Edited version of your private ruling

Authorisation Number: 1012560136172

Ruling

Subject: Net rebates

Question 1

Are the net amounts rebated to the Trusts by Entity A in its personal capacity and as the Responsible Entity (RE) of the Trusts a taxable supply that is subject to Goods and Services Tax (GST)?

Answer

No, the net amounts rebated to the Trusts by Entity A in its personal capacity and as the RE of the Trusts is not a taxable supply and therefore, has no GST consequences.

This ruling applies for the following periods:

Not applicable.

The scheme commences on:

Not applicable.

Relevant facts and circumstances

(NOTE for footnote references please see end of document)

The Constitution of each Trust:

(i) Provides that Entity A is entitled to charge the Trust a fee for the services it provides in respect of the management and administration of the Trust and of the Trust's assets;

(ii) Prescribes the maximum (but not the minimum) fees which may be charged, and otherwise enables the Responsible Entity (RE) to set a lower fee at its discretion. The RE will set the actual fee to be applied by its disclosure in the offer document (the "Product Disclosure Statement", referred to as the "PDS" in this application) for the Trust;

(iii) Provides that the management fee is calculated as a percentage of the fund value.

Invoices for the management fees are issued to the Trusts which is a direct cost to the unit holders, who each share in the payment of the fee according to the value of the unit holder's investment in the fund. The fee is calculated and accrued daily, and applied to each investor's holding in the Trust by being included in the unit price calculated for each investor. The fee is paid to Entity A monthly.

There is an important variation to this simple scenario regarding the application of the management fee to the unit holder's investment, in that a managed investment scheme (MIS) might not itself hold its investments directly. Instead, the investments of the MIS might be represented by the holding of units in other managed funds (which themselves directly hold assets of that class). This is often the case where the underlying fund is not a publicly offered fund.

The Product Disclosure Statements (PDS) are regulated under the Corporations Law and must contain certain types of information and disclosures. These include information about

"the cost of the product, and any amounts that will or may be payable by a holder of the product…. [And]... any amounts that will or may be deducted from the fund by way of fees, expenses or charges"¹.

A PDS for a MIS is required by the Corporations Law to detail the amount and types of fees which will be charged to an investor. In particular, the Corporations Law requires that the fee information is presented in a defined manner, using a prescribed fees and costs template (which is in table format)².

In this fees and costs template, the RE is required to disclose "Management Costs" for the MIS. "Management Costs" are defined³, but include any fee payable for administering the fund. Management Costs therefore include the RE's management fee.

In addition, a PDS must disclose the relevant MIS's "Indirect cost ratio" ('ICR')⁴. This is defined by the Corporations Regulations as "the ratio of the management costs for the option that are not deducted directly from a product holder's account, to the total average net assets [of the MIS]"⁵.

The ICR therefore, reflects the RE's management fee charged directly to the relevant MIS, as well as any underlying management fees charged where the MIS has invested in another fund. In other words, if there are any 'cascading' management fees as a result of a fund investing in another fund, this will be reflected in the total management costs disclosed to investors in the ICR.

Commonly, the management fee for an investment fund, stated in the PDS, will be set at level that is competitive with similar funds. Typically, it will not factor in a component for cascading management fees [(i.e. management fees charged by the RE or associated REs for management of underlying funds)].

The Corporations Law requires an RE of an MIS to treat all investors (of the same class) equally⁶. This means (amongst other things) that the RE must charge investors who hold the same class of units the same management fee (subject to some exceptions, as explained below). It also means the RE must generally apply the same unit price, across all investors in a class.

In cases where a fund invests into another fund, there needs to be a way to ensure that unit holders in the investing fund are not adversely impacted, and effectively over charged management fees, as a result of the fees charged by the RE at the underlying fund level. If this occurred, then the management fees borne by those investors may end up exceeding the amount disclosed in the PDS. That could then lead to the RE breaching the Corporations Law, as the PDS would likely be 'defective', giving rise to rights in investors to have their money returned (amongst other potential actions)⁷.

Accordingly, in these cases, the RE is obliged to rebate (to the investing fund) the underlying (cascading) management fees to the extent necessary to ensure that the fees applied to investor funds in the investing Trust do not exceed the stated Management Cost (that is, to ensure there is no 'double-charging' or over charging). In the case of the Trusts that are the subject of this ruling request, each invests in other Managed Investment Trusts (the "Underlying Funds"). These Underlying Funds will themselves naturally incur a management fee for the operation of that Trust and this fee is payable to the same fund manager, i.e. Entity A. At the Underlying Funds level, the fee is deducted from the distribution paid to the Trust in its capacity as a unit holder in the Underlying Funds.

However, in order to ensure that unit holders in the Trusts are not disadvantaged by the fact that the Trusts incur fees in the Underlying Funds (which fees would not be incurred if the assets of the Trusts were held directly), a rebate is applied and the fee is 'equalised' by the passing on of a rebate. These rebate arrangements are not governed by any separate agreement between Entity A and the Trusts. The method of dealing with the potential double application of fees is explained to unit holders.

The making of these rebates is permitted under the Corporations Act, because a Trust investing in an Underlying Trust is taken to be a "wholesale client" (i.e. a wholesale investor). The law allows rebates of fees to be made to wholesale clients⁸.

Entity A as the RE of the Trusts is required to ensure that the level of fees applied in each Trust is consistent with the amount disclosed to its unit holders as the total fee to be applied (as set out by the Management Cost in the PDS). Since the return received by the Trust from the Underlying Funds is less because of the application of a fee in the Underlying Funds, this represents an indirect fee to the Unit holder in the Trust. Left unaddressed, a unit holder in the Trust would in effect be paying total fees in excess of the amount otherwise represented by the Management Cost in the PDS, and the RE would likely be in breach of the Corporations Law.

For the Trusts that are the subject of this ruling request, the calculation of the rebate results in an amount being remitted by Entity A to the Trust because the fee incurred through the Underlying Funds exceeds the fee that would otherwise be directly incurred by the Trusts in relation to the funds they hold.

The remittance of this fee is only required because of the unit pricing structure which requires all units in the Underlying Funds to be priced at the same price, and any adjustment to the unit price to be processed by Entity A as a separate remittance to the Trust.

In the situation where the gross rebate is less than the gross management fee payable by a Trust to Entity A, the RE will treat the gross rebate as an adjustment to the price for GST purposes, thereby reducing the GST payable with respect to the resulting net management fee. You submit this GST treatment is consistent with general industry practice regarding such gross rebates that result in a net management fee being paid to the RE. However, if the gross rebate exceeds the gross management fee payable by a Trust entity, the net rebate amount paid to the trust is not treated as consideration for a supply for GST purposes.

This latter 'net rebate' arrangement is the subject of this GST private binding ruling request. The commercial arrangement is therefore complicated and a diagram (diagram A) was included in the private ruling to elicit greater understanding of how the net rebate works for each Trust.

Diagram A

In diagram A, Entity A charges a 1.2% management fee to Trust A. Trust B has invested solely in Trust A, and the returns it receives take into account (are net of) Trust A's expenses including the 1.2% management fees. Having already effectively incurred 1.2% on its funds under management (through its investment returns from Trust A), Trust B's fee is 'equalised' by passing on 0.4% via a net rebate to ensure that the ICR it effectively pays is properly reduced to 0.8%. In this situation, there is no fee paid directly by Trust B. However, Trust B effectively incurs a 1.2% fee and then receives a 0.4% net rebate, netting out to its correct Management Cost of 0.8%.

In relation to the 'net commission' arrangement, a diagram (diagram B) was included in the private ruling which may elicit greater understanding of how the 'rebate' would form part of the calculation for the commission charged by Entity A to a trust if this scenario applied to it.

Diagram B

In diagram B, Entity A charges a 0.6% management fee to Trust A. Trust B has invested solely in Trust A, and the returns it receives take into account (are net of) Trust A's expenses including the 0.6% management fees. Having already effectively incurred 0.6% on its funds under management (through its investment returns from Trust A), Trust B's fee is 'equalised' by adjusting the fee otherwise payable by Trust B. The commission charged by Entity A to Trust B is 0.3% to ensure that the ICR it effectively pays is properly held at 0.9% (0.3% commission plus 0.6% incurred through the reduced investment returns).

Relevant legislative provisions

A New Tax System (Goods and Services Tax) Act 1999:

Section 7-1

Section 9-5

Section 9-10

Section 9-15

Section 9-40

Reasons for decision

For ease of reference where a Trust invests its funds in a relating Trust we refer to it as an investing Trust.

Entity A submits that the payment of the net rebate does not constitute consideration for a supply made by the respective investing Trusts. Consequently, no taxable supply comes into existence. We agree with this submission for the following reasons.

Subsection 7-1(1) of the A New Tax System (Goods and Services Tax) Act 1999 (GST Act) provides that GST is payable on a taxable supply. Section 9-40 of the GST Act provides that an entity must pay the GST payable on any taxable supply that the entity makes.

As Entity A is proposing to make a net rebate to the respective investing Trust, it must be determined if this payment constitutes consideration for a supply and thus a taxable supply made by the investing Trust.

Section 9-5 of the GST Act defines a taxable supply as follows:

You make a taxable supply if:

(a) you make the supply for *consideration; and

(b) the supply is made in the course or furtherance of an *enterprise that you *carry on; and

(c) the supply is *connected with Australia; and

(d) you are *registered, or *required to be registered.

However, the supply is not a *taxable supply to the extent that it is *GST-free or *input taxed.

(Terms marked with an *asterisk are defined at section 195-1 of the GST Act).

Paragraph 9-5(a) of the GST Act requires an entity to make a supply for consideration.

Section 9-10 of the GST Act defines a supply as any form of supply whatsoever.

Subsection 9-10(2) of the GST Act provides a non-exhaustive list of things that are included as supplies. However, subsection 9-10(4) of the GST Act provides that the payment of money does not constitute a supply for GST purposes. Section 9-10(4) states:

However, a supply does not include a supply of money unless the money is provided as consideration for a supply that is a supply of money.

The Commissioner's view on the meaning of 'supply' is set out in Goods and Services Tax Ruling GSTR 2006/9 Goods and services tax: supplies (GSTR 2006/9).

GSTR 2006/9 sets out a number of propositions to assist in analysing a transaction to identify a supply. Paragraph 222 of GSTR 2006/9 relevantly states:

222. Where the parties to a transaction have reduced their understanding of the transaction to writing, that documentation is the logical starting point in determining the supplies that have been made. An examination of any relevant documentation and the surrounding circumstances, which together form the total fact situation, is also important in determining whether the documentation captures the nature of a transaction for GST purposes.

Accordingly, in determining whether or not the net rebate is consideration for a separate supply made by the investing Trust it is pertinent that the relevant Constitutions (Deed Polls) and the Product Disclosure Statement (PDS) be examined.

In examining the Constitutions and PDS, we have not discovered any binding obligations between Entity A and the respective investing Trusts to make these net Rebates. Neither is there anything to suggest that the Unitholders (eg where investing Trusts are Unitholders of related Trusts) have entered into any binding obligations to receive these net Rebates. The only binding obligations placed on the RE is for it to manage the respective Trusts for the benefit of the Unitholders with full and complete powers of management.

The respective PDSs authorise Entity A to make net rebates however, this is an agreement between the RE and the investors. In essence these PDSs contain clauses that authorise these net rebates. For instance every PDS has a clause which states:

The Fund may invest in other funds managed by us or our associates. Where this occurs, Management Fees will not be taken from each fund. Instead, our Management Fees will be adjusted to reflect the Fund fees described above.

Proposition 2 of GSTR 2006/9 provides that generally, for every supply there is a recipient and an acquisition. Of the propositions considered in GSTR 2006/9, Proposition 5 is particularly relevant.

Paragraphs 71 to 73 of GSTR 2006/9 states:

Proposition 5: to 'make a supply' an entity must do something

71. In overseas jurisdictions the term 'supply' has been held to take its ordinary and natural meaning, being 'to furnish or to serve' or 'to furnish or provide'. The Commissioner picks up this meaning in considering the meaning of supply in the GST Act at paragraph 41 of GSTR 2004/9, a ruling which is about the assumption of liabilities:

In adopting the ordinary and natural meaning of the term, 'to furnish or provide', it follows that an entity must take some action to 'make a supply'. This approach is consistent with the use of active phrases throughout the examples of supplies in subsection 9-10(2), such as the normalised verbs: 'a provision'; 'a grant'; 'a creation'; 'a transfer'; 'an entry into'; and 'an assignment'. (Emphasis added.)

72. The use of the word 'make' in the context of section 9-5 was considered by Underwood J in Shaw v. Director of Housing and State of Tasmania (No. 2) ('Shaw') in relation to the payment of a judgment debt. His Honour was of the view that GST only applies where the 'supplier' makes a voluntary supply and not where a supply occurs without any action by the entity that would be the 'supplier' had there been a supply. He considered the actions of the judgment creditor with respect to the extinguishment of the debt when the judgment debtor made the payment of the judgment sum to meet the judgment debtor's obligations.

73. The Commissioner agrees with Underwood J's decision that there was no supply by the judgment creditor, as the judgment creditor did not do any act or thing to extinguish the obligation when the judgment debtor paid the judgment debt.

It follows from the above paragraphs in GSTR 2006/9 and the judicial authority of Shaw that a supply cannot be made unless the supplier engages in some kind of positive action. In applying these principles to the investing Trusts, it is evident that these Trusts have not engaged in any positive action to receive the net Rebates. The net Rebates were made entirely at the discretion of Entity A to ensure that it does not breach its disclosure requirements in the respective PDSs. You have also submitted that the net rebates are received by the respective Trusts simply as a matter of Commonwealth Law. That is, a breach of disclosure would be a contravention of the Corporations Act 2001 (Cth). Furthermore, the net Rebates do not require any action by the respective investing Trusts to cause it to be made.

Consideration is defined in section 9-15 of the GST Act. It includes any payment, or any act or forbearance in connection with a supply. The net Rebate is a payment and it will prima facie constitute consideration. Accordingly, the key issue so to determine if the investing Trusts made a supply for which the net Rebate was consideration.

In reaching the conclusion regarding whether the investing Trusts made a supply, we have established above that no supply has been made. Accordingly, paragraph 9-5(a) of the GST Act has not been satisfied.

Therefore the net Rebate has no nexus with anything the respective investing Trusts make. Accordingly, the net Rebate cannot be consideration for any supply the investing Trusts make, but is rather a supply of money as defined in subsection 9-10(4) of the GST Act. It is therefore, not necessary to consider the remainder of section 9-5. Accordingly, there is no taxable supply being made by the respective investing Trusts when it receives the net Rebate.

¹ Corporations Act 2001 (Cth), section 1013D(d)

² Corporation Regulations 2001 (Cth), Reg. 7.9.16N& Schedule 10

³ Ibid, Schedule 10, s 102

⁴ Ibid, Schedule 10, s 218(2)

⁵ Ibid, Schedule 10, s 104

⁶ Corporations Act 2001(Cth), section 601FC(d)

⁷ Ibid, Sections 1016E, 1016F

⁸ ASIC Class Order 03/217

Copyright notice

© Australian Taxation Office for the Commonwealth of Australia

You are free to copy, adapt, modify, transmit and distribute material on this website as you wish (but not in any way that suggests the ATO or the Commonwealth endorses you or any of your services or products).