25 JUNE

NEW ZEALAND GAZETTE

1945

(1) This determination applies to holders of Convertible Notes denominated in New Zealand Dollars issued by ABC Limited ("the Issuer") and Units in the XYZ Unit Trust ("the Unit Trust").

The arrangement involves Investors subscribing for Convertible Notes issued by the Issuer (which bear interest at the rate of 2% per annum) and Units issued by the Unit Trust. These will be subscribed for on the basis of two Convertible Notes for every Unit subscribed for. The Issuer will lend the proceeds from the issue of the Convertible Notes to the Unit Trust at interest at the rate of 2% per annum. The Unit Trust will use the total funding subscribed by Investors to contribute towards the purchase of a commercial property.

The Unit Trust will repay the loan from the Issuer by way of regular repayments of principal. The Issuer will use the money received from the repayment of the loan to repay the principal amount of the Convertible Notes on issue.

An Investor has the option to convert the Convertible Note into Units in the Unit Trust. The conversion of the Convertible Note extinguishes the Issuer’s liability to repay the principal amount owing to the holder of a Convertible Note.

(2) The form of the investment structure used to issue the Convertible Notes and Units to the Investors involves a number of financial arrangements which together form a “wider” financial arrangement. These financial arrangements include:

(i) the Units in the Unit Trust;

(ii) the Convertible Notes issued by the Issuer;

(iii) the loan of the proceeds received by the Issuer from the issue of the Convertible Notes to the Unit Trust.

(3) These financial arrangements can be analysed in the following way.

(a) The Units in the Unit Trust are deemed to be shares by section HE 1(b) of the Income Tax Act 1994. Section OB 1 of the Act therefore classifies the Units as excepted financial arrangements.

(b) The Convertible Notes have a debt and equity component. The debt component is the loan to the company with repayment being made in cash or units. The equity component is the option to convert repayment to Units in the Unit Trust and is also an excepted financial arrangement under section OB 1.

(4) In relation to the Convertible Notes, the coupon interest payments made by the Issuer to the Investors in respect of the Convertible Notes are below a “market” interest rate, but are nevertheless income or expenditure subject to the Qualified Accruals Rules.

When calculating income or expenditure in relation to the Convertible Notes the repayment in instalments of the principal amount of the Convertible Notes does not constitute income or expenditure subject to the Qualified Accruals Rules.

There is no amount attributable to the option to convert the Convertible Notes into Units in the Unit Trust because the conversion from the Convertible Notes into Units in the Unit Trust is made on a market value basis.

(5) The Units in the Unit Trust are not excluded from the application of the Qualified Accruals Rules because they form part of a “wider” financial arrangement. The fact that the proceeds of the issue of the Convertible Notes are lent by the Issuer to the Unit Trust and that the interest payable on this loan is below a “market” interest rate means that any gain on Units is not solely attributable to an excepted financial arrangement.

(6) The gain on Units is, in part, attributable to the low rate of interest that is payable on the loan from the Issuer to the Unit Trust and the correspondingly low rate of interest that is payable on the Convertible Notes. Therefore, part (or possibly all) of any gain on Units will be income for the purposes of the Qualified Accruals Rules.

(7) This Determination prescribes the method to be used to determine how much of the increase of the value of a Unit is solely attributable to an excepted financial arrangement and therefore excluded from the Qualified Accruals Rules as well as the method for spreading the accrual income, gain or loss, or expenditure under the Qualified Accruals Rules.

2. Reference

This determination is made pursuant to sections 90 (1) (c), 90 (1) (g) and 90 (3) of the Tax Administration Act 1994.

3. Scope of Determination

(1) The Determination will apply to the Convertible Notes issued by the Issuer and the Units issued by the Trust. Investors will subscribe for these on the basis of two Convertible Notes for one unit subscribed for in the Unit Trust.

(2) The terms of the Convertible Notes are that they will bear interest at a rate of 2% per annum. The Convertible Notes will be convertible at the option of the Investor. The Convertible Notes will convert on a market value and not on the basis of some pre-determined ratio.

(3) The proceeds of the Convertible Note issue made by the Issuer will be lent to the Unit Trust. This loan will be secured by a second mortgage over the properties held by the Unit Trust. The loan made to the Unit Trust of the proceeds from the Convertible Note issue will be made at the rate of 2% interest per annum. The Unit Trust will repay this loan through regular repayments. The Issuer will use these funds to pay the interest on the Convertible Notes, and to repay in regular instalments the principal amount of the Convertible Notes.

(4) Investors may elect to convert their Convertible Notes into Units in the Unit Trust. Once such an election has been made by an Investor it will be irrevocable. On receipt of a Unit in the Unit Trust, the Issuer’s liability under the Convertible Note will be extinguished.

(5) When the Issuer receives a request from an investor to convert one of the Convertible Notes, the Issuer will elect to convert the relative amount of the loan to the Unit Trust into Units in the Unit Trust. Therefore, the Unit Trust will issue Units to the Issuer and the loan from the Issuer will be reduced by the value of the units issued by the Unit Trust.

(6) The value attributed to the Units when Convertible Notes are converted by the Issuer will be determined by calculating a “unit value” for each unit so converted. The “unit value” shall be determined by dividing the market value of the Unit Trust’s net assets by the number of units currently issued by the Unit Trust.

(7) The effect of this conversion mechanism is intended to be that the balance of the Convertible Notes outstanding with the Issuer will equal the balance of the loan between the Issuer and the Unit Trust. When the Unit Trust makes regular repayments of the loan to the Issuer, the Issuer will use these amounts to redeem or partially redeem the Convertible Notes, and when an Investor wants to convert some of the Convertible Notes into Units in the Unit Trust, the liability of the Unit Trust to the Issuer will be discharged by reducing the balance of the loan outstanding. Therefore, regardless of whichever procedure occurs, the amount of the loan between the Issuer and the Unit Trust and the amount of the Convertible Notes outstanding with the Issuer will always be maintained in equilibrium.

(8) This Determination applies to all Investors and prescribes the method for determining the part of the income, gain or loss, or expenditure in respect of the