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born2invest
03-07-2013, 08:00 AM
Iíve done a bit of research but canít find any definitive information on whether I have to pay capital gains tax or can offset a capital loss against my end of year income.

For example, a bond is issued for 10 years at 8% interest. Issue price of the bond is $100.

Say I buy the bond at a price above or below $100 on the NZDX open market in year 7. For example I buy the bond for $95. I hold this bond until maturity at year 10. I get my interest payments for those 3 years (which I pay tax on at the end of the financial year) and I get $100 back.

Iíve therefore made a $5 capital gain on the $95 bond I purchased.

Do I have to pay tax on this $5 capital gain? Similar if I buy the bond for $105 and make a $5 capital loss, can I offset this capital loss against my income? Does this differ if I sell it before maturity?

Iíve looked in my most recent IR3 return and there is no section which states any capital gains or losses on investments, it only has sections for income such as wages, dividends, overseas income, fixed interest income, property, business income etc.

So all up, three questionsÖ Do I pay tax/offset losses? How do I show this in my tax return? Does it make a different if I hold to maturity or sell before maturity?

CJ
03-07-2013, 08:16 AM
Yes you do pay tax.

Google "financial arrangement rules". Not sure if anything will come up. I could refer you to the legislation but that would be annoying for whoever you live with as they will have to clean your brains off the walls after your mind explodes.

The theory is you do a 'base price adjustment' at the end of the arrangement and any gain/loss gets treated as interest in the IR3 I think.

born2invest
03-07-2013, 10:43 AM
If I buy a bond that matures in say 9 months and hold to maturity and then do the same thing over and over for a few years, do I then get classed as a “trader” and have to pay capital gains on my longer term share holdings that I have owned for 2 years and don’t plan on selling for a few years yet.

Example I’m looking at is TWC010 (Tower Bonds) closing April 2014 with a yield to maturity of 7.95%

If I buy this, hold to maturity and then repeat this with something such as IFT070 (Infratil maturing November 2015) for another 18 months or so do I get treated as a “trader” ?

I’m considering using this strategy instead of keeping cash in a term deposit or savings account. Essentially I’d invest in bonds, treating them like a 9 or 18 month term deposit and rolling over into a new bond when each matures.

My main concern with this is I don’t want to taint my long term share investments and have to pay capital gains on them when and if I sell them.

CJ
03-07-2013, 11:03 AM
I dont think there would be 'tainting' between a bond portfolio and a share portfolio - each should be treated separately.

Plus it looks like you are holding to maturity (even if not buying from new) so you are not trading.

born2invest
03-07-2013, 11:20 AM
I dont think there would be 'tainting' between a bond portfolio and a share portfolio - each should be treated separately.

Plus it looks like you are holding to maturity (even if not buying from new) so you are not trading.

Ok thanks CJ appriecate the help.

Jessie
04-07-2013, 08:02 AM
You do pay tax on capital gain from sale of bonds. I think this should be entered as 'Other Income' in the IR3 form. There is a form (IR3K) for calculating the amount to pay.

However, I am a little unclear whether you can claim a loss unless you are in the business of trading in financial arrangements (ie, a professional trader), although IR3K indicates you can claim a loss (enter as a negative amount in the Other Income box of IR3).

In that case, can people who lost money in finance companies claim these losses against their tax? I think not but would be interested to hear otherwise.

Also, although the situation is clear for bonds with fixed maturities, I am uncertain how to treat perpetuals such as IFTHA which have no fixed maturity date - I assume these should be treated the same as shares? ie, if you bought them for their interest income, then you can't claim losses nor do you have to declare profits when you sell them.

I am not sure how reset securities such as RBOHA are treated. I assume these also should be treated the same as shares? They have no certain maturity date even though there is an expectation they will be redeemed in 2017.

CJ
04-07-2013, 08:16 AM
You should be able to claim losses and well as the gains.

Having said that, in the complex formulas that determine the gain/loss, I dont think the default by the finance companies is allowed so you dont get to claim the loss on those.

Perpetuals should be the same as fixed bonds - you do the base price adjustment calc when you sell and that will give you the gain/loss.

From the master tax guide:
Base price adjustment calculation

IT07 ss EW 31, EW 47, EZ 52D, YA 1

The base price adjustment formula for a party to a financial arrangement is incorporated in the following formula:


consideration − income + expenditure + amount remitted


where:

consideration
is all consideration that has been paid, and all consideration that is or will be payable, to the person for or under the financial arrangement, … minus all consideration that has been paid, and all consideration that is or will be payable, by the person for or under the financial arrangement (ignoring non-contingent fees, if the relevant method is not the IFRS financial reporting method and non-integral fees, if the relevant method is the IFRS financial reporting method)


Note that if any of ss EW 32 to EW 48 or EZ 52D applies, the consideration is adjusted under the relevant section.

income
is income derived by the person under the financial arrangement in earlier income years; dividends derived by the person from the release of the obligation to repay the amount lent; and any suspensory loan remission

expenditure
is expenditure incurred by the person under the financial arrangement in earlier income years, and

amount remitted
is any amount that is not included as part of the consideration which has been remitted by the person or by operation of law.

An amendment applies from 26 September 2010 to adjust the consideration for financial arrangements to which both Determination G22 and Determination G22A (optional convertible notes) apply, so that any deductions claimed under Determination G22 are not clawed back: s EZ 52D. See also ∂6-218.

A non-contingent fee is a fee for services provided for a person becoming a party to a financial arrangement and that is payable irrespective of whether the financial arrangement proceeds. A non-integral fee is a fee or transaction cost that, for the purposes of financial reporting, is not an integral part of the effective interest rate of a financial arrangement.


The deduction under the income item for a company releasing a debt owed to it by a shareholder ensures that there is no double taxation of the release. The release is a dividend and not also financial arrangement income under the base price adjustment.


To calculate a base price adjustment for a financial arrangement, it is necessary to take into account the consideration payable under the financial arrangement. The topic of consideration is addressed in considerable detail by the financial arrangements rules. Specific aspects that are discussed are the following:

▪ consideration paid to a person upon exit from and entry into the financial arrangements rules together with a disposal for inadequate consideration: see ∂6-370

▪ consideration paid by a person upon entry into and exit from the financial arrangements rules together with an acquisition for inadequate consideration: see ∂6-380

▪ consideration under an agreement for the sale and purchase of property or services or a specified option: see ∂6-400

▪ consideration under a debt-parking arrangement: see ∂6-410

▪ consideration where debt is released for natural love and affection: see ∂6-420

▪ consideration upon a release of debt by statute: see ∂6-430.

The calculation will produce an amount that is nil, positive or negative. The consequences are the following:

▪ a positive amount is income derived except to the extent of non-deductible expenditure under the financial arrangement in previous income years (see ∂5-263)

▪ a negative amount is expenditure incurred for which a deduction is allowed (see ∂10-452), and

▪ a nil amount is neither income nor a deduction.

Example:
A Co issues B Co with a five-year debenture with a face value of $30,000 for $30,000. The stock pays 8% in arrears. Financial arrangement income and expenditure on a yield to maturity basis is $2,400 per annum. In the middle of the term of the stock, and before the interest payment is made in the third year, B Co sells the stock to a third party. The value of the stock has declined to $27,000, as general interest rates have risen. The base price adjustment for B Co will be:

consideration − income + expenditure + amount remitted

determined as follows:

▪ consideration = $1,800, being $27,000 plus the interest income for the past two years of $4,800 less the $30,000 lent by B Co

▪ income = $4,800, the income derived in previous years

▪ expenditure = nil, and

▪ no amount has been remitted.

The base price adjustment for B Co is:

$1,800 − $4,800 + $0 + $0 = ($3,000)

The negative amount is expenditure incurred. B Co will have an allowable deduction, because the ($3,000) arises from income derived by B Co in previous years, which is not otherwise allowed as a deduction.

For A Co, when the financial arrangement matures after six years, the base price adjustment will be as follows:

▪ consideration = ($14,400), being the $30,000 paid to A Co less the $14,400 paid by A Co in interest less the $30,000 paid by A Co

▪ income = nil

▪ expenditure = $12,000 (five years ◊ interest of $2,400 pa), the amount incurred by A Co in previous years, and

▪ no amounts have been remitted.

The result for A Co is:

($14,400) − $0 + $12,000 + $0 = ($2,400)

The negative amount is expenditure incurred for which a deduction is allowed.

The position of the creditor under the financial arrangement that is subject to the legal defeasance is also addressed. It is confirmed that when the creditor comes to calculate the base price adjustment, the calculation must include the consideration received from the party who assumed the obligations of the original debtor. As a consequence, the consideration for the purposes of the calculation encompasses what was received from both debtors. See s EW 47.

One objective of calculation of the base price adjustment appears to be to identify as income, in the hands of a debtor, the amount of any release of debt.

Example:
PR Ltd has a debt of $300,000 owed to LO Ltd but is unable to repay the debt in full. PR Ltd arranges a payment of 50Ę in the dollar in full and final satisfaction of the debt. PR Ltd must calculate a base price adjustment to identify any financial arrangement income now that the financial arrangement has matured according to the settlement agreement.

Calculation of the base price adjustment for PR Ltd is as follows:

consideration − income + expenditure + amount remitted

where:

▪ consideration = the consideration paid or payable by PR Ltd (now $150,000) less the consideration paid by LO Ltd ($150,000) = 0

▪ income = 0

▪ expenditure = 0, and

▪ amount remitted = $150,000.

The result of $150,000 is financial arrangement income for PR Ltd.

There are exceptions to an outcome of this kind. The release of debt in consideration of natural love and affection and upon discharge from bankruptcy does not result in financial arrangement income.


The release of debt also raises gift duty implications. Where the release occurs in the context of a debtor who is insolvent, there may be no inadequacy of consideration that attracts gift duty. The release confers no benefit on the debtor, because the insolvency indicates that there is no capacity to repay.


Public binding ruling BR Pub 10/21, “Interest repayments required as a result of the early repayment of a financial arrangement — deductibility”, addresses when a base price adjustment is required where the amount of interest paid is reduced as a result of the early repayment of a financial arrangement. Where there is a full withdrawal of the term deposit before contract maturity, a base price adjustment is required and the amount of interest repaid is included in the “consideration” element of the base price adjustment. Where there is a partial withdrawal of a term deposit, a base price adjustment is not required. The ruling applies from 16 December 2010 to 16 December 2013.

http://www.ird.govt.nz/forms-guides/keyword/individualincometax/ir003k-form-saledisposearrange.html

Jessie
04-07-2013, 09:02 AM
Thanks for that CJ.

However, are you sure that perpetuals are treated the same as bonds? I think I remember reading somewhere that they should be treated like shares.

I need to clarify this as in this current year I have made an $8000 profit on sale of IFTHA and a $4000 loss on sale of RBOHA.

CJ
04-07-2013, 09:50 AM
However, are you sure that perpetuals are treated the same as bonds? I think I remember reading somewhere that they should be treated like shares. Not sure.

I dont see a carve out in the excepted financial arrangement definition:
http://www.legislation.govt.nz/act/public/2007/0097/latest/DLM1515242.html

A perpetual doesn't fall within the definition of 'share'

Jessie
04-07-2013, 10:15 AM
Not sure.

I dont see a carve out in the excepted financial arrangement definition:
http://www.legislation.govt.nz/act/public/2007/0097/latest/DLM1515242.html

A perpetual doesn't fall within the definition of 'share'

Yes. It seems from this definition that perpetual bonds (eg IFTHA) and reset securities (eg RBOHA) are not 'excepted financial arrangements', and therefore capital gains or losses are taxable.

However, preference shares (eg KCSHA) are 'excepted financial arrangements' and capital gains/losses are not taxable.

However, I would like to be sure before I fill in next year's tax form.

BIRMANBOY
04-07-2013, 01:37 PM
If you want to be SURE contact the IRD or talk to your accountant (as long as they are CPA)
Yes. It seems from this definition that perpetual bonds (eg IFTHA) and reset securities (eg RBOHA) are not 'excepted financial arrangements', and therefore capital gains or losses are taxable.

However, preference shares (eg KCSHA) are 'excepted financial arrangements' and capital gains/losses are not taxable.

However, I would like to be sure before I fill in next year's tax form.

Dubdee
05-07-2013, 02:36 PM
if you are a trader all income is assessable and losses deductible.

If you are not a trader then the income from bonds is subject to the accrual rules ( over the life of the arrangment income is everthing that came in less the arangement cost). Special rules apply to how that income is apportioned each year. Trusts and companies must use the accrual rules, a private individual holder may return the cash payments only . However over the life of the holding you must return the same amount: All that came in less cost. So there is no tax free income on a bond. Remember a bond is a debt security so preference shares are not bonds. However for capital account holders there is a snag.

If the sale price is below cost price the return might be negative, thereby giving a loss. This would be normally tax deductible. However if the loss is due to issuer specific causes ( reduction in issuer credit standing or rating, insolvency or a compromise with creditors (read Blue Star) the the loss is not deductible. To my knowledge this has never been tested in court.

Since everthing is assessable but sometimes some capital losses are non deductible, there is no point in holding bonds on capital account. you should be always be a trader if you hold bonds.

Snoopy
09-07-2013, 11:23 AM
If you are a trader all income is assessable and losses deductible.

If you are not a trader then the income from bonds is subject to the accrual rules (over the life of the arrangement income is everything that came in less the arrangement cost). Special rules apply to how that income is apportioned each year. Trusts and companies must use the accrual rules, a private individual holder may return the cash payments only.


Are you sure about that? I once held a bond in my own name on which I made a small capital loss when it matured. I did as you suggested and paid tax in accordance with the cash payments only, with a wind up calculation to account for the loss at the end. However, I was told that subsequent to me buying that bond the tax rules had changed. That means that while what I did was OK, if I did the same thing again I would be subject to the accrual rules and that effectively means (in this example) drip feeding my roll up calculation loss against the bond income assuming that I would hold the bond to maturity, even if I did not do so and sold out early. IOW the accrual rules now apply to individuals as well.



Since everything is assessable but sometimes some capital losses are non deductible, there is no point in holding bonds on capital account. You should be always be a trader if you hold bonds.


Perhaps, but if you just hold one or two bonds in reputable companies, I think the amount of time and money setting up different trading entity should be evaluated against the unlikely event of your blue chip bond going belly up.
Personally I don't know anyone who has set up a trading entity just to hold bonds.

SNOOPY

CJ
09-07-2013, 12:01 PM
Snoopy - I am pretty sure the cash basis person rules are still there. Maybe you are richer than the maximum criteria to which they apply?

Xerof
09-07-2013, 01:19 PM
CJ, where can I find a definition of a financial arrangement, in the context of hybrids traded on NZDX? I'm wondering if I will need to file an IR3K for next year on a sale of OCFHA

I am definitely a cash basis person, as defined

CJ
09-07-2013, 01:28 PM
CJ, where can I find a definition of a financial arrangement, in the context of hybrids traded on NZDX? I'm wondering if I will need to file an IR3K for next year on a sale of OCFHA

I am definitely a cash basis person, as definedThe legislation was linked in post #9 (quote below). If you look around that part of the act, you will get all the answers, if you can interpret it. Actually I lie, that is only half the story as you need to look at determinations as well but it is a good start.


I dont see a carve out in the excepted financial arrangement definition:
http://www.legislation.govt.nz/act/public/2007/0097/latest/DLM1515242.html

A perpetual doesn't fall within the definition of 'share'

Xerof
09-07-2013, 02:53 PM
Thanks

you were right, someone is trying to clear my brain matter of the walls

Dubdee
10-07-2013, 11:08 AM
Simply put the accrual rules apply to all investors in debt securities and they are quite simple: income is everything that came in less the cost of the arrangment, over its life. However where it gets complicated is how to report it over any income year. Trusts and companies must use a spreading system such as yield to maturity, whilst indivuals if they are small holders can record annual income using cash bais excpet for the final year where any "capital" gain or loss must be captured. Over the whole life income should be the same. I use YTM. I doubt if there is anyone in IRD quafied to check my calculations (whats the YTM on a perpetual bond bought at a discount?)

However I have taken a bath on bond defaults (Credit Sails and Blue Star) and the only way to get relief on the loss is to be a trader which I am in my bond holding entity. Loss cause by issuer credit events for capital holders does not gain tax relief.

CJ
10-07-2013, 11:22 AM
(whats the YTM on a perpetual bond bought at a discount?)YTM probably doesn't apply to perpetuals so you would need to use one of the other methods?

But you are right, in theory simple, in practice, no one knows whether they are right or wrong but the IRD doesn't know any better.

Jessie
11-07-2013, 09:47 PM
Isn't OCFHA defined as a preference share in which case it is an excluded financial arrangement? In that case, capital gains may not be taxable.

Dubdee
13-07-2013, 11:27 AM
Jessie you are right that a preference share is an exempted financial arrangement. However I dont think this gets you off the capital gains tax hook. It seems clear to me if the issuer redeems or the pref is sold and you have purchased at a discount the gain on sale or redemption should be taxable on genral principles of what constitutes income. Its all about intent: if you intend to sell than the gain or loss on sale is taxable. This is unlike a rental property where I think it can be more readily argued that gain on sale was incidental to the primary purpose of gaining rent.

Jessie
15-07-2013, 08:19 PM
Dubdee, I'm not so sure. OCFHA has no redemption date. I would buy it purely for its income in the form of interest. Any rise or fall in capital value would be incidental. It is no different to buying a dividend-paying share. This same argument would apply to a number of other perpetual preference shares such as BNSPA. However, because IFTHA is not a preference share it is not an excluded financial arrangement. Therefore, I am assuming that capital gain on IFTHA is always taxable.