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Special determination S20: Convertible redeemable notes and preference shares

This Determination may be cited as Special Determination S20: "Convertible Redeemable Notes and Preference Shares".

1. Explanation (which does not form part of the determination)

  1. This Determination relates to convertible redeemable notes (CRNs) issued by Company A (Issuer) to Company B (Noteholder), and to Preference Shares issued by Company C.
  2. The CRNs are perpetual debt securities in respect of which the Noteholder loans funds to the Issuer. Coupon Interest will be paid (in cash) on the Principal Amount of the CRNs until the CRNs are redeemed or converted. The Issuer may redeem the CRNs in cash for the Principal Amount plus the Cash Redemption Premium. Alternatively, the Issuer may convert the CRNs to ordinary shares by issuing Conversion Shares in repayment of the Principal Amount, being a fixed number of ordinary shares in the Issuer.
  3. It was expected at issue that the CRNs would become an expensive form of funding over time, as the Interest Rate increases. As the Cash Redemption Premium increases over time, there is an increasing economic incentive for the Issuer to convert the CRNs to Conversion Shares rather than redeem them for cash.
  4. The Issuer used the Principal Amount to subscribe for Preference Shares in Company C.
  5. An amount (whether it is income, consideration, gain, loss or expenditure) that is solely attributable to an excepted financial arrangement (as described in ss EW 5(2) to EW 5(16) of the Income Tax Act 2007) is not taken into account under the financial arrangements rules (in accordance with s EW 6(2)).
  6. This Determination prescribes a method for determining the part of the consideration receivable by the parties to the arrangement that is solely attributable to the excepted financial arrangements.

2. Reference

  1. This Determination is made pursuant to s 90AC(1)(h) of the Tax Administration Act 1994.

3. Scope of determination

  1. This Determination applies to a wider financial arrangement constituted by
    1. the CRNs;
    2. the Preference Shares; and
    3. the Conversion Shares.

4. Principle

  1. The CRNs, the Preference Shares and the Conversion Shares are each part of a wider financial arrangement that has "excepted financial arrangement" components as defined in s EW 5 of the Income Tax Act 2007. The excepted financial arrangements are:
    1. the Preference Shares; and
    2. the Conversion Shares.
  2. The CRNs are a hybrid financial arrangement which have a debt and an equity component. The equity component arises from the option available to the Issuer to issue the Conversion Shares to the Noteholder in lieu of repayment in cash (of the Principal Amount plus the Cash Redemption Premium).
  3. As the CRNs have this dual character, when calculating income or expenditure in relation to the CRNs it is first necessary to separate the debt and equity components of the CRNs. For the purposes of this determination it is assumed that, if the Issuer issues Conversion Shares to the Noteholder in lieu of payment of the Principal Amount in cash, any difference between the market value of the Conversion Shares and the Principal Amount is solely attributable to the Conversion Shares. Consequently, the difference is solely attributable to an excepted financial arrangement.
  4. Any income, consideration, gain or loss, or expenditure that is solely attributable to an excepted financial arrangement is not included when calculating income or expenditure under the financial arrangements rules.
  5. This Determination specifies that the amounts that are solely attributable to the excepted financial arrangements are:
    1. the amounts paid under or with respect to the Preference Shares; and
    2. if the Issuer issues Conversion Shares to the Noteholder in lieu of payment in cash, any difference between the market value of the Conversion Shares and the Principal Amount.
  6. This Determination specifies that no part of the Principal Amount, the repayment of the Principal Amount, the Coupon Interest, and any Cash Redemption Premium under the CRNs is solely attributable to an excepted financial arrangement.

5. Interpretation

  1. In this Determination, unless the context otherwise requires, words and expressions which have not been defined elsewhere within the determination have the same meaning as in s YA 1 of the Income Tax Act 2007.
  2. In this Determination, the following expressions (which have not been defined elsewhere in this Determination) have the following meanings:
    1. “Cash Redemption Premium” means any amount paid by the Issuer to the Noteholder in excess of the Principal Amount on redemption of the CRNs for cash. If the CRNs are redeemed for cash under clause 4.5(b)(ii) of the Terms and Conditions, the Cash Redemption Premium is 2% if the CRNs are redeemed on or before 31 December 2011, 4% if the CRNs are redeemed from 31 December 2011 but on or before 31 December 2012, 6% if the CRNs are redeemed from 31 December 2012 but on or before 31 December 2013, then it continues to increase by a further 2% for each successive two yearly Interest Rate reset period (as stated in clause 4.2(b)(ii) of the Terms and Conditions).
    2. "Conversion Shares" means a fixed number of fully paid ordinary shares in the Issuer issued to the Noteholder pursuant to clause 4.3 of the Terms and Conditions, after making any adjustment required pursuant to clause 5 of the Terms and Conditions. Pursuant to clause 4.3, the $1 Principal Amount of each CRN will convert to 2.1 fully paid ordinary shares in the Issuer.
    3. "Coupon Interest" means quarterly interest payments by the Issuer to the Noteholder pursuant to clause 3 of the Terms and Conditions, and includes any amount of unpaid interest which is subsequently paid pursuant to clause 3.2(b) of the Terms and Conditions.
    4. "Interest Rate" means 8% until 31 December 2011, and subsequently the rate determined under clause 3.5 of the Terms and Conditions. Under clause 3.5 the interest rate is: from 31 December 2011 until 31 December 2013, a two year interbank swap rate on 31 December 2011 plus a margin of 550 basis points; from 31 December 2013 until 31 December 2015 a two year interbank swap rate on 31 December 2013 plus a margin of 650 basis points; and from 31 December 2013 reset at a 2 year interbank swap rate plus a margin of 650 basis points every two years (while the CRNs remain on issue).
    5. "Preference Shares" means preference shares in Company C which the Issuer subscribed for in accordance with clause 2.2 of the Subscription Agreement for Convertible Redeemable Notes between the Issuer and the Noteholder, or any such shares that are reclassified as ordinary shares.
    6. "Principal Amount", in relation to each CRN, means $1. References to the aggregate Principal Amount are to the aggregate of the Principal Amount of all the CRNs, being an aggregate Principal Amount of approximately NZ$32.5 million.
    7. "Terms and Conditions" means the CRN terms set out in Schedule 1 to the Subscription Agreement for Convertible Redeemable Notes between the Issuer and the Noteholder.

6. Method

  1. Where the CRNs are converted to Conversion Shares pursuant to clause 4.1 of the Terms and Conditions, any amount by which the value of the Conversion Shares is above or below the aggregate Principal Amount of the CRNs is solely attributable to the Conversion Shares.
  2. The amounts that are solely attributable to the Preference Shares are:
    1. The issue price per Preference Share of $1;
    2. Any dividends paid on the Preference Shares by the Issuer;
    3. Any other distributions paid on or with respect to the Preference Shares; and
    4. Proceeds derived by the Issuer from the disposal or redemption of the Preference Shares.
  3. No other income, gain, loss, expenditure or consideration paid under or with respect to the wider financial arrangement is solely attributable to an excepted financial arrangement component of the wider financial arrangement. Consequently, all other amounts in relation to the CRNs (such as the Principal Amount, Coupon Interest and any Cash Redemption Premium) are taken into account under the financial arrangements rules.

7. Examples

Example A: Value of Conversion Shares exceeds the aggregate Principal Amount

  1. This example illustrates the application of the method (set out in this Determination) for determining the amounts attributable to both the debt and equity components of the CRNs to be issued by the Issuer to the Noteholder.
  2. The example assumes the following:
    • The CRNs are issued on 16 January 2010 and the Noteholder will continue to hold the CRNs until 31 December 2015.
    • The aggregate Principal Amount subscribed for the CRNs is NZ$32.5 million.
    • The Issuer uses the aggregate Principal Amount to subscribe for Preference Shares in Company C, and derives dividends from them.
    • Coupon Interest payments are not at any time suspended.
    • The Issuer exercises its option to convert the CRNs to Conversion Shares on 31 December 2015.
    • On conversion, the value of the Conversion Shares is NZ$40 million, ie exceeding the aggregate Principal Amount.
  3. The Coupon Interest will not be solely attributable to an excepted financial arrangement. Consequently it will be expenditure under the financial arrangements rules.
  4. All other income or expenditure will be solely attributable to the excepted financial arrangement components of the wider financial arrangement. Consequently the financial arrangements rules will not apply to such amounts.
  5. The difference between the value of the Conversion Shares and the aggregate Principal Amount will be attributable to an excepted financial arrangement, and so will not be income or expenditure under the financial arrangements rules.

Example B: Aggregate Principal Amount is equal to or less than the value of Conversion Shares

  1. This example proceeds on the same basis as Example A, except that the value of the Conversion Shares is less than the aggregate Principal Amount.
  2. The amounts solely attributable to an excepted financial arrangement are the same as in Example A. Consequently the expenditure under the financial arrangements rules will be the same as in example A.

Example C: Value of Conversion Shares less than the aggregate Principal Amount

  1. This example proceeds on the same basis as Example A, except that the Issuer exercises its option to redeem the CRNs for cash on 31 December 2015.
  2. The Coupon Interest and the Cash Redemption Premium equal to 6% of the aggregate Principal Amount payable on redemption will not be solely attributable to an excepted financial arrangement. Consequently these amounts will be expenditure under the financial arrangements rules.

This Determination is signed by me on the 12th day of December 2011.

Howard Davis
Director (Taxpayer Rulings)