28 SEPTEMBER 2006

NEW ZEALAND GAZETTE, No. 112

3309

To calculate the amount of consideration attributed to the equity component of the optional convertible notes, subclause 6 (5) of this determination must be applied, unless subclause 6 (3) applies. As the companies are members of the same wholly owned group of companies, the amount of consideration attributable to the warrant component of the optional convertible notes is nil.

Accordingly, all of the consideration received from the issuance by XYZ Ltd of the optional convertible notes must be attributed to the bond component.

Therefore, no financial arrangement income or expenditure arises in relation to this financial arrangement.

A similar calculation must be undertaken to calculate the holder’s position if the holder is subject to the financial arrangements rules.

Example C

On 1 April 2007, a publicly listed New Zealand company, XYZ Ltd, raised $100 million through the issue of 100 million $1.00 optional convertible notes with a five-year term. The optional convertible notes had an aggregate face value of $100 million, paid a coupon of 3% per annum, semi-annual, and were issued at par to the optional convertible notes’ face value. For commercial reasons, the subscriber for the optional convertible notes was a member of the same wholly owned group of companies that acquired the notes with the intention of selling the optional convertible notes to institutional third party investors for $100 million. Settlement with the institutional third party investors was to occur on 1 July 2007.

At the time the optional convertible notes were issued, XYZ Ltd had one billion shares on issue, which were trading at $1.00 each. The terms of the optional convertible notes provided that the holders could at any time over the term of the optional convertible notes elect to redeem the optional convertible notes for cash or for one share per note held. The exercise price on the American-style warrant component of the optional convertible notes is $1.00 per share. The total consideration paid by the subscriber (a member of the same wholly owned group of companies as XYZ Ltd) of the optional convertible notes was $100 million. No fees were payable by XYZ Ltd in relation to issue of the optional convertible notes.

The five-year New Zealand government bond rate at the time of issue (1 April 2007), and when the optional convertible notes were on-sold (1 July 2007), was 5.81%.

XYZ Ltd has a 31 March balance date.

Given the subscriber’s intention to sell the optional convertible notes within 93 days of their issuance date, the provisions contained in subclause 6 (3) of this determination do not apply if the notes are sold to relevant third parties within the requisite period. In such circumstances, the bifurcation process described in subclause 6 (5) of this determination must be applied by XYZ Ltd when the optional convertible notes are initially issued to the member of the same wholly owned group of companies on 1 April 2007. The bifurcation process must also be applied by the relevant parties (to the extent that the financial arrangements rules apply) on 1 July 2007 when the subscriber sells the optional convertible notes to the third party investors.

XYZ Ltd’s financial arrangements rules treatment of the optional convertible notes is the same as if it had issued the notes directly to third party investors. However, should the subscriber fail to sell the notes to those investors within the requisite time frame, subclause 6 (3) will apply to XYZ Ltd.

In regard to the first part of this arrangement, the aggregate consideration for the optional convertible notes when they were initially issued was $100 million. Therefore y = $100 million.

The PV of the bond component on the original date of issue applying subclause 6 (7) is $87,956,749.20. Therefore s = $87,956,749.20.

The aggregate amount attributable to the equity component of the optional convertible notes is therefore:

$100,000,000.00 – $87,956,749.20 = $12,043,250.80.

This amount may be ignored for the purposes of calculating income or expenditure under the financial arrangement rules.

The YTM method or alternative method, as prescribed under the Act, must be applied in order to calculate financial arrangement income or expenditure on the bond component of the optional convertible notes by XYZ Ltd.

For the tax period ending 31 March 2008, XYZ Ltd’s calculation of financial arrangement expenditure will be $5,140,939.04.

If the optional convertible notes are not exercised and run for their full maturity under the contracted terms of the arrangement, XYZ Ltd will be entitled to claim total financial arrangement expenditure of $27,043,250.81, apportioned each year under the YTM method and BPA requirements.

If the financial arrangements rules apply to the subscriber, that person will derive income from the bond component of the optional convertible notes calculated in accordance with subclause 6 (5) of this determination and the requirement to perform a BPA.

Assuming the subscriber is subject to the financial arrangements rules, it paid $100 million to XYZ Ltd on 1 April 2007 and received $100 million from third party investors when the optional convertible notes were sold on 1 July 2007. The PV of the bond on 1 July 2007 was $89,218,194.23, applying the bifurcation process, a difference of $1,261,445.03 from the PV of $87,956,749.20 calculated applying the bifurcation process on 1 April 2007. The subscriber is required to perform a BPA and account for this amount of financial arrangement income.

The formula for a BPA is:

Consideration – income + expenditure + amount remitted.

Consideration in relation to the financial arrangement is:

(87,956,749.20) + 89,218,194.23 = 1,261,445.03

Income is zero as the BPA occurs in the first year of the financial arrangement and, consequently, no other income has been recognised for the purposes of the financial arrangements rules.

Expenditure is zero.

There is no remission.

The BPA amount is therefore:

1,261,445.03 – 0.00 + 0.00 + 0.00 = 1,261,445.03.

As this is a positive amount, it is financial arrangement income for the subscriber.