As a consequence, bonds and risk-hedging derivatives [including options, swaps and forwards, or any other assets generating interest and return capital to investors] become subject to TOFA from 1 July. This requires investors to report current and future financial arrangements under the rules prescribed by the law. DST Global Solutions, a vendor of investment administration software, has worked with clients to interpret the legislation: to understand what it requires from them; and to determine which of the specified reporting methods would be most appropriate for them. The law provides two default options [‘compounding accruals’ and realisation] and four electives: hedging, financial reports, fair value, foreign exchange transactions.
If an investor chooses an elective, their decision is irrevocable. “When you understand what the various methods are, you have to think about what the upstream impact of adopting one of them will be,” Ian Mathieson, chief executive of DST, said. For instance, choosing the ‘fair value’ elective would apply this tax treatment to equity portfolios as well as financial arrangements, and terminate any capital gains tax concessions granted to shares owned for more than 12 months, Mathieson said. Most of DST’s clients have chosen to use the compounding accruals method, which forces investors to pay tax on earnings at regular intervals, rather than at the end of the life of investments – such as bond returns.
The vendor has built a TOFAenabled version of its investment administration system, HiPortfolio, and has worked with clients as they test the software and “cleanse” historical transaction data for inaccuracies, Mathieson said. “Because we’re talking about supporting taxation over the life of an investment, you need more than balances. You need the transaction details. “A systems upgrade is fairly daunting, but the extra complexity of a whole new taxation program means they’ve had to cleanse their data.” A major backoffice challenge that funds would face down the track would be ensuring a smooth transfer of clean transaction data when they change custodians, he said. “There are some provisions that allow for estimations. But you have to have a demonstrable, clear set of estimations and evidence. Sometimes this can be more work than having the data cleansed.” Although investors are nearing the end of their preparation for TOFA, Mathieson was “sure there will be issues” when the legislation becomes live.