The federal government is still planning to eliminate so-called “character conversion” transactions, as promised in the latest federal budget, but it is now proposing a much more forgiving transition to the new tax treatment.
In the budget, the government proposed measures designed to halt the use of derivatives to convert ordinary income into capital gains, a technique that many investment funds use to boost after-tax returns. (See Investment Executive, Budget 2013: Funds, ETFs take a hit, April 2013.)
Given that the change will have a significant impact on the fund industry, it sparked a call from the industry for more time to adjust, a call that the government now appears to be heeding.
Under the original budget proposal, funds would only have 180 days from budget day (March 21) as a transition period.
However, on Thursday the government released a proposal to extend the transitional relief for transactions entered into before March 21, until the end of 2014. “This would provide affected taxpayers with additional time to transition away from their derivative forward agreement structures,” it says.
The extended grandfathering would apply to situations where investment funds use a series of rolling 30-day agreements, and longer-term transactions, that terminate by the end of 2014. “For example, where an investment fund enters into rolling forward agreements every 30 days, the fund would be able to continue entering into new forward agreements as continuation of the series and be entitled to grandfathering, provided that the series of forward agreements concludes prior to 2015,” it says.
To prevent firms from exploiting the more flexible transition arrangements, the proposals specify that relief won’t be available to agreements if they are increased beyond certain limits after March 21 of this year. “As a result, investment funds that stay within their growth limits would have until the end of 2014 to unwind their derivative forward structures while still qualifying for grandfathering,” it notes.
However, the proposed rule would allow funds to merge, as long as the resulting increase in the notional amount of the derivatives doesn’t exceed their combined amount immediately before the merger.
Grandfathering could also continue past 2014 for forward agreements that are scheduled to finally settle after 2014, it notes, provided that limits on growth are followed. And, the grandfathering would end for good by March 21, 2018, which, the government says will “ensure that investment funds are not given an inappropriately long period of grandfathering…”