Authorised investment funds (AIFs): structure, arrangement and tax status of funds: manager's equalisation
In parallel with the creation and cancellation of units, the manager may operate a ‘box’. That is, the manager will repurchase units from unit holders, hold them for a period, and then sell them on to new unit holders. The manager ends up out of pocket, as, although on resale the manager recovers the original value of the unit, the accrued income which formed part of the manager’s purchase price and the income accruing whilst the unit was held by the manager is not recovered (since the equalisation included in the sale price is paid to the trustee/ depositary and then returned to the unit holder at the end of the distribution period).
An amount, or an averaged amount, representing the unrecovered income is distributed from the distribution account to the manager, notwithstanding that the units are no longer held. This amount may be referred to as the ‘manager’s intermediate holding income’ or as ‘equalisation paid to the manager’.
A trust has two unit holders A and B.
The capital value of the trust is £1000 and income accrues at 8% per annum throughout the distribution period, which is six months.
After three months A decides to sell a unit and the price paid by the manager is £510. (This is made up of £500 representing the underlying capital value and £10 reflecting the accrued income - £1000 x 8% x 3/12 x 1/2 = £10.) A receives this as a capital sum.
The manager holds the unit in the ‘box’ for one and a half months, a further £5 income accruing to the trust.
The unit is then sold to C who pays £515 made up of £500 capital value and £15 accrued income, (£10 for the first 3 months and £5 for the next month and a half). The manager retains the £500 capital as this is the reimbursement for the £500 (representing the underlying capital value) paid to A, but the £15 representing the accrued income - the ‘equalisation payment’ is paid to the trustee who retains this in the distribution account.
At the end of the distribution period the amount available for distribution is £55 made up of £40 income (£1000 x 8% x 6/12) and £15 ‘equalisation’.
B and C each receive £20 but B receives £20 income having held the unit throughout the distribution period and C receives £20 of which £5 is income (reflecting the one and a half months which C held a unit) and £15 is the returned ‘equalisation’.
That leaves £15 income in the trust (B has received £20 and C £5) and this amount is paid to the manager; £10 reimburses the manager for the amount paid to A and £5 is the income which accrued whilst the manager held the unit in the ‘box’.
Note that in practice calculations would be done on a daily and not a monthly basis. Also in practice, in the case of a fund paying interest distributions the calculation may include further adjustments to take into account the effect of income tax deducted from distributions so that a ‘net price’ can be quoted by the fund.