Funds with global currency exposure affected by tax law
Funds with foreign exchange currency hedging exposure may run into trouble under Australian tax law in the coming months, according to Zenith investment analyst Andrew Cassar.
A research report from Zenith said the Macquarie International Infrastructure Securities Fund has halted income distributions to unit holders for the March quarter as a result of the fund’s foreign exchange hedging position.
The fund has been affected by Australian tax law, which states that realised gains or losses on forward foreign exchange contracts are treated as ‘income’ which cannot be offset by unrealised gains or losses on the underlying investments, which are categorised as capital.
Realised capital losses are quarantined and carried forward and can only be offset by realised capital gains.
“It’s an Australian tax legislation which is currently being looked at to avoid this occurrence happening but until such time, they by law have to not distribute income while they currently hold a realised loss on their books,” Cassar said.
This is an issue a number of funds with hedging exposures going forward may face, Cassar said, and could include global property, international fixed interest and infrastructure funds.
“Anything with a global currency exposure which hedges back into Australian dollars will potentially face [problems],” Cassar said.
“This is the tip of the iceberg and Macquarie were good enough to come out and keep us all informed on their situation.”
Zenith is expecting to see similar occurrences over the next few months as the research house heads into its global property review, beginning in July.
“We expect it to [raise] its ugly head when we review global property,” Cassar said.
However, “at this point of time no one has come to us stating their position but we are tracking it amongst our recommended list".
The Macquarie International Infrastructure Securities Fund is fully hedged to the Australian dollar with forward foreign exchange contracts used.
The decline in the Australian dollar between July and October last year created a realised loss when the foreign exchange contract expired and simultaneously created an unrealised foreign exchange gain on the value of the underlying securities.
According to Zenith, at this point the fund maintains an ‘accounting’ realised loss on its profit and loss statement, which restricts the payment of income distributions to unit holders until the realised loss is recouped.
However, the unit price in the Macquarie fund has not been affected, Cassar said.
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