Uncertainty remains over index funds

Uncertainty still surrounds the future place of index funds, although the Inland Revenue Department made a clear policy statement on their status late last year.

Since that review was announced many of the original index funds have had to renew the binding rulings they had from IRD which allows them to keep their capital-gains free tax status.

Good Returns has spoken to the majority of managers who provide index funds and found there is still considerable uncertainty about the status of existing funds. None of the funds that currently have to renew their binding rulings have had long-term extensions.

Instead they have had their existing rulings rolled over for a three-month period which expires at the end of June.

Good Returns has been unable to get comment on the issue from IRD. However, it understands that the new rulings haven't been issued because the department is still working through a number of points.

One of the main one relates to ownership of the funds. IRD said in its review that passive funds must be widely held and cannot be controlled by a single or a small group of entities.

While the criteria seems innocuous it has far reaching affects as some of the biggest funds are caught by this decision.

Fund managers and tax experts are baffled by this criteria and why IRD are insisting on it.

"You have to question IRD's right to look at ownership structures as that is not part of the passive test," one expert says.

Deloitte Touche Tohmatsu tax partner Joanne McCrae says she is aware of a number of single investment funds which have chosen not to renew their rulings because of this ownership issue.

The only widely-held (or retail funds) which have been hit by the IRD review are Direct Funds Management's First and Second 15 funds.

The funds (which were formerly established and run by Renouf Asset Management) have recently been closed.

Direct boss Nigel Wynn says despite the Second 15 fund having great performance it was uneconomical to renew the rulings.

He says the two funds had about $3 million of funds under management in total.

FundSource executive chairman David van Schaardenburg says the IRD review has made it a lot tougher for index funds as their costs for getting a ruling have ballooned significantly.

He reckons that the break-even point for a passive fund has risen.

While index funds were the big innovation five years ago the industry has moved on and is using other structures now such as Australian domiciled funds, he says.

Besides the funds currently going through the review process and those that have chosen not to, there is a third grouping. This group haven't started on the renewal process, or aren't due to do so until next year. This includes offering from Bank of New Zealand and Guardian Trust's property sector funds.