Amendments to the PIE rules
(Clauses 16, 29, 40 to 55, 95 and 167)
Summary of proposed amendment
The bill contains several remedial amendments to the portfolio investment entity (PIE) rules, including some amendments to the recently enacted rules for foreign investment PIEs. Some amendments are to correct minor anomalies in how the rules operate while others are to correct minor technical errors.
The amendments will apply from the date of enactment unless otherwise stated.
The amendments will:
- narrow the capital gains exemption that applies to PIEs investing in New Zealand and Australian listed shares, to ensure that it applies only to shares that provide an equity interest;
- amend section HM 17 of the Income Tax Act 2007 which requires all investors to have the same rights to investment proceeds to clarify that it should not apply when a PIE invests in financial arrangements only;
- add Quayside Holdings Limited, the investment arm of the Bay of Plenty Regional Council, to schedule 29, which will mean its investments will be exempt from some of the requirements of the PIE rules;
- amend the flow-through rule to ensure expenses are treated appropriately in all situations; and
- correct minor drafting errors.
Tax exclusion for non-participating shares
Section CX 55 of the Income Tax Act 2007 provides that income from a PIE’s share-trading gains from New Zealand and certain Australian shares is generally excluded. When this rule was developed, it was only intended that it would apply to shares that provide a true equity interest in the underlying company. Reflecting this intention, the share-trading exclusion does not apply to non-participating redeemable shares at present.
Nevertheless, some types of share do not provide a true equity interest yet do not fall within the definition of a non-participating redeemable share. Further, some elements of the definition are of no concern from a policy perspective – for example, it is irrelevant whether or not a share carries voting rights.
Accordingly, the bill will modify the share-trading exclusion to more closely reflect the original policy intent. Specifically, the share-trading exclusion will not apply to shares that are:
- a fixed-rate share; or
- a share to which the amount payable on its cancellation is no more than the original subscription amount of the share.
Application of anti-streaming rule for cash PIEs
Section HM 17 of the Income Tax Act 2007 sets out a specific rule to prevent the streaming of different types of investment proceeds to different investors. This rule is designed to combat tax minimisation strategies and generally operates as intended. It can, however, be read in a way that causes difficulties for so-called “cash PIEs” (i.e. term deposits that have been structured as PIEs) because of the way these PIEs are often structured.
The bill amends section HM 17 to clarify that it does not apply to PIEs that invest only in financial arrangements, such as cash PIEs. The clarification will ensure that cash PIEs can continue to structure themselves in the most commercially sensible manner. As all amounts received under a financial arrangement, whether capital or revenue in nature, are taxable, allowing such streaming does not provide any tax advantage.
Flow-through rule for foreign investment PIEs
To facilitate the use of inter-PIE investment of foreign investment PIEs, a flow-through rule was created. The rule allows one PIE (PIE A) to treat its share of the gross income derived by another PIE (PIE B) as if the income had been derived directly. Say, for example, PIE B derived $100 of gross income and wishes to charge PIE A $10 in fees (leaving $90 net). Under the flow-through rule, PIE A would be treated as deriving $100 of income. However, for the flow-through rule to work effectively, the treatment of expenses also needs to be considered.
If PIE B attributes the full $100 of income to PIE A and sends a separate bill for $10, it is clear that PIE A will have incurred $10 of expenditure. However, say instead PIE B deducts the $10 from the amount it pays to PIE A, so only $90 is attributed. In this case it is unclear whether PIE A has incurred the $10 of expenditure, even though it will be deemed to have earned the full $100 under the flow-through.
To ensure the appropriate result is achieved, the bill introduces new subsection HM 6B(4). The subsection clarifies that a PIE using the flow-through rule is deemed to have incurred expenditure equal to the difference between the amount of income deemed to have been derived under the flow-through and the amount actually attributed to the PIE. In the example above, PIE A is treated as deriving $100 of income under the flow-through mechanism but has only been attributed $90 of income. Accordingly, subsection HM 6B(4) will deem PIE A to have incurred a $10 expense.
This clarification applies from the beginning of the 2012−13 income year.
Adding Quayside Holdings to schedule 29
Normally an entity can only own up to 20 percent of a PIE and there must be at least 20 investors in a PIE. The rationale for these restrictions is to ensure that PIEs are widely held, so a single investor cannot dominate the actions of a PIE. Entities listed in schedule 29, however, can hold up to 100 percent of a PIE and can be a PIE’s sole investor. This is on the basis that such entities are themselves widely held. The PIE will therefore, in effect, still be widely held even if one such entity has a significant interest in it.
The bill adds Quayside Holdings to schedule 29. Quayside’s investments are held for the benefit of the Bay of Plenty Regional Council’s ratepayers. As such, it is effectively widely held. In addition, Quayside is similar in function to other entities already listed on schedule 29, such as Auckland Council, EQC and the New Zealand Superannuation Fund. All these entities invest for the benefit of a significant sector of the public.
Minor drafting errors
Amendments in the bill correct the following minor drafting errors:
- section HL 21(13) is being replaced by new section HL 21(9B), which will correctly modify an investor’s prescribed investor rate as opposed to their portfolio investor rate with application from 1 April 2008. A similar amendment is being made to section HL 20 of the Income Tax Act 2004 with application from 1 October 2007;
- the erroneous reference to “an exiting investor referred to in section HM 61” will be removed from the definition of zero-rated investor;
- the rule that provides how a PIE should allocate tax credits will be amended to correctly apply to all types of credit, other than PIE-specific credits;
- references to “tax year” and “income year” in section HM 34 will be corrected, with application from the beginning of the 2011−11 income year;
- references to defined terms in sections HM 35B and EZ 63 will be corrected, with application from the beginning of the 2010−11 income year and 30 June 2010, respectively;
- sections HM 51(1)(b) and HM 53(1)(b)(ii) are being amended to provide that transitional residents that have elected a 0% tax rate cannot benefit from certain tax credits;
- section HM 32(3) is being re-worded (with effect from the date of enactment), while sections 64(3) and 65(5) will be amended (with effect from the date of enactment of the Taxation (Tax Administration and Remedial Matters) Act 2011) to clarify the policy intent; and
- cross-referencing errors will be corrected in sections HM 11(2) and (3), HM 12(2) and HM 19C(2), with effect from the date of enactment of the Taxation (Tax Administration and Remedial Matters) Act 2011.