended section HL 7(3), the entity can adjust the investor's portfolio investor interest in the relevant class, or their interest in another class.  This means that a portfolio tax rate entity can adjust an investor's interest in any way it sees fit to reflect the tax paid.  This change, like the changes to section HL 20 and the tax credits provisions (described below), provides greater flexibility for portfolio tax rate entities.

Remedial changes to section HL 7(3) provide that the investor return adjustment must be made within two months of the end of the tax year, if the entity has made an election to pay tax under section HL 23.

The legislation allows the investor return adjustment to be made more frequently than within two months of the end of a calculation period or a tax year (depending on the type of portfolio tax rate entity).  Section HL 7(3) specifies the maximum timeframe for making the return adjustment.  It is not intended to preclude an entity making adjustments to investor interests earlier, if this is desired from a commercial perspective.

Allocation of portfolio investor allocated income to zero-rated portfolio investors aligned with investor's income year

Previously, investors in portfolio tax rate entities that are zero-rated portfolio investors with non-standard balance dates were treated as deriving portfolio investor allocated income (or loss) in an income year, if the relevant income allocation period fell within their income year.  Portfolio tax rate entities that pay tax under sections HL 21 and HL 23 must operate on a 31 March tax year basis.  This could have resulted in zero-rated portfolio investors having to return income for two tax years of the entity, in their income year.

For example, an investor with a 30 June balance date would have needed to include all portfolio investor allocated income derived between 1 July 2008 and 30 June 2009 in their 2008-09 tax return.  In contrast, the 2008-09 tax year for the portfolio tax rate entity would be from 1 April 2008 to 31 March 2009.  The investor would therefore need to include their share of the income in the entity's 2009-10 tax year as well (the three months from 1 April 2009 to 30 June 2009).  However, income information for the 2009-10 tax year would not be communicated to the investor until 30 June 2010 and would not separately identify the 1 April to 30 June income.

Sections CP 1 and HL 24 have been amended so that zero-rated portfolio investors with non-standard balance dates only derive in an income year an amount of portfolio investor allocated income from a portfolio tax rate entity that relates to the portfolio allocation periods in the entity's income year that end in the investor's income year.

Similarly, zero-rated portfolio investors with non-standard balance dates only have in an income year an amount of portfolio investor allocated loss, in relation to a portfolio tax rate entity that pays tax under section HL 21 or HL 23, that relates to the portfolio allocation periods in the entity's income year that end in the investor's income year.  No portfolio investor allocated loss arises in relation to a portfolio tax rate entity that pays tax under section HL 22.

Amendments have also been made to section HL 27 to ensure that the allocation of foreign and New Zealand tax credits matches the allocation of the income for
non-standard balance date zero-rated investors.

Under these changes, the investor in the example above would only be treated as deriving in their 2008-09 income year (the period 1 July 2008 to 30 June 2009) the portfolio investor allocated income or loss that relates to the portfolio tax rate entity's 2008-09 tax year (1 April 2008 to 30 March 2009).  Any portfolio investor allocated income relating to the period 1 April 2009 to 30 June 2009 would not be included in the investor's return of income for 2008-09, as this relates to the portfolio tax rate entity's 2009-10 tax year.  Similarly, only the investor's share of New Zealand and foreign tax credits that relate to the portfolio tax rate entity's 2008-09 tax year would be available as a credit in the investor's 2008-09 income year.

Foreign tax credits

Consistent with the changes to sections HL 20 and HL 7, section HL 27 has been amended so that tax credits (both foreign and New Zealand) are allocated to an investor as a member of a portfolio investor class, and are able to be used by a portfolio tax rate entity to reduce the investor's portfolio entity tax liability relating to the portfolio investor class.  In the case of foreign tax credits, depending on whether application of foreign tax credits is restricted to the tax liability of an investor as a member of a specific portfolio investor class or all portfolio investor classes the investor has an interest in, a different tax result may arise. 

A number of amendments have been made to add greater flexibility to the way a portfolio tax rate entity (particularly entities that pay tax under section HL 23) can use tax credits.  The provisions do not remove other options available under the portfolio investment entity
tax rules.

Foreign tax credits allocated to investors each day

Under section HL 27(3), foreign tax credits are allocated for each portfolio allocation period (for example, a day) to each investor as a member of a portfolio investor class.  The amount of foreign tax credit allocated is based on the investor's share (that is, the investor fraction) of the class's share of the foreign income which gives rise to the credit.

Foreign tax credits can only be used by a portfolio tax rate entity to reduce the portfolio entity tax liability of the investor to which they have been allocated.  Therefore, a portfolio tax rate entity must track foreign tax credits allocated to each investor in a tax year.  This is also necessary because an investor who exits a portfolio investor class during the tax year, but re-enters the class in a future period within the same year, should be able to get the benefit of any foreign tax credit not previously used.

The allocation of foreign tax credits to investors (which will occur daily in most cases), and the ability of a portfolio tax rate entity to use the credits to pay the portfolio entity tax liability for an investor, should be distinguished.  The ability for a portfolio tax rate entity to use foreign tax credits is given under section HL 27(10).  Similarly, if the investor is a zero-rated portfolio investor, section HL 27(7) governs the ability of the investor to use foreign tax credits to reduce the tax liability on their portfolio investor allocated income.  A number of changes have been made to these sections.  These are discussed in greater detail below.

Foreign tax credits can be used to reduce a portfolio entity tax liability for any portfolio investor class of the investor

Foreign tax credits allocated to an investor as a member of a portfolio investor class can be used by a portfolio tax rate entity as a credit against income tax payable by the entity for the investor as a member of that class.  Under the amendments to section HL 27(10), a portfolio tax rate entity can also use foreign tax credits that have been allocated to the investor as a member of one portfolio investor class, to reduce the portfolio entity tax liability of the investor for another portfolio investor class.

Therefore, amended section HL 27(10) gives flexibility to portfolio tax rate entities in the way that they make use of foreign tax credits allocated to investors.  If foreign tax credits can be used across different portfolio investor classes of the same investor, rather than just to reduce the portfolio entity tax liability of the class that gives rise to the credit, a different tax result will arise.  Example 2 illustrates.

If an entity chooses to use foreign tax credits allocated to an investor only against the portfolio entity tax liability of the portfolio investor class which gives rise to the credit, the total portfolio entity tax liability for Class A would be $0 (and no foreign tax credit would be able to be used).  For Class B, a liability of $25 with an available credit of only $10 would arise.  On the other hand, if the portfolio tax rate entity chooses to utilise the credits available to the investor as a member of both Class A and Class B to reduce the aggregate tax liability for the investor, the liability would be $25, with total available foreign tax credits of $15.  In this case, the investor would benefit from having an extra $5 of tax credit.

Example 2

The above result would be an absolute tax difference, rather than a tax timing difference, as any excess foreign tax credits are forfeited at the end of a tax year.  In other circumstances, a class approach to utilising foreign tax credits may be more beneficial - for example, where the overall entity result for the investor is a loss but they have foreign tax credits allocated to investment classes that are profitable. 

The amended legislation allows both approaches outlined above, to provide greater flexibility to portfolio tax rate entities.

New section HL 27(10B) outlines the amount of foreign tax credit that is available to be used in a portfolio calculation period to reduce an investor's portfolio entity tax liability as a member of the portfolio investor class that gives rise to the credit, or as a member of another portfolio investor class.

The amount of the credit is the lesser of available allocated foreign tax credits (excluding credits used in previous calculation periods) and the amount of the investor's portfolio entity tax liability (again, excluding credits used to meet tax liabilities in previous periods).

Foreign tax credits allowed to be carried back to reduce a portfolio entity tax liability of an investor in previous portfolio calculation periods

The amendments to section HL 27 ensure that foreign tax credits can be used for the benefit of an individual investor in a portfolio tax rate entity that pays tax under section HL 23, in a tax year, irrespective of the portfolio calculation period in which they arise.

Under the changes, a portfolio tax rate entity that pays tax under section HL 22 or HL 23 can use foreign tax credits to reduce an investor's portfolio entity tax liability in the portfolio calculation period in which the credit is allocated and earlier portfolio calculation periods in the same tax year.

This effectively allows foreign tax credits allocated to an investor to be carried back (as well as forward) to previous allocation periods in the tax year.  This provides a more consistent income year approach to the use of foreign tax credits by a portfolio tax rate entity, rather than use of the credits being limited to the day in which they arise and any future period.  Any foreign tax credits unable to be used at the end of the tax year would, as previously, be forfeited.  

A broadly similar approach applies to a portfolio tax rate entity that pays tax under section HL 21 - the main difference being that foreign tax credits can only be carried back within a portfolio calculation period.

Foreign tax credits allocated to zero-rated investors

Under the amended section HL 27(7), foreign tax credits that are allocated to investors in a portfolio tax rate entity that are themselves portfolio tax rate entities can be used by these investor entities without restriction.

This allows such investors to flow-through the allocated foreign tax credits to their investors each day.  Previously, all zero-rated investors in portfolio tax rate entities were restricted to the lesser of the allocated foreign tax credit or the entity's share of the portfolio investor allocated income multiplied by the entity's basic tax rate for the relevant tax year.  This is no longer the case for investors in portfolio tax rate entities that are themselves portfolio tax rate entities.

Section HL 27(8) has been amended to deal with foreign tax credits allocated to zero-rated investors that are not portfolio tax rate entities.  For these investors the maximum the investor can use in their income year is the lesser of the amount of the credit that is allocated or:

• for an investor with a portfolio investor exit period in a portfolio tax rate entity that pays tax under section HL 21, the amount calculated by multiplying the investor's portfolio investor rate by their portfolio investor allocated income for the exit period;
• for a zero-rated portfolio investor in a portfolio tax rate entity that pays tax under section HL 21 or HL 23, the amount calculated by multiplying the basic statutory rate of tax for the investor by their portfolio investor allocated income for the tax year.

As noted earlier, amendments have also been made to align the foreign tax credits allocated in a tax year of the portfolio tax rate entity to the income year of zero-rated investors with non-standard balance dates.