IFM02230 - Authorised investment funds (AIFs): structure, arrangement and tax status of funds: equalisation
Equalisation is a mechanism that features in many authorised investment funds. Its purpose is to ensure that the rights of existing investors in such funds to share in the income of the fund is not affected by the issue of further units or the redemption of existing units.
Issue of new units (or re-sale of existing units) by fund manager
To achieve this, and also ensure that the same distribution is paid in respect of every unit, the creation price of new units or the purchase price of re-issued units (‘offer price’) may include an amount of income that has accrued up to the date of purchase. This accrued income element in the price is called ‘equalisation’.
Units that are purchased or held at the beginning of a distribution period and held throughout that distribution period are referred to as Group I units. This type of unit will be entitled to a full share of the income that has accrued in the distribution period.
Units which are purchased part way through a distribution period are referred to as Group II units and are only entitled to a share of the income that has accrued in the distribution period from the date of purchase. It follows that ‘equalisation’ is paid only on Group II units.
The equalisation element in the ‘offer price’ is passed from the manager to the AIF to be included in the distribution account and is distributed to Group II unit holders at the end of the distribution period.
The distribution payable per unit for a distribution period is the same for Group I units and Group II units. For Group I units, the distribution is all income. For Group II units, the distribution is partly income and partly equalisation. A Group II unit holder receives a distribution comprising two amounts:
- Income which has accrued from the date of purchase, and
- A return of capital in the return of the equalisation element.
The overall effect is that income is distributed to unit holders broadly in proportion to the length of time of ownership of the units in the distribution period.
Because returned equalisation is not part of the income distribution and is a capital receipt it should be deducted from the unit holder’s cost of the units for CGT purposes (see CG57705).
Redemption of units (sale by participant to fund manager)
A unit holder who sells units will receive a single capital sum which will include an amount in respect of the income accrued to the date of disposal. The realisation price (the ‘bid price’) will reflect the income accrued up to the date of redemption. The full amount of the realisation price will be disposal proceeds for participants in any capital gains calculation.
Example of equalisation
An AIF has two unit holders A and B each holding one unit.
The capital value of the AIF is £1000 and income accrues at 8% per annum throughout the distribution period, which is six months.
After three months C decides to purchase a unit and the price to be paid is £510. (This is made up of £500 capital value plus £10 reflecting the accrued income - £1000 x 8% x 3/12 x 1/2 = £10.) The £10 is the ‘equalisation’ payment.
At the end of the distribution period the amount available for distribution is £60 made up of £50 income (£1000 x 8% x 6/12 + £500 x 8% x 3/12) and £10 ‘equalisation’.
Each unit holder receives £20 but A and B each receive £20 income having held their units throughout the distribution period and C receives £20 of which £10 is income (reflecting the three months which C held a unit) and £10 is the returned ‘equalisation’, a capital sum.
Note that in practice calculations would be done on a daily and not a monthly basis.