Technical amendments to the portfolio investment entitiy rules

2007 remedial changes to the new portfolio investment entity (PIE) rules.

Sections CB 4B, CX 44C, CX 44D, DB 43B(2)(a), EG 3, EX 1(1B), HL 2, HL 3, HL 4(2), HL 5B, HL 5C, HL 6, HL 7(3), HL 9, HL 10, HL 11, HL 11b(1)(a), HL 12, HL 13, HL 16(2)(e), HL 20, HL 21, HL 23, HL 24, HL 25, HL 27, HL 31(3)(d), IG 1(2B), KD 1(1)(e)(viii), ME9(4) and OB 1 of the Income Tax Act 2004; sections CB 26, CX 55, CX 56, DB 53, HL 2, HL 3, HL 4(2(a), HL 5B, HL 5C, HL 6, HL 7(3), HL 8, HL 9, HL 10, HL 11, HL 12, HL 13, HL 14, HL 17(2), HL 21, HL 22, HL 24, HL 25, HL 26, HL 27, HL 29, HL 33(3)(d), IC 3, MB 1(5), OB 66(2) and YA 1 of the Income Tax Act 2007; sections 28B, 31B, 33, 38(1B), 57B and 61 of the Tax Administration Act 1994

A number of remedial changes have been made to the new portfolio investment entity (PIE) rules.

Background

New tax rules for collective investment vehicles that meet the definition of a "portfolio investment entity" were enacted by the Taxation (Savings Investment and Miscellaneous Provisions) Act in December 2006. The rules apply from 1 October 2007.

Portfolio investment entities are not taxable on realised share gains made on New Zealand and certain Australian companies. Portfolio investment entities pay tax on investment income based on the tax rates of their investors (capped at 30% from 1 April 2008). Income earned via a portfolio investment entity generally does not affect investors' entitlements to family assistance, their student loan repayments or child support obligations.

A number of technical issues with the operation of the new rules were identified as they were implemented. Remedial amendments to the rules were made in the Taxation (Annual Rates, Business Taxation, KiwiSaver, and Remedial Matters) Bill in 2007, during the select committee and committee of the whole House stages.

Application dates

Most remedial changes contained in the Income Tax Act 2004 are effective from 1 October 2007. The effect of the new rules combined with the transitional provisions contained in the Income Tax Act 2007 ensure that the portfolio investor rate will be 30% from the 2008-09 income year, to be consistent with the reduction in the company tax rate.

The remedial changes contained in the Income Tax Act 2007 are effective from the 2008-09 income year.

Detailed analysis

Re-organisation of sections HL 2 and HL 3

Sections HL 2 and HL 3 of the Income Tax Act 2004 and the Income Tax Act 2007 have been replaced. These new provisions are intended to convey more clearly the overall structure and scheme of the portfolio investment entity tax rules.

Investor requirements

Investor requirements for superannuation schemes that are declining in size

Under the previous rules, problems could arise when superannuation funds that were established before introduction of the portfolio investment entity rules decreased in size. Because the number of investors in the fund can fall, the fund can fall below the investor requirements in sections HL 6 and 9 of the Income Tax Act 2004 and Income Tax Act 2007. This was a particular problem for existing superannuation funds because their trust deeds may not have sufficient flexibility to reorganise the membership of their funds so that this does not happen.

Superannuation funds that were in existence before the introduction of the Taxation (Savings Investment and Miscellaneous Provisions) Bill 2006 on 17 May 2006 are therefore not required to meet the investor test, provided that no investor (other than the fund's manager or trustee) can control the investment decisions relating to any of the entity's funds. This applies only to superannuation funds that, if they were unit trusts, meet or would have once met paragraphs (a) and (c) to (e) of the definition of "qualifying unit trust".

Qualifying unit trust safe harbour applies to portfolio investor class

To qualify as a portfolio investment entity, an entity must generally meet the investor membership requirement in section HL 6 of the Income Tax Act 2004 and Income Tax Act 2007 and the investor interest size requirement in section HL 9 of the Income Tax Act 2004 and Income Tax Act 2007. There are exemptions to these requirements if the entity, if it were a unit trust, would meet the requirements of one or more of paragraphs (a) and (c) to (e) of the "qualifying unit trust"definition. These exemptions are designed to provide widely held savings vehicles with more certainty that they will meet the portfolio investment entity eligibility requirements. These exemptions previously applied if the entity could satisfy the qualifying unit trust definition. The problem with this was that it could result in a portfolio investor class of a qualifying entity gaining portfolio investment entity status even though that particular class is not widely held. This is inconsistent with the policy intent of the rules. Therefore, these exemptions have been amended so that each "portfolio investor class", rather than the entity itself, is required to meet paragraphs (a) and (c) to (e) of the definition of "qualifying unit trust"(if the entity were a unit trust).

Investors can benefit differently from proceeds of a portfolio investment if difference only due to different tax rates

For a group of investors to constitute a single "portfolio investor class"each investor must participate equally (in proportion to their percentage holding in the fund) in the underlying investments of the fund. An issue arises where the portfolio investment entity holds financial arrangements that provide investors with capital guarantees. Typically, under these arrangements if investors suffer a capital loss over the investment term the portfolio investment entity exercises the capital guarantee and receives a taxable amount that, after application of investors' portfolio investor rates, is sufficient to compensate each investor for their capital loss.

As investors can have different portfolio investor rates there is an argument that this results in investors potentially having different interests in a portfolio entity investment (the capital guarantee being the portfolio entity investment). In many cases, the financial arrangement that provides the capital guarantee would not be a portfolio entity investment as the arrangement would not generally be entered into with the prospect of deriving a positive return. People who invest in a portfolio investment entity that holds such a capital guarantee should not be prevented from being part of the same portfolio investor class merely because they have different portfolio investor rates.

The definition of "portfolio investor class"in section HL 5B of the Income Tax Act 2004 and Income Tax Act 2007 has therefore been clarified so that investors can benefit differently from the proceeds of a portfolio entity investment in the case of a capital guaranteed investment if that difference results only from the application of different portfolio investor rates over the term of the investment.

Exception to investor membership requirement if Auckland Regional Holdings is an investor

The investor membership requirement in section HL 6(1) of the Income Tax Act 2004 and Income Tax Act 2007 has been amended to allow a portfolio investor class to qualify if it has fewer than 20 investors if one of the investors is "Auckland Regional Holdings". The reason for providing this exception is that current exceptions apply for similar government-owned entities, such as the Accident Compensation Corporation, the New Zealand Superannuation Fund and Earthquake Commission.

Exception to investor interest size requirement if Auckland Regional Holdings is an investor

The investor interest size requirement in section HL 9(4) of the Income Tax Act 2004 and Income Tax Act 2007 has been amended to allow Auckland Regional Holdings to hold an interest in a portfolio investment entity that would otherwise cause the portfolio investment entity to breach the investor interest size requirement. The reason for providing this exception is that current exceptions apply for similar government-owned entities, such as the Accident Compensation Corporation, the New Zealand Superannuation Fund and Earthquake Commission.

Investment type requirements

Investment type requirements include land not currently in use

Section HL 10(1) of the Income Tax Act 2004 and Income Tax Act 2007 requires that an entity must use or have available to use 90 percent or more by value of the entity's assets in deriving income from owning an interest in land. This section has been amended to ensure that the provision covers land that is not currently in use, but will be in the future. An example of this is when land is vacant or when property is under construction. This has been done by removing the current income derivation wording. Therefore, the investment type requirement is that 90 percent or more by value of the entity's assets must be qualifying assets.

Operating expenses for land

The following amendments have been made:

  • section HL 10(2) of the Income Tax Act 2004 and the Income Tax Act 2007 has been amended to include replacement payments;
  • section HL 10(2)(b)(iii) of the Income Tax Act 2004 and Income Tax Act 2007 has been amended to include payments from lessees that relate to their interest in land, such as operating expenses; and
  • section HL 10(2)(iv) of the Income Tax Act 2004 and Income Tax Act 2007 has been amended so that it is clear that the provision only captures proceeds from the disposal of property referred to in section HL 10(1).

Investments in other portfolio investment entities not taken into account for the entity shareholding investment requirement

Section HL 10(4) of the Income Tax Act 2004 and Income Tax Act 2007 has been amended so that it is clear that investments in PIEs and certain other collective investment vehicles are not considered when applying the shareholding investment requirements in sectionHL10(3).

Portfolio listed companies

Qualifying unit trust requirement removed for portfolio listed companies

Previously, under section HL 11B of the Income Tax Act 2004 and section HL 12 of the Income Tax Act 2007, an unlisted company must have met the requirements of paragraph (a) of the definition of "qualifying unit trust"in order to be treated as a portfolio listed company. This requirement has been replaced with a requirement in section HL 11B of the 2004 Act and section HL 12 of

the Income Tax Act 2007 that the company has at least 100 shareholders, as this ensures that the company is widely held.

Taxation of trustee income

The policy underlying the portfolio investment entity rules is that the maximum tax rate on any investor in a portfolio investment entity should be 30% from 1 April 2008. Previously section CX 44D(3)(b) of the Income Tax Act 2004 could result in a trustee investor in a portfolio listed company being taxed at 33% on their imputed income from the portfolio listed company. As this treatment is not consistent with the policy intent, the law has been changed so that New Zealand-resident trustee investors in portfolio listed companies are treated the same as individual New Zealand-resident investors in respect of imputed income from portfolio listed companies and are taxed at 30% from 1 April 2008.

Portfolio land companies should be subject to the income type requirement

Portfolio investment entities can own and lease land and buildings to active businesses as long as they are not themselves active businesses. Examples of non-active businesses include listed property trusts that own commercial property.

The income type requirement in section HL 10(2) of the Income Tax Act 2004 and the Income Tax Act 2007 provides that the majority of the entity's income must be passive income, such as dividends, interest and rent.

Currently, this requirement does not apply to a portfolio land company, which is a subsidiary of a portfolio investment entity. This is contrary to the policy intent of the rules. The definition of "portfolio land company"in section OB 1 of the Income Tax Act 2004 and section YA1 of the Income Tax Act 2007 has therefore been amended to ensure that it must meet the requirement in section HL10(2).

Superannuation funds: transfer of unvested contributions if vesting schedule is longer than five years

Section HL 16(2) of the Income Tax Act 2004 and section HL 17(2) of the Income Tax Act 2007 have been amended to cater for superannuation schemes that existed on or before 17 May 2006, and where investors' interests have been transferred to a new scheme that came into being after 17 May 2006. Under the amended rules, the new superannuation fund can apply a member's prescribed investor rate to unvested employer contributions regardless of the length of the vesting period. The transfer must be from a superannuation scheme that existed before 17 May 2006 to a new superannuation scheme, and there must be no change in substance to the benefits a member will receive from unvested contributions. If these conditions are met, the income from unvested employer contributions will continue to be taxed as if the transfer had not occurred. This means that income relating to the unvested contributions will continue to be taxed at the portfolio investor's rate.

Changing December due date to 15 January

Section HL 23 of the Income Tax Act 2004 and section HL 24 of the Income Tax Act 2007 have been amended so that any due date for a return or payment which falls on 31 December is changed to the following 15 January.

Tax calculation

Zero-rated investor deduction should refer to the portfolio tax rate entity's tax year

Section DB 43B(2) of the Income Tax Act 2004 and section DB 53 of the Income Tax Act 2007 provides that zero-rated and certain exiting investors in portfolio investment entities are generally allowed a tax deduction for losses that flow through to them from those portfolio investment entities. Currently, the provision requires investors in "quarterly zero"portfolio tax rate entities (portfolio tax rate entities that pay tax under section HL21 of the Income Tax Act 2004 and section HL 22 of the Income Tax Act 2007) to recognise such losses in the investor's income year that includes the end of the portfolio investment entity's portfolio calculation period (usually a quarter). To maintain consistency with other similar provisions in the rules, section DB 43B of the Income Tax Act 2004 and section DB 53 of the Income Tax Act 2007 have been amended to provide that the investor has a deduction for the amount of portfolio investor allocated loss in the investor's income year that includes the end of the portfolio investment entity's income year.

Definition of "portfolio investor rate"

The definition of "portfolio investor rate"in section OB 1 of the Income Tax Act 2004 and section YA 1 of the Income Tax Act 2007 has been amended so that the portfolio investor rate applies to a portfolio allocation period rather than a portfolio calculation period. This will also clarify that if an investor notifies a correction to their portfolio investor rate at any time during the year, the new portfolio investor rate will apply to any amount for which the tax liability has not already been calculated.

Paragraph (b)(ii) has been amended so that the "portfolio investor rate"is the rate that the investor notifies the entity as their prescribed investor rate, and that notification is the latest notification. The "portfolio investor rate"for the investor is the latest notified prescribed investor rate at the time the entity calculates the portfolio entity tax liability for the investor and their income, or calculates a payment under section HL23B of the Income Tax Act 2004 or section HL 25(1) of the Income Tax Act 2007 that they intend to be a final payment of the portfolio entity tax liability.

Option to not use excess foreign tax credits from one portfolio investor class to offset tax from other portfolio investor classes

The intention of the rules is that portfolio tax rate entities and portfolio investor proxies should be allowed, but not required, to use excess foreign tax credits received for an investor from one portfolio investor class against the tax liability of that investor from other portfolio investor classes. This flexible approach is appropriate as the sophistication of systems will vary across providers. It was not clear whether section HL 27 of the Income Tax Act 2004 or section HL 29 of the Income Tax Act 2007 provides portfolio tax rate entities and portfolio investor proxies with the option of not using excess foreign tax credits from one portfolio investor class to offset tax from other portfolio investor classes. Section HL27(10B)(b)(ii) of the Income Tax Act 2004 and section HL 29(11)(b)(ii) of the Income Tax Act 2007 have been clarified to provide this flexibility.

Foreign tax credits

It is common for people to hold a portfolio of investments via a custodian. These are often referred to as "wrap accounts"and provide investors with the same benefits of direct ownership of the underlying investments. In addition, the custodian will often provide a range of investment services including, in some cases, the deduction of resident withholding tax (RWT) on dividends and interest.

The portfolio of investments that the custodian holds for the investor is likely to include interests in managed funds. The portfolio investment entity rules have been designed so that a custodian (referred to in the legislation as a "portfolio investor proxy") can calculate tax on behalf of its investors when someone invests through a custodian into an underlying portfolio investment entity. This is consistent with the current tax treatment for wrap accounts, because the custodian is likely to be deducting RWT for the investor on the investor's non-portfolio investment entity investments.

The rules achieve this treatment by the portfolio investment entity applying a zero percent tax rate to the portfolio investment entity income earned on behalf of the portfolio investor proxy, with the portfolio investment entity income flowing through to the portfolio investor proxy. The portfolio investor proxy is then required to calculate and deduct tax on that income as if the portfolio investor proxy were a portfolio investment entity. Broadly, this means that the portfolio investor proxy can treat the person's separate investments in underlying portfolio investment entities as if they were a single investment in an underlying portfolio investment entity. The person's separate investments in underlying portfolio investment entities, from the perspective of the portfolio investor proxy, are treated as separate portfolio investor classes in the same portfolio investment entity. This approach allows the rules relating to investor exit, use of tax credits and losses to work appropriately.

The problem with the rules as originally enacted was that a portfolio investor proxy's foreign tax credits were restricted to the lesser of the allocated credits or the maximum tax liability on the allocated income. The tax credit rules in section HL 27 of the Income Tax Act 2004 and section HL 29 of the Income Tax Act 2007 have therefore been amended so that portfolio investor proxies can use the full amount of foreign tax credits received from portfolio investment entity investments to offset tax on portfolio investment entity income. This aligns the foreign tax credit rules that apply to portfolio investor proxies investing in portfolio investment entities with those applying to portfolio tax rate entities that invest in other portfolio investment entities.

Portfolio investor proxies can satisfy PIE tax on behalf of investors by directly accessing cash accounts

Under the rules, portfolio tax rate entities will generally pay tax on behalf of investors by reducing investors' interests in the portfolio investment entity. In contrast, some portfolio investor proxies have been structured to pay portfolio investment entity tax on behalf of investors by directly accessing the cash accounts that investors hold with the portfolio investor proxy. There is no policy reason why a portfolio investor proxy should not be able to satisfy portfolio investment entity tax on behalf of its investors in this way, and section HL 7 of the Income Tax Act 2004 and the Income Tax Act 2007, and section HL 31 of the Income Tax Act 2004 and HL 33 of the Income Tax Act 2007 have been amended to explicitly provide for this option.

Portfolio investor rate that is lower than the prescribed investor rate

Previously, section CX 44D of the Income Tax Act 2004 and section CX 56 of the Income Tax Act 2007 could be interpreted so that the portfolio investor allocated income of an investor for the year was not excluded income if the investor had provided the portfolio investment entity at the start of the year with a portfolio investor rate that was lower than their prescribed investor rate. This could result in portfolio investor allocated income being taxed to investors even if the investor had provided their correct rate before the portfolio investment entity performed a final tax calculation for the investor. Therefore, section CX 44D of the Income Tax Act 2004 and section CX 56 of the Income Tax Act 2007 have been amended so that portfolio investor allocated income remains excluded income for a year and the portfolio investment entity applies the investor's correct rate when performing a final tax calculation or a calculation under section HL23B of the Income Tax Act 2004 or section HL 25 of the Income Tax Act 2007 that the entity intends to be final. This ensures that portfolio investor allocated income will continue to be excluded income to the investor if the investor provides to the portfolio investment entity a portfolio investor rate that is lower than their prescribed investor rate and the portfolio investment entity has not subjected that income to a final tax calculation.

Timing of receipt of tax credits

Section HL 27(6) of the Income Tax Act 2004 and section HL 29(6) of the Income Tax Act 2007 have been amended to ensure that credits for both zero-rated investors and exiting investors are treated as being received in the investor's income year that includes the end of the portfolio investment entity's income year. This ensures that the same timing rules apply to receipt of credits for both zero-rated investors and exiting investors.

Allocation of credits by portfolio tax rate entities

Section EG 3 of the Income Tax Act 2004 and Income Tax Act 2007 allows portfolio investment entities to recognise amounts for tax purposes at the same time they recognise those amounts for unit pricing and financial reporting purposes. The section has been clarified so that it allocates tax credits to the same period as the income to which the credits relate.

Investor expenditure

Section HL 20 of the Income Tax Act 2004 and section HL 21 of the Income Tax Act 2007 have been amended to ensure that expenditure transferred from an investor under subpart DV is deductible as investor expenditure under section HL 20 of the Income Tax Act 2004 or section HL 21 of the Income Tax Act 2007. This allows a non-portfolio investment entity superannuation fund that invests in a portfolio tax rate entity to gain the benefit of a deduction for the expenditure at the portfolio tax rate entity level.

Exiting investors

Accommodation of partial withdrawals and switches within the same portfolio investment entity

Section HL 23B of the Income Tax Act 2004 and section HL 25 of the Income Tax Act 2007 now accommodate partial withdrawals and switches between investor classes within the same portfolio investment entity. The previous wording of section HL 23B of the Income Tax Act 2004 and section HL 25 of the Income Tax Act 2007 could be interpreted as only applying when an investor reduces their total interest in the portfolio investment entity. The provision has therefore been amended so that it is clear that it applies when an investor switches their investment from one class in the portfolio investment entity to another class in the same portfolio investment entity.

Exiting investors do not have to return excess tax credits

Section HL 27(9) of the Income Tax Act 2004 and section HL 29(9) of the Income Tax Act 2007 have been repealed to ensure that exiting investors do not have to return excess tax credits.

Under the previous section HL 27(9) of the Income Tax Act 2004 and section HL 29(9) of the Income Tax Act 2007, investors in portfolio tax rate entities needed to return any excess New Zealand tax credits in their tax return if they exceeded the investor's share of the portfolio entity tax liability for the portfolio investor exit period. This was contrary to the policy intention that investors in portfolio tax rate entities should have no further tax obligations if they fully exit a fund, and any excess tax credits should be rebated to the entity.

Grouping rules

Portfolio investment entities can be part of a group

Section IG 1 of the Income Tax Act 2004 and section IC3 of the Income Tax Act 2007 have been amended so that the grouping provisions can apply to a group of companies if the only entities in the group are portfolio tax rate entities and portfolio land companies. The grouping rules can apply only when a portfolio tax rate entity parent owns 100 percent of the voting interests in the portfolio tax rate entities and portfolio land companies.

Portfolio investment entities can be part of a group for GST purposes

Section 55 of the Goods and Services Tax Act has been amended to allow portfolio investment entities to be part of a group for GST purposes. Portfolio investment entities can be part of a group for GST purposes if they would have been eligible to be a group for income tax purposes (in the absence of the prohibition on portfolio tax rate entities being part of a group under section IG 1 of the Income Tax Act 2004).

Portfolio investment entity income does not affect family tax credits for exiting investors

Section KD 1 of the Income Tax Act 2004 and section MB 1(5) of the Income Tax Act 2007 have been amended to ensure that portfolio investment entity income will not affect family tax credits for exiting investors who are required to file tax returns for their portfolio investment entity income. This reflects the policy that portfolio investment entity income should not affect family tax credits.

Cancellation of shares

Section HL 7 of the Income Tax Act 2004 and the Income Tax Act 2007 has been amended so that a fund can cancel units at any time up to the end of the relevant period. The current references to "period"in section HL 7(3)(a) have also been made consistent.

Exclusion of Australasian share gains

Anti-avoidance rule

The Act has introduced new section CX 44C(1)(c) to the Income Tax Act 2004 and section CX 55(1C) to the Income Tax Act 2007, which provide that the Australasian share gains exclusion does not apply when the gain on the share was guaranteed. This anti-avoidance rule was originally contained in proposed section CX 44C(d) in clause 12 of the Taxation (Annual Rates, Savings Investment, and Miscellaneous Provisions) Bill 2006 as introduced. It was intended that this provision be amended to focus on the time of acquisition of the relevant share, but this provision was inadvertently omitted at the Finance and Expenditure Committee stage of the bill. Accordingly, the provision has been reinstated.

Disposal of certain shares by a portfolio investment entity after declaration of a dividend

Section CB 4B of the Income Tax Act 2004 and section CB 24 of the Income Tax Act 2007 provide that when a share is sold between the date a dividend is declared and the date it is paid, an amount representing the unimputed dividend must be included in the portfolio investment entity income calculation. The section has been amended so this applies on a net basis.

New Zealand Superannuation Fund subject to dividend stripping rule

Under section CX 44C of the Income Tax Act 2004 and section CX 55 of the Income Tax Act 2007, the New Zealand Superannuation Fund (NZSF) has been provided with the exclusion from tax on gains from the disposal of New Zealand and certain Australian shares. This is the same exclusion that portfolio investment entities benefit from. Section CB 4B of the Income Tax Act 2004 and section CB 24 of the Income Tax Act 2007 have therefore been amended so that the dividend stripping rule applies to the NZSF, in the same way that it applies to portfolio investment entities.

Filing and information requirements

Resident investors should be required to advise the portfolio tax rate entity of a tax file number

Section 28B of the Tax Administration Act 1994 has been amended to require that all New Zealand-resident investors investing in a portfolio tax rate entity provide their tax file number to the entity.

This amendment applies from 1 April 2008.

Timeframe for providing information to zero-rated portfolio investors

Section 31B of the Tax Administration Act 1994 has been amended to specify a timeframe for providing information to zero-rated portfolio investors. A portfolio tax rate entity must now give notice before the end of the one-month period beginning after the period to which the notice relates

Provision of information - "annual provisional tax"portfolio investment entities with non-standard balance dates

Section 31B of the Tax Administration Act 1994 has been amended so that it caters for "annual provisional tax"portfolio tax rate entities (portfolio investment entities that pay tax under section HL 22 of the Income Tax Act 2004 and section HL 23 of the Income Tax Act 2007) with non-standard balance dates.

Returns by portfolio tax rate entities and section HL 23B payments

Section 57B of the Tax Administration Act 1994 has been amended to require that optional payments of tax made by portfolio tax rate entities under section HL 23B of the Income Tax Act 2004 or section HL 25 of the Income Tax Act 2007 are made with a tax return.

Changing December due date to 15 January

Section 57B(3)(a)(ii) has been amended and new section 57B(3B) introduced so that any due date for a return or payment which falls on 31 December should be changed to the following 15 January. This applies to returns or payments made by an "annual exitor" portfolio tax rate entity (portfolio investment entities that pay tax under section HL 23 of the Income Tax Act 2004 and section HL24 the Income Tax Act 2007).

This is consistent with a number of provisions in the Inland Revenue Acts that provide that if the due date for a return or payment falls on 31 December, that due date is changed to the following 15 January.

Assessments for "quarterly zero"and "annual exitor"portfolio tax rate entities

New section 33(1C) of the Tax Administration Act 1994 provides for an assessment for "quarterly zero"and "annual exitor" portfolio tax rate entities which have provided the tax returns required under section 57B.

Section 57B (7) has been inserted to require quarterly zero and annual exitor portfolio tax rate entities that make optional payments in terms of section HL 23B to file a tax return if one was not already being filed for the period.

Transitional issues

Imputation credits earned before entity was a portfolio investment entity

Section ME 9(4) of the Income Tax Act 2004 and section OB 66(2) of the Income Tax Act 2007 has been amended. The amendment allows an entity to the end of the income year in which it becomes a portfolio investment entity to pay any further income tax that arose from a debit balance in its imputation credit account at the time it stops being an imputation credit account company and becomes a portfolio investment entity. This ensures that a portfolio investment entity can distribute the benefit of imputation credits to its investors when those imputation credits have arisen from the entity's tax obligations before it became a portfolio investment entity.

Removal of penalties and interest when provisional tax increased as a result of becoming a portfolio investment entity

Section HL 13 of the Income Tax Act 2004 and section HL 14 the Income Tax Act 2007 have been amended to provide relief in situations when an increased provisional tax liability arises due to an entity becoming a portfolio investment entity. Without this amendment, portfolio investment entities with investments in other portfolio investment entities that are zero-rated and exempt from resident withholding tax may incur an increased provisional tax liability. Entities with a standard balance date that elect to become portfolio investment entities on 1 October 2007 would have had their first provisional tax payment due on 7 July 2007, so could not have prevented an underpayment.

This relief applies for provisional tax payments that have already been made for the income year in which the transition occurs, and any provisional payments falling due within the two months of becoming a portfolio investment entity.

Share lending rules and deemed sale and reacquisition of Australian shares

Under section HL 12(3) of the Income Tax Act 2004 and section HL 13(3) of the Income Tax Act 2007, there is a deemed sale and reacquisition of Australian shares held at the time an entity becomes a portfolio investment entity. This provision ensures that any gain or loss on Australian shares that are held on revenue account by entities becoming portfolio investment entities is realised at the time of entry into the PIE rules. Before this amendment, section HL 12(3) of the Income Tax Act 2004 and section HL 13(3) of the Income Tax Act 2007 referred to "shares held by the entity". This wording may not have captured shares subject to share lending transactions whereby shares are lent shortly before an entity enters into the portfolio investment entity rules (the earliest date being 1October 2007) and reacquired after that date. The share lending rules could have prevented a tax liability arising for the intending portfolio investment entity. This is because the shares are not held by the intending portfolio investment entity on the transition date and therefore would not have been caught by section HL 12(3) of the Income Tax Act 2004 and section HL 13(3) of the Income Tax Act 2007. The share lending rules themselves would prevent there being a taxable event on the date the shares are lent and the Australasian share trading exclusion for portfolio investment entities in section CX 44C of the Income Tax Act 2004 and section CX 55 of the Income Tax Act 2007 would still seem to apply when the relevant shares are eventually sold.

Section HL 12(3) of the Income Tax Act 2004 and section HL 13(3) of the Income Tax Act 2007 have therefore been amended to ensure that for the purposes of that provision any original share subject to a returning share transfer is treated as being held by the share supplier (that is, the intending portfolio investment entity) and not by the share user. The treatment of any dividend paid on the lent shares will continue unchanged - that is, the dividend will be taxable to the share user under ordinary rules with the replacement payment for dividends being deductible to the share user and taxable to the share supplier.

Minor drafting corrections

A number of amendments have been made to correct minor drafting and cross-referencing errors. The key amendments are:

  • Section CX 44D(2) and (3) of the Income Tax Act 2004 and section CX 56(2) and (3) of the Income Tax Act 2007 have been amended to make it clear that they apply to a dividend from a portfolio tax rate entity or a portfolio listed company that is not a distribution.
  • Section HL 4(2) of the Income Tax Act 2004 and the Income Tax Act 2007 have been amended so that an entity ceases to be eligible to be a portfolio investment entity only if a portfolio investor class of the entity fails to meet a requirement under sections HL 6 or HL 9 of the Income Tax Act 2004 and the Income Tax Act 2007. These amendments will ensure consistency with sections HL 6 and HL9 which apply on a portfolio investor class basis. The failure to meet a requirement under section HL 10 of the Income Tax Act 2004 and the Income Tax Act 2007 is tested on an entity basis as the section HL 10 requirements apply on this basis.
  • The references to "tax year"in section HL7(3)(a)(ii) of the Income Tax Act 2004 and the Income Tax Act 2007 have been replaced with a reference to the entity's "income year".
  • An amendment has been made to section HL 12 of the Income Tax Act 2004 and the Income Tax Act 2007 providing that for the purposes of section NH4(5)(f) the relevant DWP account credit balance is that existing immediately before the entity becomes a portfolio investment entity on 1 October 2007. An entity becoming a portfolio investment entity is not able to receive a refund of DWP it has paid under section NH 4(5) (which allows a refund of DWP when a company ends up with a net loss for an income year). In particular, section NH 4(5)(f) provides that the DWP refund cannot exceed the company's DWP account credit balance at the end of the imputation year - in this case 31 March 2008. In the case of a company which became a portfolio investment entity on 1October 2007, its credit balance will be nil, which will prevent a DWP refund being made. If the company had not become a portfolio investment entity it could have received a refund of DWP.
  • The definition of "portfolio land company" in section OB 1 of the Income Tax Act 2004 and section YA 1 of the Income Tax Act 2007 requires that 90 percent of the company's assets must be land assets and that this must be the case for 80 percent of the year. This requirement has been changed so that it will be met if it is for 80 percent or more of the year.
  • Section 57B(1)(b) has been reworded to clarify due dates at the end of the calendar year for certain portfolio investment entities.

Drafting consistency with core provisions

The following drafting amendments have been made to ensure that the portfolio investment entity rules interact correctly with the Income Tax Act's core provisions and are consistent with the rewrite of that Act:

  • Sections HL 21 and HL 23 of the 2004 Act have been amended to clarify that the income tax liability of quarterly zero portfolio tax rate entities and annual exitor portfolio tax rate entities is equal to the portfolio entity tax liability for the portfolio calculation periods in the tax year.
  • Section HL 22 of the 2007 Act has been amended to clarify that the income tax liability of annual provisional tax portfolio tax rate entities is equal to the portfolio entity tax liability for the portfolio calculation periods in the tax year.
  • Portfolio investment entity rebates for excess credits and losses have been excluded from the section OB 1 definition of allowable rebates in the 2004 Act.