Qualifying foreign private annuity exemption from the Foreign Investment Fund regime

Section CG 15(2)(g), Income Tax Act 1994 - what constitutes an interest in a Foreign Investment Fund

A taxpayer has asked for clarification of the operation of the qualifying foreign private annuity ("QFPA") exemption in section CG 15(2)(g).  In particular, she has asked at what point the test for a QFPA is to be applied.  This query was raised in the context of Example 2 of Part 2, and Example 9 of Part 5, of the Appendix to Tax Information Bulletin Vol 8, No 5 (September 1996) which contains a description of the QFPA rules. 

Section CG 15(2)(g) states:

An interest held by a person in a foreign entity at any time during an income year shall not be treated as an interest in a foreign investment fund -
...

7. If, subject to subsections (3) and (4), at the time, the interest is a qualifying foreign private annuity. (Emphasis added)

Section OB 1 defines the qualifying foreign private annuity in part as follows:

"Qualifying foreign private annuity" means an entitlement of a natural person to benefit from a pension or annuity provided by a foreign entity while the person is resident in New Zealand, if-

1. The consideration for the entitlement to the pension or annuity is provided to the foreign entity-
1. At a time when the person is not resident in New Zealand; or
2. At a time when the person is resident in New Zealand falling before the first day of the 4th income year succeeding the income year in which the person last becomes a resident of New Zealand; or
3. From the accumulated balance or proceeds of an interest of the person in a superannuation fund and that interest is commuted or transferred in anticipation of, or following, the person ceasing to be a resident of New Zealand; and ...

To be a QFPA within the definition of that term in section OB 1, a pension or annuity must meet certain criteria.  One requirement is that the consideration for the QFPA must be provided "at a time when the person is resident in New Zealand falling before the first day of the 4th income year succeeding the income year in which the person last becomes a resident of New Zealand". 

 The exemption in section CG 15(2)(g) uses the words "at the time", indicating that it is the QFPA status at a particular time that is important.  The taxpayer has asked if, when a breach occurs, this means that:

• the annuity was never a QFPA at any time; or

• it fails to be a QFPA only from the time of the breach.

Example 2 in the above mentioned Tax Information Bulletin implies that if taxpayers breach the above criterion they will be said never to have met the QFPA definition, and will therefore have been subject to the foreign investment fund ("FIF") regime from the point when they last became resident in New Zealand.  

The test is whether the consideration is paid before the first day of the 4th income year after the taxpayer becomes resident in New Zealand.  There are two possible interpretations of the Act as to the consequences of this requirement.  One is to say that if the time limit is breached, the taxpayer has failed to meet the definition from the beginning of the grace period, i.e. from the point when the person last became resident.  In that case a breach would mean that the FIF interest was never a QFPA. 

The alternative interpretation is to say that the definition may be met up until the beginning of the income year in which the time limit requirement is breached.  This would mean that the FIF interest ceases to be a QFPA when this particular criterion is not met.

The legislation is ambiguous as to when the test is to be applied.  In CIR v Alcan New Zealand Ltd  [1994] 3 NZLR 43 the Court of Appeal said that words in legislation must be given their ordinary meaning, but that if the meaning is unclear it is permissible to consider the purpose of the legislation, having regard to the total context of the words used while still being constrained by the actual words used in the section, in order to arrive at the meaning intended by the legislature.  This ensures that an anomalous interpretation is not favoured when two or more interpretations are available.  The Court also said that one should approach the question of statutory interpretation on the premise that the legislature will not have intended absurdity or injustice.  Therefore, it is worth considering the scheme and purpose behind the QFPA definition and section CG 15(2)(g) to see which of the two possible interpretations is to be preferred.

The QFPA exemption (relating to returning residents) may be compared with the "new resident exemption" in section CG 15(2)(f).  It is arguable that the two exemptions were intended by the legislature to parallel each other, and that accordingly the same result should be reached under both types of exemption.  The new resident exemption does not require that consideration be provided within any particular time period.  New residents with interests in foreign pension plans simply have 3 years before they must return FIF income.  The QFPA exemption was introduced some time after the new resident exemption.  It is not clear why the QFPA exemption imposes the time limit on consideration paid to foreign annuities while the new resident exemption does not.  However, it is strongly arguable that Parliament did not intend returning residents to be treated more harshly than new residents. 

Also, interpreting the exemption so that taxpayers who breach fall outside the exemption from when they last became resident, would have practical consequences as taxpayers breaching the 4-year limit would have to amend their returns for the previous 4 years in order to comply with the FIF regime.  In addition to these compliance costs, potentially harsh interest and penalties may be imposed on taxpayers that breach the time limit but have not previously returned their FIF income.

It is considered that the correct interpretation of this exemption is that taxpayers who breach the consideration requirement are deemed to hold a FIF interest from the first day of the 4th income year from when they last became resident.  In other words, a FIF interest ceases to be a QFPA from the beginning of the income year in which the time limit requirement is breached.  

This means that in Example 2 in Part 2 of the Appendix to Tax Information Bulletin Vol 8, No 5 (September 1996) (pages 4-5) the taxpayer's interest in her foreign superannuation scheme would cease to be a QFPA from the 1 April 2001 (the fourth income year), as Mrs P (the taxpayer in that example) continues to make contributions after this date.  The definition of a QFPA would be met for the period from 11 July 1997 (the date that she returned to New Zealand) until 31 March 2001.

It should be noted that although a QFPA is not taxable under the FIF regime, distributions may still be taxable under other provisions of the Act.