Determination G9B: Financial Arrangements That Are Denominated in a Currency Other Than New Zealand Dollars: An Expected Value Approach
This determination may be cited as ``Determination G9B: Financial Arrangements that are Denominated in a Currency other than New Zealand Dollars: An Expected Value Approach''. 1. Explanation (which does not form part of the determination) When do you use this determination? You may use this determination if you have financial arrangements where the rights and obligations under the financial arrangement are fixed or otherwise determined in a currency other than NZD, including variable rate financial arrangements that are denominated in a currency other than NZD. However, this determination only applies to financial arrangements where the payment dates are known not later than your first balance date after you become a party to the financial arrangement; and forward rates for the currency in which the financial arrangements are denominated can be determined. What methods can be used to calculate income or expenditure in relation to a financial arrangement that comes within the scope of this determination? Expected Value Approach This determination sets out an expected value approach to calculate gross income or expenditure from a financial arrangement where any rights and obligations of the parties are expressed in a base currency other than New Zealand dollars. This base currency might be a foreign currency or a commodity. This expected value approach can only be used for financial arrangements within the scope of this determination, which is narrower than Determination G9A: Financial Arrangements that are Denominated in a Currency or Commodity other than New Zealand Dollars. If you elect to use this determination, you must not use Determination G9A for any such financial arrangement, and you must not use Determination G14: Forward Contracts for Foreign Exchange and Commodities for any forward contract within the scope of Determination G14A: Forward Contracts for Foreign Exchange and Commodities: An Expected Value Approach. Mark to Spot Approach You can use Determination G9A: Financial Arrangements that are Denominated in A Currency or Commodity other than New Zealand Dollars to calculate gross income or expenditure of any financial arrangement within the scope of this determination if you have not used this determination or Determination G14A: Forward Contracts for Foreign Exchange and Commodities: An Expected Value Approach. Alternatively, you may use the mark to market method if you satisfy the requirements of section EH 1 (6) of the Act. You may also use a method allowed by the proviso to section EH 1 (5) (a) of the Act. How do I use the method set out in this determination? Under this method, the gross income or expenditure from a financial arrangement where the rights and obligations of the parties are expressed in a base currency other than New Zealand dollars is the total of an expected component and an unexpected component. To apply this method: determine the expected component by taking into account all the base currency payments and payment dates in relation to the financial arrangement when you become a party to the financial arrangement. use the initial interest rate to calculate the base currency payments under a variable rate financial arrangement denominated in a base currency other than NZD, and assume that this rate will apply throughout the term of the financial arrangement. translate the base currency payments into expected NZD payments on the basis of the forward rates available at the time you become a party to the financial arrangement. spread the expected NZD net amount under the yield to maturity method and allocate it to each income year over the term of the financial arrangement on a daily basis. measure the unexpected component at the end of each balance date as the difference between actual and expected NZD payments. calculate the gross income or expenditure of a financial arrangement entered into before the income year you elect to use this determination as set out above, except that you must: (a) use actual NZD payments up to the income year you elect to use this determination and expected NZD payments for the remaining term of the financial arrangement in determining the expected component of the gross income or expenditure; and (b) use the relevant forward rates at the end of the income year you elect to use this determination for the purpose of calculating the expected NZD payments. How do I elect to use the method outlined in this determination? You may elect to use this determination by returning your gross income or expenditure on the basis of this determination for the 19981999 income year, or the 19992000 income year, or in the first income year in which you become a party to the financial arrangement that is within the scope of this determination. In the income year you elect to use this determination to calculate gross income or expenditure from a financial arrangement entered into before the income year, you must perform a transitional adjustment calculation. This determination provides for a transitional adjustment calculation that is comparable to Determination G25: Variations in the Terms of a Financial Arrangement. How do I calculate the transitional adjustment? The transitional adjustment must be made in the income year you elect to use this determination. The transitional adjustment calculation must be made for each financial arrangement entered into before the income year you elect to use this determination. It requires that you treat the difference between the total amount that would have been gross income or expenditure calculated as described in this determination and the total amount actually recognised over the previous income years, as gross income or expenditure in the income year of the adjustment. How is income or expenditure calculated in the year the financial arrangement matures or is disposed of? Regardless of which method you choose to use, you must calculate income or expenditure under the base price adjustment in section EH 4 of the Act. Miscellaneous Issues This determination requires that where a financial arrangement involves or is expressed in more than one currency or commodity, each separate currency or commodity tranche is to be treated as a separate financial arrangement. Where a facility provides for the rollover of a financial arrangement, the financial arrangement matures when the rollover occurs. Section EH 4 of the Act applies in the income year the rollover occurs. Any payment arising from the rollover of a financial arrangement will be taken into account under section EH 4 of the Act unless the payment is related to a separate financial arrangement. 2. Reference This determination is made pursuant to section 90 (1) (c) of the Tax Administration Act 1994. 3. Scope (1) This determination applies to the calculation of gross income or expenditure from a financial arrangement, to the extent that any right or obligation under the financial arrangement is fixed or otherwise determined in a currency other than NZD and is not fixed in NZD. The payment dates under the financial arrangement must be known not later than the first balance date of the issuer or holder after issue or acquisition. (2) This determination does not apply to (a) A futures contract; (b) A security arrangement; (c) A financial arrangement denominated in a currency where the forward rates of the currency cannot be determined; or (d) Any financial arrangements covered by the following determinations Determination G14: Forward Contracts for Foreign Exchange and Commodities; Determination G19: Exchange Traded Option Contracts; Determination G20: Discounted Value of Amounts Payable in Relation to Trade Credits Denominated in a Foreign Currency; Determination G21: Discounted Value of Amounts Payable in Relation to Deferred Property Settlements Denominated in a Foreign Currency; Determination G21A: Agreements for Sale and Purchase of Property Denominated in Foreign Currency: Discounted Value of Amounts Payable; Determination G27: Swaps; Determination G29: Agreements for Sale and Purchase of Property Denominated in Foreign Currency: Exchange Rate to Determine the Acquisition Price and Method for Spreading Income and Expenditure; except as specifically allowed by those determinations. (3) You may use this determination if (a) an election to use this determination is made by returning your income or expenditure on the basis of this determination in the 19981999 income year or the 19992000 income year or the first income year in which you become a party to the financial arrangements within sub-paragraphs (1) and (2) above; and (b) Determination G9A: Financial Arrangements that are Denominated in a Currency or Commodity other than New Zealand Dollars is not used to calculate gross income or expenditure of any financial arrangement that is within sub-paragraphs (1) and (2) above; and (c) Determination G14: Forward Contracts for Foreign Exchange and Commodities is not used to calculate gross income or expenditure of any forward contract that is within the scope of Determination G14A: Forward Contracts for Foreign Exchange and Commodities: An Expected Value Approach. (NOTE: A determination to which Determination G9B refers may be changed or rescinded by a new determination made by the Commissioner. In such a case, a reference to the old determination is extended to the new determination.) 4. Principle (1) If you are a party to a financial arrangement to which this determination applies, the gross income or expenditure in respect of the financial arrangement is calculated by taking into account all amounts arising from the fluctuations of exchange rates or commodity prices. (2) The gross income or expenditure from the financial arrangement is the total of an expected component and an unexpected component. You must measure the expected component at the time you become a party to the financial arrangement. You must also recognise the unexpected component when it is realised. (3) To measure the expected component you must convert the base currency payments into expected NZD payments on the basis of forward rates at the time you become a party to the financial arrangement, and spread the expected NZD net amount over the term of the financial arrangement. (4) You must measure the unexpected component as the difference between the actual NZD payments and the expected NZD payments. (5) You may use this determination to calculate gross income or expenditure of financial arrangements entered into before the income year in which you made the election and in respect of which section EH 4 of the Act does not apply. You must then use this determination for all such financial arrangements. In this case, you must follow the principle set out above except that you must calculate the expected NZD net amount using actual NZD payments up to the end of the income year in which you elect to use this determination and the forward rates at the end of that income year. Transitional Adjustment (6) You must perform the transitional adjustment calculation in the income year in which you elect to use this determination to calculate gross income or expenditure of any financial arrangement entered into before that income year. (7) This adjustment ensures that the gross income or expenditure up to the end of the income year in which you elect to use this determination is equal to that that would have been returned if the actual NZD payments and the forward rates, as described in sub-paragraph (5), and this determination had been used since you become a party to the financial arrangement. 5. Interpretation In this determination: (1) A reference to the ``Act'' is a reference to the Income Tax Act 1994. (2) ``Base currency'' in relation to a financial arrangement means the currency or commodity in which rights and obligations under the financial arrangement are fixed. ``Covered interest parity'' means the proposition that the differential between forward and spot exchange rates is equal to the interest differentials. That is, the forward rate for a foreign currency exchange at time t for 1 period ahead is equivalent to the spot rate at time t, S[in't'] , multiplied by one plus the foreign interest rate, i[in'f'] , divided by one plus the domestic interest rate, i[in'd'] . Forward rates at time t for n periods, Fwd[in't'][in','][in'n'] , can thus be derived based on the principle of covered interest parity as (1 i[in'f'])[su'n'] [li-5]Fwd[in't'][in','][in'n'] S[in't'][li5] (1 i[in'd'])[su'n'] [li-5] [li5] ``Currency'' includes any commodity used as a medium of exchange or account, whether in general use or for the purpose of an arrangement. ``Exchange rate'' means the price of one currency expressed in another currency. ``Forward rate'' means the exchange rate for a forward contract as defined in Determination G6D: Foreign Currency Rates or the forward exchange rate calculated using the principle of covered interest parity or other methods that are commercially acceptable. In the case where the base currency is a commodity, the forward rate is the future value of the commodity (in NZD). ``Financial arrangement'' has the same meaning as in the Act: Provided that, where a financial arrangement creates obligations in two or more currencies or commodities and the consideration to be given and received in respect of the obligations in each of the currencies is separately identifiable, the consideration to be given and received in respect of the obligations in each currency will be treated as relating to separate financial arrangements. ``Floating rate arrangement'' means a financial arrangement where the interest rate is reset periodically according to a predetermined formula, linking the interest rate to an indicator rate such as the bank bill or interbank rate. ``Future value'' in relation to a commodity and a future date means the value of the commodity at the future date, on a given date, derived from any commercially acceptable, market-based method of valuation. ``GBP'' means the currency of the United Kingdom. ``Initial interest rate'' in relation to a financial arrangement means the interest rate that applies to the first period after the date of issue or acquisition of the financial arrangement. ``Interest'' means any periodic payment in relation to the financial arrangement, to the extent intended to provide a return to the lender on the sums provided to the borrower. It does not include fees, discounts, or premiums, or payments effecting a reduction of principal. ``NZD'' means the currency of New Zealand. ``Period'' means a term commencing immediately after a payment is payable or receivable, and ending when the next payment is payable or receivable. ``Reviewable rate arrangement'' means a financial arrangement where the interest rate is set periodically in line with market rates. ``Spot rate'' means the exchange rate for a spot contract as defined in Determination G6D: Foreign Currency Rates or in the case of a commodity, the spot value (in NZD) of the commodity. ``Spot value'' in relation to a commodity and a day means the value of the commodity on that day derived from any commercially acceptable method of valuation. ``USD'' means the currency of the United States of America. ``Variable rate financial arrangement'' means a floating rate arrangement or a reviewable rate arrangement. (3) All other terms used have the same meaning given to them for the purpose of the qualified accruals rules in the Act. 6. Method (1) Your gross income or expenditure in an income year from a financial arrangement under this determination is the total of: (A) the expected component, calculated in accordance with sub-paragraphs (2) to (5); and (B) the unexpected component, calculated in accordance with sub-paragraph (6) of this section. (2) You must calculate the expected component for each income year of the remaining term of the financial arrangement at the time you become a party to the financial arrangement. The expected component is calculated by first taking into account all base currency payments in relation to the financial arrangement. (3) You must calculate the base currency payments of a variable rate financial arrangement denominated in a currency other than NZD using the initial interest rate and assuming that this rate will apply throughout the term of the financial arrangement. (4) You must convert the base currency payments into NZD using forward rates at the time you became a party to the financial arrangement. (5) You must spread the expected NZD net amount using the yield to maturity method consistent with Determination G3 and, where necessary, allocate it to the income year on the basis of Determination G1A. This will give the expected component for each income year. (6) The unexpected component is the difference between the actual NZD value of the payments during the year and the expected NZD value of those payments as calculated under sub-paragraph (4). Transitional Adjustment for Existing Financial Arrangements (7) If you elect to use this determination to calculate gross income or expenditure of any financial arrangement entered into before the income year you made the election, you must follow the method set out in sub-paragraphs (1) to (6) to calculate gross income or expenditure of these financial arrangements, except that (a) the NZD net amount to be spread under sub-paragraph (5) consists of actual NZD payments that have occurred since you become a party to the financial arrangement until the end of the income year you elect to use this determination, and expected NZD payments in the remaining term of the financial arrangement; and (b) the expected NZD payments in the remaining term of the financial arrangement must be calculated on the basis of the forward rates available at the end of the income year you elect to use this determination. (8) You must perform a transitional adjustment calculation in the income year in which you elect to use this determination to calculate gross income or expenditure of any financial arrangement entered into before the income year you made the election. You must perform the transitional adjustment calculation for each of those financial arrangements in accordance with the following formula: a b c d where a is the sum of all amounts that would have been income in respect of the financial arrangement from the time it was entered into until the end of the income year, if this determination was applied from the time you become a party to the financial arrangement; b is the sum of all amounts that would have been expenditure in respect of the financial arrangement from the time was entered into until the end of the income year, if this determination was applied from the time you become a party to the financial arrangement; c is the sum of all income in respect of the financial arrangement since it was acquired until the end of the previous income year; d is the sum of all expenditure in respect of the financial arrangement since it was acquired until the end of the previous income year. A positive net amount is gross income while a negative net amount is gross expenditure in the income year you elect to use this determination. 7. Examples (1) A New Zealand investor holds a United States Treasury Bond on its balance date of 30 June 2000. The bond has a term of 5 years and bears 10% interest payable semi-annually on 1 September and 1 March. It has a face value of USD $10 million. The bond was purchased at issue for USD $8,300,000 and matures on 1 September 2004. (2) The New Zealand investor has to calculate the expected NZD net amount on the basis of forward rates available at the time it becomes a party to the financial arrangement. It then has to spread and allocate the expected NZD net amount to the income years over the term of the financial arrangement in accordance with Determination G3 and Determination G1A. In each of those income years, the investor also has to determine the unexpected component of the gross income or expenditure. The unexpected component is measured as the difference between the actual NZD payments and the expected NZD payments. Signed on the 27th day of April 1998. ROBIN OLIVER, General Manager, Policy.