DATE OF ISSUE: 14 AUGUST 1995
INCOME TEST TREATMENT OF CAPITAL DISTRIBUTIONS FROM MANAGED INVESTMENTS
The purpose of this Departmental Instruction (DI) is to clarify and amend current policy regarding the income test treatment of:
capital distributions for "saved" Accruing Return Investments (ARI) or Market Linked Investments (MLI) which occur as part of the process of winding up such an investment;
capital distributions for "saved" ARI's or MLI's which occur as part of the ongoing operations of such an investment; and
capital distributions for managed investments assessed on an ongoing basis.
Treatment of capital distributions for saved ARI or MLI funds which occur as part of the process of winding up the fund
2.Occasionally, the managers and trustees of and/or investors in a saved ARI or MLI investment fund will elect to terminate (or wind-up) the product either because the product has reached the end of its stated life or because it has been determined that for some reason the fund should be wound up prematurely eg., due to trading or financial difficulties.
3.In a wind-up situation, the assets of the fund are sold off, often in a gradual process, and returns of capital are made to investors in the fund. Return of capital in this situation fits the definition of a 'realisation' as specified in subsection 5J(7) VEA.
4.As income is assessable on realisation for saved ARI's and MLI's, in the case of a return of capital for such a fund due to a winding-up, it is important to determine for service pension purposes what amount of profit, if any, is attributable to the return of capital.
5.As it is difficult during a wind-up to determine the actual value of a pensioner's investment, and as it is possible that the pensioner may not yet have made any profit on the investment, it is inappropriate to use the Managed Investment Withdrawal Worksheet (MIWW) to assess each distribution of capital as a withdrawal.
6.Therefore, in order to accurately assess profit, if any, for such investments, the following procedures are to be followed:
Ascertain the value of the original capital invested in the fund by the pensioner.
Monitor the interim returns of capital to the pensioner as they are made and subtotal these returns. Since each pensioner's case will be unique, a running sheet should be kept on the pensioner's file to monitor the returns of capital so that they can be compared to the original capital invested.
Refer to and update the running sheet as partial returns of capital are made.
If the total capital returned to the pensioner exceeds the original capital invested, hold any excess as profit using the MIWW to calculate the amount to be assessed as income per fortnight. If any further returns of capital are received by the pensioner, these will be assessed as profit in the same way.
If the total capital returned to the pensioner is less than the original capital invested, and no further returns of capital will be made, the pensioner has made a loss which can be offset against certain other investment income. Use the MIWW to calculate the amount of the loss which can be offset each fortnight. Only when the last distribution of capital has been made will it be possible to know for certain that the pensioner has made a loss and so a loss calculation should only be done after the final payment is received.
The types of income against which such losses can be offset are:
-income from other saved investments; or
-withdrawals from superannuation investments made prior to pension age.
Where a pensioner has held an investment over periods where he or she was not receiving a pension (eg. the pensioner held the investment for some time before being granted pension), only the profit or loss arising in respect of the periods where pension was received (the assessable period) is assessable. Use part four of the MIWW to apportion the profit or loss arising from the investment in accordance with the length of the assessable period.
7.It is important to note that as long as a fund is not fully paid out, the PIPS Investment Information facility (PP.II) will continue to display complete data for the product, allowing the product to be added to or refreshed on the MI screen.
8.When a fund is fully paid out, the word "TERMINATED" followed by the date of termination of the fund will appear on the PP.II Screen and PIPS will not allow the product to be added to a pensioner's assessment or to be updated on the MI Screen.
9.Staff should be aware that the above-mentioned policy formalises a working policy to the same effect which has been in use by both this Department and the Department of Social Security (DSS) up until this time.
Treatment of capital distributions for saved ARI or MLI funds which occur as part of the ongoing operations of the fund
10.Saved ARI or MLI investment funds may also make distributions of capital as part of the ongoing operations of the fund ie., the distributions are made as part of the investment strategy of the fund and are not part of a process to wind-up the fund.
11.Where the pensioner acquired the investment prior to 1 January 1988 for a saved ARI and prior to 9 September 1988 for an MLI, capital distributions are assessable for income test purposes using the same methodology applied to realisations of such investments.
12.Therefore, any capital distributions for such investments are to be treated as a withdrawal from the fund and profit should be calculated in the normal manner through use of the MIWW.
13.Staff should contact their Investment Policy Officer for advice if there is any doubt as to whether a particular distribution for a fund represents a return of capital, a "normal" income distribution or a combination of both.
14.Staff should be aware that the above-mentioned policy formalises a working policy to the same effect which has been in use by DSS and was adopted by and used by DVA up until this time.
Treatment of capital distributions for managed investments assessed on an ongoing basis which occur as part of the ongoing operations the fund
15.Treatment of capital distributions made as part of the ongoing operations of a fund are also assessable as income where the investment was acquired by the pensioner after the above-mentioned savings dates and therefore has income assessed on an ongoing basis using a rate of return.
16.Effective immediately, it is Departmental policy that capital distributions for managed investments assessed on an ongoing basis are to be included in the rate of return calculation, in the same manner as normal income distributions, because such capital distributions represent a cash gain to the investor. Staff should note that this change in policy has no effect other than formalising the way in which capital distributions for managed investments assessed on an ongoing basis are currently being assessed.
17.Capital returns need to be taken into account when calculating rates of return otherwise the true performance of the trust is not measured. For example if a unit is worth $2.00 at the start and end of a 12 month period it would appear to have not made a gain or a loss. However, if there had been a capital return of $0.50 during the 12 months the share has actually made a 25% return over that period for service pension purposes.
18.A dilution factor is used to adjust a unit's historical value (the unit price 12 months ago or the distributions paid in the last 12 months) so that it can be compared to current value. Effectively the formula treats capital returns for investments assessed on an ongoing basis in the same manner as an ordinary distribution.
19.In the majority of such cases, the rate of return recorded for a specific product on the managed investment database will have been adjusted (through use of the appropriate dilution factor) and the adjusted rate of return will be applied to the appropriate client assessments when they are next reviewed (either through automatic or manual reassessment).
20.In some rare cases, manual adjustment of a rate of return may be required to incorporate a return of capital made by the fund. However, most investments fitting this category will be "special" category products or similar and should be referred to your local Investment Policy Officer for action.
21.It is important to note that because capital distributions represent a return of capital they are not included in the calculation of the cents per unit (CPU) dividend for a fund.
22.Staff should be aware that the above-mentioned dilution factor policy is identical to current policy which is applicable to the assessment of shares (see DI B73/93 and the GOSP "Shares" chapter for more detail). Although DSS have an identical policy regarding the treatment of shares in such circumstances, they do not have a current policy regarding managed investments assessed on an ongoing basis, though this issue is currently under consideration.
Client queries regarding dilution factors
23.Clients requesting a detailed explanation of dilution factors should be referred to the local Investment Policy Officer or DSS FIS Office. Both of these contact points have previously been supplied with detailed information regarding dilution factors and so are equipped to deal with client queries on the subject.
Contact Officer
24.The contact officer regarding inquiries related to this Instruction is Laurie Howell - telephone 06-2896706.
MURRAY HARRISON
BRANCH HEAD
INCOME SUPPORT