With their analytical work and systems re-wiring in train, the investment administrators and custodians who have taken TOFA seriously can now pause to suck in a few lungfuls of air before the new tax regime begins, and their long, hard slog to comply continues. DST Global Solutions, which delivered its TOFA-compliant version of HiPortfolio3 in January, knuckled down more than a year ago to correctly interpret the new legislation, understand the tax options available to investors, and then update its processes and systems. Ian Mathieson, chief executive officer of the company’s Australian business, says the TOFA-Ready project has been the most demanding undertaken by DST on domestic shores. “We’ve gone through Y2K, GST, CGT. None of these have equalled the amount of effort that has gone into TOFA from a project point of view,” Mathieson says.

Few funds have taken the option of implementing TOFA in the current financial year, ahead of the compulsory start date of July 1, 2010. It aims to bring tax law up to speed with new financial instruments, such as derivatives, and provide more certainty over the taxation of ‘financial arrangements’ – that is, where taxpayers have the right to receive, or an obligation to provide, a financial benefit which can be settled in cash. This means that debt instruments such as bonds, or risk-hedging derivatives such as options, swaps and forwards, or any other assets that generate interest and return capital to investors, are subject to TOFA. The laws force investors to pay tax on earnings, such as bond coupons or rent payments, during the life of the investment on a “compounding accruals basis”, rather than in one final hit at the end.

Paul Khoury, chief operating officer at State Street, says it should make tax more manageable and potentially stop “large tax surprises” as assets mature, but won’t lead to large reductions in liabilities. “The tax on these instruments themselves should be the same, it’s about the timing,” Khoury says. Investors have been presented with five methods of applying TOFA to their portfolios. The default ‘compounding accruals’ option, and four electives: hedging, financial reports, fair value and foreign exchange retranslation. Because each option can affect funds in different ways, and the decision to choose an elective option is irrevocable, TOFA has become a very big deal. “The impact of taking the wrong election could make an impact on people’s retirement, and many people haven’t taken this view,” Mathieson says. He points out that if a funds manager chooses the ‘fair value’ elective, the tax treatment will also be applied to equity portfolios, terminating the capital gains tax concessions awarded to shares owned for more than 12 months.

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