Amendments to the portfolio investment entity rules

2009 amendments to the portfolio investment entity (PIE) rules address identified technical problems or amend the rules to cater for different circumstances.

Sections CX 55, CX 56, DV 2, DV 4(B), DV 5, DV 7, HL 4(1), HL 4(2), HL 5B(1), HL 6, HL 7, HL 9, HL 10(2), HL 12(1), HL 13, HL 29(7), IC 3, LA 6(1), LE 1, LS 1, LS 2, OB 9B and YA 1 of the Income Tax Act 2007; sections HL 4(1), HL 4(2), HL 10(2), HL 11B(1), HL 12, HL 27(7), ME 4(1) and OB 1 of the Income Tax Act 2004; sections 31B(1), 57B(3B), 57B(6) and 61(1C) of the Tax Administration Act 1994

A number of remedial amendments have been made to the tax rules for portfolio investment entities (PIEs). These amendments ensure that the rules achieve their intended policy effect.

Background

New tax rules for collective investment vehicles that meet the definition of a "portfolio investment entity" (PIE) were enacted by the Taxation (Savings Investment and Miscellaneous Provisions) Act in December 2006.

The PIE rules were designed to alleviate a number of long-standing problems with the taxation of collective investment vehicles. The rules treat investment through PIEs largely in the same way as direct investment by individuals, thus removing long-standing disadvantages of saving through collective investment vehicles, such as superannuation funds being taxed at a rate higher than investors in those funds with a lower marginal tax rate. These reforms were particularly important given the implementation of KiwiSaver in 2007.

PIEs are not taxable on realised share gains made on investments in New Zealand and certain Australian companies. They pay tax on investment income for their individual investors at a rate of 19.5% or 30%, depending on the investor's income in the previous two years. Income earned through a PIE generally does not affect investors' entitlements to family assistance, their student loan repayments or child support obligations.

Key features

The amendments in this Act are of a remedial nature and address technical problems that have been identified with the rules or amend the rules to cater for different circumstances. The amendments are consistent with the policy intent of the tax rules for portfolio investment entities. 

The Act also rewrites the PIE rules to ensure they are consistent with the plain language drafting approach adopted more generally across other pats of the Income Tax Act. In particular, the entire subpart HL is rewritten as subpart HM.

Application dates

There are various application dates for the changes to the PIE rules. The amendments to the PIE rules in the Income Tax Act 2007 apply from 1 April 2008. The amendments to the PIE rules in the Income Tax Act 2004 are effective from 1 October 2007. The relevant amendments to the Tax Administration Act 1994 are effective from 1 October 2007. The changes to the rules related to the rewrite apply from 1 April 2010 to prevent them having any retrospective application.

Detailed analysis

Australasian share gains exclusion

Section CX 55 of the Income Tax Act 2007, which provides that proceeds from disposals of certain Australasian shares by PIEs are excluded income, has been amended to reinstate the previous Australian Stock Exchange listing and franking account requirements. These requirements were contained in the former section CX 55(1)(a)(ii) and (iii) and were inadvertently omitted when an amendment was made to this provision by the Taxation (Business Taxation and Remedial Matters) Act 2007.

Transfer of expenditure to portfolio investment entities (PIEs)

The PIE tax rules allow a superannuation fund or a unit trust (a member fund) that has not elected to be a PIE but that has invested in a PIE to transfer deductible expenditure to the PIE. A member fund may want to transfer expenditure to a PIE in this way as it may not have sufficient income against which to offset the expenditure. The member fund gains the tax benefit of the expenditure it transfers because the PIE offsets the transferred expenditure against the income that it earns for the member fund.

A number of remedial amendments to the expenditure transfer rules in subpart DV of the Income Tax Act 2007 have been made to ensure that they apply appropriately for PIEs that are portfolio tax rate entities.

Section DV 2(6) has been amended to ensure that the transferred expenditure is deductible to the portfolio tax rate entity in the income year the expenditure is transferred by the member fund.

Sections DV 2 and DV 5 of the Income Tax Act 2007 have been amended to provide that a portfolio tax rate entities deduction is limited to the member fund's share of the portfolio tax rate entities taxable income for the income year in which the expenditure is transferred (sections DV 2(8B) and DV 5(7B)).

Sections DV 4(B) and DV 7(1) provide that excess expenditure that cannot be transferred in a year can be carried forward by the member fund and transferred in a later income year.

Entity type eligibility requirement

Section HL 4(1)(a) of the Income Tax Act 2007 and Income Tax Act 2004 has been amended to provide that an entity ceases to be a PIE if the entity fails to meet the entity type requirements in section HL 2(2). For example, the key entity type requirement for a portfolio tax rate entity is that the entity must be a company, superannuation fund or a group investment fund.

Effect of failure to meet eligibility requirements

Section HL 4(2)(a) of the Income Tax Act 2007 and the Income Tax Act 2004, concerning breaches of certain eligibility requirements, has been restructured to clarify that some requirements are on a class basis while others are on an entity basis. An entity ceases to be eligible to be a PIE if a portfolio investor class of the entity fails to meet a requirement of section HL 6 (Investor membership requirement) or section HL 9 (Investor interest size requirement) within the prescribed timeframes. New section HL 4(2)(ab) on the other hand, provides that an entity ceases to be eligible to be a PIE if the entity fails to meet a requirement of section HL 10 (Requirements relating to PIE investments) within the prescribed timeframes.

Portfolio investor proxy

Section HL 5B(1)(d) of the Income Tax Act 2007 has been repealed so that, for an investment in a PIE held through a portfolio investor proxy (PIP), the ultimate investor rather than the PIP is treated as the investor. This is relevant when PIEs are considering whether the investor membership requirement in section HL 6 or the investor interest size requirement in section HL 9 have been satisfied.

Public unit trusts

Section HL 6 of the Income Tax Act 2007 has been amended so that it is clear that there is no investor membership requirement for a portfolio investor class if the class itself is a public unit trust (that satisfies paragraphs (a) and (c) to (e) of the definition) or an investor in the class is a public unit trust. Similar amendments have been made to the investor interest size requirement in section HL 9.

Investor interest adjustment

Portfolio tax rate entities must make an adjustment to reflect the effect of the portfolio investor rate of an investor, within certain time periods. An amendment has been made to section HL 7 of the Income Tax Act 2007 to allow the Commissioner to extend the time limit for which an adjustment must be made if it is reasonable in the circumstances. This is to ensure that the PIE status of an entity is not automatically lost when the investor return adjustment requirement is not satisfied within the required time period.

Application of fund withdrawal tax rules to superannuation funds that have elected to be portfolio tax rate entities

An amendment has been made to section HL 7 of the Income Tax Act 2007 to ensure that the income that a PIE (that no longer files an income tax return) derives under the fund withdrawal tax rules should be treated as income to which no investor has an entitlement. This change effectively results in the PIE accounting for the fund withdrawal tax along with its other PIE tax obligations.

Exemption for investor interest size

Section HL 9 of the Income Tax Act 2007 sets out the investor interest size requirement for PIEs. The general rule in section HL 9(1) is that an investor in a portfolio investor class of the PIE cannot hold more than 20% of the portfolio investor class. The list of exceptions to this requirement has been amended to add a portfolio investor class of fewer than 20 persons, provided certain criteria are met.

Exception for community trusts

Community trusts are established to manage public assets and, as such, are analogous to entities that have exemptions applying to them, such as the Earthquake Commission and Auckland Regional Holdings. An amendment has therefore been made to sections HL 6 and HL 9 of the Income Tax Act 2007 to add "community trusts" to the list of investors to which exemptions apply.

Land-owning companies

As well as holding shares and debt investments, PIEs can also directly own land because passive investments in land can be a major element of a diversified investment portfolio. However, weaknesses in the previous law allowed land-rich active businesses (for example, rest homes and airports) to use the ability of portfolio investment entities to own land directly to their advantage and restructure themselves as PIEs. This was contrary to the policy intent of the portfolio investment entity rules, which were designed to be used by widely held passive savings vehicles.

In particular, previously, the weakness in the law allowed a land-rich active business to be effectively split up into a land-owning company (the PIE), and an operating company, using a structure that ensured the operating company did not "taint" the land-owing company and prevent it from being a PIE. This could be done by:

  • stapling shares in the land-owing company to shares in the operating company; or
  • leasing the PIE's land and buildings to an associated operating company and ensuring the operating company does not represent a significant portion of the PIE's total investments.

The weaknesses have been addressed by amending the income type requirement in section HL 10(2)(b)(iii) of the Income Tax Act 2004 and the Income Tax Act 2007, which previously provided that income under a lease of land meet the income type requirement. The amendment provides that income under a lease of land derived by a PIE from an associated person (which includes a company whose shares are stapled to the shares in the PIE) does not count as qualifying income for the purposes of the income type eligibility requirement in section HL 10(2)(b)(iii).

Becoming a portfolio investment entity

Section HL 13 of the Income Tax Act 2007 and section HL 12 of the Income Tax Act 2004 contain rules dealing with consequences of an entity becoming a PIE. Section HL 13(1)(b) of the Income Tax Act 2007 and section HL 12(1)(b) of the Income Tax Act 2004 provide that an entity is considered never to have been a PIE if, within 12 months of the date of election to become a PIE, it fails to meet one or more of the eligibility criteria referred to in section HL 4.

These deeming provisions have been amended so they apply only if an entity fails to meet one or more of the eligibility requirements in section HL 6 (Investor membership requirement), HL 9 (Investor interest size requirement), or section HL 10.

Credits received by portfolio tax rate entities

The credit allocation rules for PIEs in section HL 29(7) of the Income Tax Act 2007 and section HL 27(7) of the Income Tax Act 2004 have been amended to ensure that an investor with a portfolio investor exit period (exiting investor) is not able to gain a double benefit for the allocated amount of credits.

An exiting investor in a quarterly portfolio tax rate entity should be treated as receiving a credit which has been allocated to the investor in the quarter in which the exit occurs. Previously, under the wording of these provisions, the exiting investor may have got the benefit of credits that were allocated in previous quarters twice - first by the portfolio tax rate entity reducing its portfolio entity tax liability, and secondly by the investor being able to use the allocated credit against other tax liabilities. Therefore a clarifying amendment has been made to section HL 29(7) of the Income Tax Act 2007 and section HL 27(7) of the Income Tax Act 2004 to ensure that the proper amount of credit is allocated to an exiting investor.

Consolidated tax group including portfolio tax rate entities

The policy intention of the grouping rules as they apply to portfolio tax rate entities is that the benefits of the wholly owned group rules apply when a portfolio tax rate entity parent owns 100% of the underlying companies and the underlying companies are portfolio tax rate entities or portfolio land companies. An amendment has been made to section IC 3 of the Income Tax Act 2007 to ensure this policy intent has been met.

Use of allocated imputation credits

A clarifying amendment has been made to section LE 1 of the Income Tax Act 2007 to ensure that persons are allowed a tax credit if imputation credits are allocated to them under section HL 29(7)(b). The relevant persons are zero-rated portfolio investors such as companies and trustees, and investors with portfolio investor exit periods. Section LE 1(1B) provides that an investor in a portfolio tax rate entity who is allocated an imputation credit under section HL 29(7)(b) has a tax credit for the tax year of an amount equal to the imputation credit.

The main imputation crediting provision in section LE 1(1) refers to a person whose assessable income for an income year includes an imputation credit. This inclusion is achieved by section CD 15, which provides that an amount of a dividend is increased by an imputation credit attached to the dividend. This provision, however, is not applicable to investors in portfolio tax rate entities who are allocated imputation credits under section HL 29(7)(b) separately from any dividend.

Section LE 1(4) has consequently been repealed.

Confirming refundability of certain tax credits for portfolio tax rate entities

A clarifying amendment has been made to ensure that tax credits under section LS 1 of the Income Tax Act 2007 are refundable to a portfolio tax rate entity (other than an entity that chooses to pay provisional tax). The relevant credits are credits (not being foreign tax credits) allocated to individual investors (other than investors with portfolio investor exit periods) under section HL 29 and credits arising under section HL 21(2).

The amendment confirming refundability of credits arising under section LS 1 involves including section LS 1 credits in the list of refundable credits in section LA 6(1). The section YA 1 definition of "refundable tax credit" has also been amended to include credits arising under section LS 1.

Imputation credit of ICA company passed on by portfolio tax rate entity

A change has been made to section ME 4(1) of the Income Tax Act 2004 to allow an imputation credit account (ICA) company an imputation credit for the amount of imputation credit allocated to it by a portfolio tax rate entity.

Recording allocated credits in company investor's imputation credit account

A new provision, section OB 9B, has been inserted in the Income Tax Act 2007 to ensure that a company investor in a portfolio tax rate entity can include imputation credits allocated to it under section HL 29(7)(b) in its imputation credit account. The imputation credit will be recorded in the company investor's imputation credit account on the date the credit is allocated by the portfolio tax rate entity to the investor.

Previously, section OB 9 allowed a company to include in its imputation credit account an imputation credit attached to a dividend derived by the company. This did not cater for a company investor in a portfolio tax rate entity which was allocated imputation credits under section HL 29(7)(b) separately from any distribution from the portfolio tax rate entity.

Selection of incorrect portfolio investor rate

An amendment has been made to the definition of "portfolio investor rate" in section YA 1 of the Income Tax Act 2007 to allow the Commissioner to override a rate incorrectly selected by an investor; the exercise of this discretion would result in the default portfolio investor rate of 30% applying.

Normally, the portfolio investor rate is the rate that an investor notifies to the portfolio tax rate entity as the investor's prescribed investor rate. The portfolio tax rate entity is entitled to rely on the rate notified to it by the investor. Under the amendment, the rate notified by the investor to the portfolio tax rate entity will continue to apply as the portfolio investor rate unless the Commissioner has notified the entity that the rate notified by the investor is to be disregarded, in which case the default rate of 30% under paragraph (a) of the portfolio investor rate definition applies.

Prescribed investor rates and trustees of charitable trusts

The definition of "prescribed investor rate" in section YA 1 of the Income Tax Act 2007 and section OB 1 of the Income Tax Act 2004 has been amended to prevent trustees of charitable trusts electing a 30% rate instead of being zero-rated portfolio investors. If charitable investors could elect a 30% rate they could access the benefit of refundable credits for portfolio investor allocated losses and excess imputation or other credits, something they could not get as zero-rated portfolio investors. This would be contrary to the policy intent of the portfolio investment entity rules.

Prescribed investor rate for trustees

An amendment has been made to section YA1 of the Income Tax Act 2007 to allow trustees to elect the 19.5% prescribed investor rate.

Section CX 56 has been amended so that portfolio investor allocated income allocated to a trustee that has had the 19.5% prescribed investor rate applied to that income, is not excluded income.

Section LS 2 has been amended to allow the trustee a tax credit for tax paid at the PIE level on the allocated income.

The changes will help trustees manage their provisional tax obligations.

Listed PIEs electing to be portfolio tax rate entities

To ensure there is consistency with the policy intent of the PIE rules, an amendment has been made to section YA 1 of the Income Tax Act 2007 that allows PIEs that are listed on a recognised exchange to elect to be portfolio tax rate entities.

Information provided by portfolio tax rate entities to investors

Section 31B(1) of the Tax Administration Act 1994, which contains the requirement for portfolio tax rate entities to provide information statements to zero-rated portfolio investors, has been repealed. This means that these investors are covered by the information statement rules in section 31B(3), which require portfolio tax rate entities to provide information statements to their investors by 30 June after the end of the tax year (or a later date if the entity has a late balance date). 

Previously, portfolio tax rate entities were required under section 31B(2B) to provide information statements to their zero-rated portfolio investors within one month of the end of the relevant period, which in practice was an insufficient period to comply with. Also, quarterly portfolio tax rate entities were required to issue a statement each quarter to zero-rated portfolio investors rather than on an annual basis.

Returns by portfolio tax rate entities

Section 57B(6)(c) of the Tax Administration Act 1994 has been amended to provide an additional month for portfolio tax rate entities that are ceasing to file their final return. This means that such entities have three months rather than the previous two months to provide their final return.

A cross-referencing correction to section 57B has been made in section 61(1C). The amended section 61(1C) requires a portfolio tax rate entity (not being an entity that chooses under section HL 23 to pay provisional tax) to disclose its interests in foreign companies or foreign investment funds by the due date for the entity's return under section 57B(7).

The provision in section 57B, containing the deadlines by when portfolio tax rate entities must perform their responsibilities for investors with portfolio investor exit periods, has been re-enacted as subsection (3B) - the provision previously had incorrectly been located within section 57B(7).

Minor drafting corrections

A number of amendments have been made to correct minor drafting and cross-referencing errors. These include:

  • Section HL 6(4)(a) and (b) of the Income Tax Act 2007 and the Income Tax Act 2004, relating to the investor membership requirement, have been amended to include a cross-reference to the paragraph that lists Auckland Regional Holdings.
  • Section HL 9(6)(a) and (b) of the Income Tax Act 2007 and the Income Tax Act 2004, relating to the investor interest size requirement, have been amended to include a cross-reference to the paragraph that lists Auckland Regional Holdings.
  • Section HL 12(1)(a) of the Income Tax Act 2007 and section HL 11B(1)(a) of the Income Tax Act 2004, relating to unlisted companies choosing to become portfolio listed companies, have been amended so that the reference to an unlisted company needing to have 100 shareholders has changed to an unlisted company needing to have at least 100 shareholders.