Edited version of your written advice

Authorisation Number: 1051508974617

Date of advice: 24 April 2019

Ruling

Subject: Reclassification of the units in the Fund

Question 1

Will the reclassification of existing W class units in the Fund held by the taxpayer to new Z class units (‘the reclassification’) result in any capital gain or loss for the taxpayer under section 104-10 (CGT event A1) of the ITAA 1997?

Answer

No

Question 2

Will the reclassification result in any capital gain or loss for the taxpayer under section 104-25 (CGT event C2) of the ITAA 1997?

Answer

No

Question 3

Will the reclassification result in any capital gain or loss for the taxpayer under section 104-155 (CGT event H2) of ITAA 1997?

Answer

No

This ruling applies for the following periods:

Years ending 30 June 2019 to 30 June 2020

The scheme commences on:

30 June 2019

Relevant facts and circumstances

The Fund

1. The Fund is an Australian unlisted public unit trust, of which the trustee company and the responsible entity is XX Trustees Limited.

2. XX Trustees Limited has appointed YY Australia Limited as the investment manager for the Fund.

3. YY Australia Limited is a subsidiary of a global investment management organisation with significant assets under management.

4. The Fund is a registered managed investment scheme for the purpose of the Corporations Act 2001.

5. For Australian tax purposes, the Fund is a ‘managed investment trust’, and is subject to the attribution management investment trust (AMIT) regime under Division 276 of the Income Tax Assessment Act 1997 (ITAA 1997).

6. The Fund currently has three classes of units including W, M and S classes.

7. The main difference between the three classes of units relates to the level of management fee that is charged. Otherwise, all of the rights attaching to each class of units are identical.

8. Units in these classes are the interests held by the Fund’s investors (also referred to as the ‘members’ or ‘unitholders’).

The taxpayer

9. The taxpayer is an Australian unit trust that is a registered managed investment scheme for the purpose of the Corporations Act 2001.

10. The taxpayer has the same trustee and investment manager as the Fund.

11. The taxpayer is also a ‘managed investment trust’ and is subject to AMIT regime under Division 276 of the ITAA 1997.

12. The taxpayer will be taxed on capital account in relation to the units in the Fund that it holds.

13. The taxpayer is primarily invested in W class units in the Fund.

14. There will be no amendments made to the Constitution of the Fund (‘Constitution’) to reflect the proposed reclassification of units and modification to the management fees.

15. The Constitution effectively require that where units are being reclassified between two existing classes that the unit price of the two classes are equal at the time the reclassification occurs. This is achieved through the requirement that the units only be reclassified on a ‘bonus unit issue day’ and the provisions that deal with the issue of bonus units.

16. Consistent with the Constitution, the responsible entity has entered into an arrangement with the investment manager under which the investment manager agrees to provide investment services in relation to the Fund in exchange for a management fee. Accordingly, the responsible entity is entitled to pay the management fee out of the assets of the Fund, such as these fees constitute an expense or liability of the fund from time to time.

The Scheme–creation of new unit class and reclassification of units

Background

17. To date, a single management fee has been paid in respect of the W Class, such that the management fee is reflected in the unit price of the W Class.

18. However, particular unitholders in the W Class are able to enter into separate arrangements with the investment manager to receive an amount being a rebate of the management fee charged by the investment manager to the Fund and reflected in the unit price of the unitholder’s unit.

19. From 1 July 2013, the Future of Financial Advice (FOFA) reforms outlawed conflicted rebates. However, existing arrangements were grandfathered. Accordingly, existing conflicted rebate arrangements for units in the W class were grandfathered under these reforms in 2013.

20. The investment manager has adopted an approach under which it still offers the ability to pay rebates in respect of the W class units in the Fund, but rebate arrangements cannot be conflicted and the benefit of the rebate must either be passed on to end clients or pay for a legitimate business cost which would not influence financial advice.

21. One of the recommendations made by the Royal Commission into Misconduct in the Banking, Superannuation and Financial Services Industry was the removal of grandfather rebates under FOFA.

22. A number of unitholders in the W class have approached the responsible entity and investment manager regarding how to unwind these grandfather rebates. In particular, these unitholders have asked whether it is possible to transition their investment in the Fund such that the unitholder:

(a) Invests into a class of units from which no management fee is charged by the investment manager to the Fund, and reflected in the unit price; and

(b) Enters into an arrangement with the investment manager directly under which management fee can be paid directly by the unit holder to the investment manager outside of the Fund.

This removes the requirement for rebates and allows unitholders in the W class to be invoiced their relevant fee rebates directly.

The Scheme

23. The responsible entity and the investment manager have identified an opportunity through which they could simplify and improve the administration of the W class units in the Fund in this regard.

24. In particular, the responsible entity and the investment manager are seeking to implement a proposed scheme:

(a) A new Z class unit will be created. The Z class units will have the same rights, obligations and restriction as W class units, except that the Z class will not carry any management fee.

(b) The investment manager will agree, with effect from 1 July 2019 that its management fee will not be charged in relation to that portion of the value of the Fund that is referrable to W class units. However, the investment manager may enter into separate direct fee arrangements with holders of proposed Z class units in the Fund.

(c) As the management fees charged constitute ‘class liabilities’ and ‘class expenses’ of each class of units in the Fund for the purpose of the Constitution, this will have the result that the unit price and the amount of a unitholder’s entitlement to income distributions in respect of proposed Z class units will be determined without reference to the investment management fee.

(d) The creation of the Z class will be given effect through a reclassification of some of the W class units in the Fund into Z class units and this will occur at the end of the financial year.

(e) As there is more than one class of units on issue in the Fund, in order to comply with the requirement of the Constitution, the responsible entity and the investment manager will determine that the day on which the reclassification occurs is a ‘bonus unit issue day’ for the purposes of the Constitution. However, no bonus units will be issued on the basis that the issue of bonus units is unnecessary to equalise the unit prices of units of the two classes between which the relevant units are being reclassified, as the proposed Z class is being created upon the reclassification.

(f) The reclassification will take place at the end of the financial year for the Fund. The responsible entity and the investment manager are implementing the reclassification at this time on the basis that all of the accrued income of the Fund will have been distributed to members and all of the Fund’s liabilities in respect of the management fee for the W Class units will be discharged. Accordingly, at this time, the reclassification of units from W Class into Z class units will not result in any change in:

● the unit price of the units being held by the participating unitholders, or

● any of the current rights and entitlements of the units being held by the participating unitholders.

(g) No consideration, compensation or new property will be provided to participating unitholders including the taxpayer in respect of the reclassification of their units.

25. The reclassification will not cause a legal and beneficial change in ownership of the units being held by the taxpayer.

26. After the scheme is implemented, new investors in the Fund would also have the opportunity to subscribe for units of the new Z class if they meet the requirements set out by the responsible entity and the investment manager.

Relevant legislative provisions

Income Tax Assessment Act 1997 subsection 104-10(1)

Income Tax Assessment Act 1997 subsection 104-10(2)

Income Tax Assessment Act 1997 subsection 104-25(1)

Income Tax Assessment Act 1997 subsection 104-25(2)

Income Tax Assessment Act 1997 subsection 104-155(1)

Income Tax Assessment Act 1997 subsection 104-155(3)

Income Tax Assessment Act 1997 subsection 108-5(1)

Income Tax Assessment Act 1997 subsection 108-5(2)

Income Tax Assessment Act 1997 subsection 116-20(2)

Reasons for decision

Question 1

Summary

The reclassification of existing W class units in the Fund held by the taxpayer to new Z class units (‘the reclassification’) will not result in any capital gain or loss for the taxpayer under section 104-10 (CGT event A1) of the ITAA 1997.

Detailed reasoning

Part 3-1 of the ITAA 1997 contains the general CGT provisions of the income tax law.

Section 100-20 of the ITAA 1997 provides that you can make a capital gain or capital loss if and only if a CGT event happens. The capital gain or loss is made at the time of the CGT event (section 102-20 of the ITAA 1997).

CGT events are detailed in Division 104 of the ITAA 1997.

Most CGT events involve a CGT asset. A ‘CGT asset’ is defined in section 108-5 of the ITAA 1997 and includes any kind of property. Note 1 to section 108-5 gives examples of CGT assets, which specifically include units in a unit trust.

In the context of the reclassification under the proposed scheme, the relevant ‘CGT asset’ is the Taxpayer’s units in the Fund, rather than any interest the unit holder has in the underlying property of the unit trust. This is consistent with Taxation Determination TD 2000/32 Income tax: capital gains: for capital gains purposes is the unit held by a unit holder in a unit trust the relevant CGT asset?

CGT Event A1

Subsection 104-10(1) of the ITAA 1997 provides that:

CGT event A1 happens if you dispose of a CGT asset.

Subsection 104-10(2) of the ITAA 1997 provides that:

You dispose of a CGT asset if a change of ownership occurs from you to another entity, whether because of some act or event or by operation of law. However, a change of ownership does not occur if you stop being the legal owner of the asset but continue to be its beneficial owner.

As noted above, in the context of the reclassification, the relevant ‘CGT asset’ is the taxpayer’s units in the Fund.

The creation of the new Z class units will be given effect through a reclassification of some of the W class units in the Fund through the application of the Constitution.

The units are taken to be reclassified only when they are recorded in the register of members.

The reclassification will only apply to those unitholders who participate. At the time units are reclassified, the price of the units will not change nor will the rights and entitlements. The only change is the removal of a management fee being imposed.

The Commissioner has provided his opinion on whether a variation of rights attaching to shares will result in a disposal of shares in Taxation Ruling TR 94/30 Income tax: capital gains tax implications of varying rights attaching to shares. This ruling concerns Part IIIA of the Income Tax Assessment Act 1936 (ITAA 1936). Part IIIA which dealt with capital gains and losses has since been repealed and rewritten into the ITAA 1997. In particular, disposals of an asset formerly covered under subsection 160M(1) of the ITAA 1936 are now captured by CGT event A1 under the ITAA 1997. Similarly, paragraph 108-5(2)(a) of the ITAA 1997, which replaces former section 160R of the ITAA 1936, ensures that part disposals of a CGT asset are also captured under CGT event A1.

In respect of former subsection 160M(1)of the ITAA 1936, paragraph 8 of TR 94/30 state:

8. A variation in rights attaching to a share... does not result in a full disposal of an asset for the purposes of Part IIIA unless there is a cancellation or redemption of the share. In determining whether a disposal has occurred under Part IIIA, it is not relevant to consider whether the variation is slight (such as a small change to the nominal value of shares) or more significant (such as disposing of the preference to receive dividends).

As stated in the relevant facts and circumstances, under the scheme, a new class of unit (Z class) will be created and the Z class units will have the same rights, obligations and restriction as W class units, with the exception that it will not carry any management fee.

Therefore the variation to remove the management fee by reclassifying the units from W class to Z class will not cause a full disposal for the purposes of section 104-25 of the ITAA 1997.

In summary, for the purposes of this ruling, the reclassification of the units from W class to Z class will not give rise to CGT Event A1, as there has been no change in the beneficial ownership of the units. As such, no capital gain or loss is realised by the taxpayer at this time.

Question 2

Summary

The reclassification will not result in any capital gain or loss for the taxpayer under section 104-25 (CGT event C2) of the ITAA 1997.

Detailed reasoning

Section 104-25 of the ITAA 1997 provides the circumstances in which a CGT event C2 happens.

CGT event C2 happens if your ownership of an intangible CGT asset ends because the asset expires or is redeemed, cancelled, released, discharged, satisfied, abandoned, surrendered or forfeited (subsection 104-25(1) of the ITAA 1997).

The time of the event is when a taxpayer enters into the contract that results in the asset ending. If there is no contract, the time of the event is when the asset ends (subsection 104-25(2) of the ITAA 1997).

The ordinary meaning of the term 'cancel' is to cross out, to make void, annul or to render invalid for re-us according to paragraph 16 of TR 94/30.

The relevant Macquarie Dictionary meaning of the term 'redeem' is 'to buy back or pay off'.

In the present case, as stated in Question 1, the relevant CGT asset for CGT purposes is the W class unit held by the taxpayer in the Fund as oppose to the interest the taxpayer (unit holder) has in the property of the unit trust.

In the context of the reclassification under the proposed scheme, the taxpayer will continue to hold the same CGT asset (being the W class units) as they have held previously, the same CGT assets remain on issue at all time before and after the reclassification. No consideration, compensation or new property is to be provided to the taxpayer by them participating in the reclassification of their units.

A variation in rights of the units does not involve a cancellation or redemption of the unit and does not amount to a disposal for the purposes of section 104-25 of the ITAA 1997. In summary, the reclassification will not give rise to CGT Event C2, as there has been no redemption, cancellation or similar ending for the taxpayer.

Question 3

Summary

The reclassification will not result in any capital gain or loss for the taxpayer under section 104-155 (CGT event H2) of ITAA 1997.

Detailed reasoning

CGT event H2

CGT event H2 in subsection 104-155(1) of the ITAA 1997 happens if an act, transaction or event occurs in relation to a CGT asset and the act, transaction or event does not result in an adjustment being made to the asset’s cost base or reduced cost base.

Paragraph 10 of Taxation Ruling TR 94/30 provides that a variation in rights for money or other consideration, may give rise to a deemed disposal under subsection 160M(7) of the ITAA 1936 where the other requirements of the subsection are met. That subsection has been rewritten as CGT event H2.

The reclassification of the units from W class to Z class will constitute an act, transaction or event in relation to a CGT asset owned by the taxpayer. Furthermore, the reclassification of units will not result in an adjustment being to the cost base or reduced cost base of the units in accordance with Divisions110 and 112 of the ITAA 1997.

Therefore, the reclassification will result in CGT event H2 happening.

Is there a capital gain?

In relation to CGT event H2, subsection 104-155(3) of the ITAA 1997 states:

You make a capital gain if the capital proceeds because of the CGT event are more than the incidental costs you incurred in relation to the event…

For the purposes of CGT event H2, ‘capital proceeds’ is defined in the table in subsection 116-20(2) of the ITAA 1997 as:

The money or other consideration you received, or are entitled to receive because of the act, transaction or event…

At the time of the reclassification of the units owned by the taxpayer, the price of the W class will be the same as the unit price of Z class. In addition, all of the other rights and entitlements will remain the same except for removal of the management fee for those unitholders who participate in the reclassification of their units in the W Class.

As stated in the relevant facts and circumstances, no consideration, compensation or new property will be provided to the taxpayer in respect of the reclassification of their units. Consequently, the proposed reclassification will not result in a capital gain arising for the taxpayer pursuant to CGT event H2 as specified in subsection 104-155(3) of the ITAA 1997. No capital proceeds will be received because of the reclassification and therefore there will be no capital gain for the purposes of CGT event H2.