Accumulation units – tax on reinvested dividends UK - Monevator (2024)

1Pete ComleyMay 16, 2012, 3:07 pm

Thanks for explaining this. It did spur me to think of a question however. If one had money in a fund with no fees for investing or withdrawing money (as I believe is the case with the HSBC trackers) then would it be possible to avoid income tax by selling shares in the fund just before the dividend paid out and purchasing them back afterwards. Given that the share price moves to reflect the dividend amount the fact that one has not received the dividend payment should not matter.

I am assuming here that this would all take place within one’s capital gains tax allowance and not incur any charges in this way.

I’m new to investing (to date I’ve been a cash-ISA only man) but having had a good look at this website I’m really excited by the prospect of being a little more creative with my savings.

However! I must confess I’m still confused by the tax treatment (and since I’m a tax lawyer that’s a little embarrassing). I understand that the accumulation units (or shares in the case of OEICs) might pay out dividends and automatically reinvest them for you out of convenience. If that’s the case then surely you would have to pay tax on the dividends, you would have more shares / units in your portfolio, and your base cost would increase (so although you get taxed on the dividend, at least you don’t have to pay capital gains tax on that element further down the line).

But is that how all OEICs work? I’m specifically looking at the Vanguard Lifestrategy range of funds at the moment. Why would they pay out a dividend, and trigger tax, and reinvest it, when the money could simply stay in the fund and be reinvested without a tax charge on the individuals, which would then increase the capital value of the shares on which you pay CGT when you finally cash out.

Even after looking at the Key Investor Info for one of the Vguard LS range I’m confused. It uses phrases like “income from the fund will be reinvested” which to my mind is ambiguous.

Can anyone help?

I think I’ve answered my own question, but for the benefit of anyone who’s interested:

The key is that legally OEICs have a special tax regime.

It seems that if you have an equity fund (and painting with very broad brush strokes, this is a fund which doesn’t hold at least 60% of its assets in cash / gilts / similar approved investments, and very definitely not shares) then all of its distributions are treated as dividends for tax purposes AND (crucially) any income amount which is available for distribution by the fund (i.e. income from underlying investments) is automatically treated as if it were actually distributed, whether or not cash goes out to the shareholder. So this is why the fund doesn’t actually pay out a dividend and then reinvest it. The income is allocated to reinvest in the capital of the fund (without ever leaving the fund company) but is still treated as though distributed for tax purposes.

So that’s satisfied my curiosity. Anyone who is similarly curious can have a flick through the Authorised Investment Funds (Tax) Regulations 2006.

Very useful article. I have been investing small monthly amounts into an accumulating tracker fund since 2002, for the purpose of creating a college fund for my darling son. These were the days before junior ISA’s and child trust funds. I have kept the statements and tax vouchers, but never really understood the importance of the vouchers. It now seems that I have been a tax evader and if I want to offset capital gains tax when selling my fund ,when my son is 18 next year, I will have to tell the tax man about the accumulated dividends over the last 13 years.

Any thoughts on that ?

In order to take advantage of the new £5,000 dividend nil rate band for both me and my spouse, I would like to transfer to my spouse’s trading account, as a gift, some of the holdings in my own trading account. I am thinking to transfer shares in Vanguard FTSE U.K. All Share Index A. The income version of this fund will next pay a dividend at 31 December 2016. My accumulation version has this dividend reinvested. What I want to know is: what do I need to do to be sure that the tax on the dividend is owed by my partner, rather than me. Does it make any difference whether I transfer the fund to his account early in the year, say 10 April 2016, or later in the year, say at 10 November 2016?

I am new to investing in the UK and have not yet seen how a UK tax reporting statement from my platform will look, so I do not yet understand how this works – if one owns shares in an accumulation shares of a fund for X% of a tax year, does that mean that one owes tax on X% of the annual dividend, or is it the case that the person who owns the shares at a certain point in the year (say when the income version goes ex-dividend) owes the tax on the entire dividend for the entire year? I hope you understand the question I am asking.

Rob asked above if I had found the answer to my own questions. Yes, here are things I have discovered.

Firstly, so long as I transfer the fund to my spouse’s ownership before a dividend is paid, then that entire dividend will accrue to my spouse’s tax liability, even if I had been holding the fund for most of the previous accounting period. (My spouse will go forward with the same capital gains basis that I had.)

Secondly, funds (income and accumulation) can have their dividends paid with a so-called “equalisation” amount. This happens only in your first year of ownership of the purchased shares in the fund. The equalisation amount is a return of capital. It reduces the disadvantage of buying accrued dividends. The practical effect is that for an income fund your taxable dividend in this first year is decreased by the equalisation amount, and your cost basis (for your future capital gains tax calculations when selling) is also decreased by the equalisation amount. For an accumulation fund your taxable dividend in this first year is decreased by this amount, but the cost basis is unaffected.

Not all funds operate an equalisation regime. For example, Fundsmith Equity does not, whereas Vanguard FTSE all share does.

ETF and company shares also do not operate any equalisation. So if you buy an ETF/share just before its ex-dividend date, you are effectively buying the next dividend, which will be returned to you in just a couple weeks. This means you will incur a small amount of dividend tax on money that has not really been invested at all long. The equalisation regime operated by funds helps eliminate this infelicity.

Hi Richard, I recommend asking Vanguard directly. They may tell you the Accumulating ETF doesn’t pay dividends.
Some Acc ETFs report distributions, some don’t. Why the non-reporting ones don’t, and whether that’s OK with HMRC is a mystery I haven’t got to the bottom of.

Investegate have a useful tool for discovering dividend announcements:

https://www.investegate.co.uk/AdvancedSearch.aspx?qsArticleType=news

Company news > Advanced Search > Article type = Announcements, All Categories = Dividends, search by company name e.g. Vanguard.

Highly interesting article however I am confused.

I have owned units in the Vanguard Lifestrategy 60% Equity Accumulation fund for the past 12 months. I have used the following notional distribution per unit figure (https://www.trustnet.com/factsheets/o/acdq/vanguard-lifestrategy-60-equity) and thus calculated the gross distribution applied to my holding on 31/05/2019 (fund distribution date). I have subsequently used the notional distribution per unit figure as an off-set against gains when selling.

I spoke with a Vanguard representative to double check the notional distribution per unit figure from the Trustnet website. The representative could not provide this figure and thus requested that I contact my broker. Upon contacting my broker they too could not provide a figure however they did state the ACC fund class is not subject to dividend taxation. Is the broker correct?

I would be highly appreciative of anyone who may offer some clarity on this!

I suffered a bit doing the old tax return this time round as had to square away CGT on accumulating units (also had to muck about with ERI on ETFs which I begrudged as numbers turned out tiny). It was doable but not super pleasant.

I was lucky in that I got a bit of help from this community and an IFA mate to add some confidence that I was ‘doing the right things’, but what I did note while scouting around for assistance was another mate (20 years in investment banking) who confidently told me just buy acc units then you don’t have to worry about any dividend tax. There is a lot of confusion out there, even from those who you’d expect to have a handle on it.

@The Rhino — Absolutely. I didn’t actually know about this until @TA brought it to my attention all those years ago. I thought he was just being finickety! Set against that, who knows if/how often HMRC actually tracks anyone in the small fry category for non-payment. Also I’d hope most people have now got most of their funds in ISAs/SIPPs by now, so it’s clearly a minority concern.

For that minority (older, had a lot of assets perhaps in the old generous dividend allowance days, or anyone who comes into a lot of wealth suddenly) it remains a live issue though.

And yeah, aside from the fact that everyone should be paying their taxes due when they’re due (after taking any legal mitigation steps) you wouldn’t want to find HMRC calling after 20 years of compounded Acc unit reinvestment and asking to see your sums. The bill due might be less painful than the paperwork/hassle! 🙁

I always thought the easiest way to go was:
a) for DC/SIPP/ISA’s – use accumulation units; and
b) for taxable accounts e.g. GIA – use income units.
Tax reporting is then relatively straight-forward and any income needs can be met from dividends and/or selling units. If/when there are no income needs any dividends can be re-invested as and when and they may also assist with any re-balancing required.

What have I missed?

It’s exactly that reason I recommend to a) avoid Accumulation flavour b) avoid mixing up Dividends/Interest in the same fund (i.e. Lifestrategy) in GIA accounts or when investing through a limited company.

I find that Vanguard when investing directly (not via the online website) gives some very decent reporting by post. There’s a £100k minimum/fund though.

This is such a great and important article, thank you. I am fairly up on tax, but still struggle with this.

For a while I used to get the Acc Divis on my TR, but would forget to deduct them on Capital Gains.

I suppose if one wants to be really comprehensive (though it’s a separate issue from this), there is sometimes also Equalisation to deal with – for most people it will be a tiny sum, but I think this should be deducted from the Acquisition Cost when doing CGT calcs.

It is also not helped by the fact that so few online brokers do Accumulation Divi reporting (and even fewer do Excess Reportable Income…). It really should be mandatory.

In line with another comment are you sure this article is correct ? It seems ridiculously too complicated and impossible to enforce in reality surely below is the tax position

Income shares : you pay tax on the dividend in the tax year it’s paid out

Accumulation shares : you pay CGT only when you sell . The difference is simply the value you bought off the value you sellleaving the profit which includes the rise in share price plus any reinvested dividends ? Is the issue perhaps when you sell shares you don’t know this amount ? In my H&L account I get a read out of what they cost versus any profit or loss as total and percentage (which would include share price increase and reinvested dividend ) if I had £10k which had gone up by 10% would my cgt not simply be 10% of whatever I sell ?

@Lesley
I’m afraid that being “ridiculously too complicated and impossible to enforce in reality” doesn’t always stop something being written into the tax rules.

I came to the same conclusion as others, if only for the sake of simpler book-keeping: acc units in the ISA/SIPP; inc units in taxable accounts. Are there any major snags with that approach?

@David C

Are there any major snags with that approach?

Possibly excess reportable income which TA mentions. For example, Vanguard declared for VWRL an amount of $0.1147 per unit in their June 2020 report. See https://www.vanguardinvestor.co.uk/content/documents/legal/vf-plc-excess-reportable-income-30-june-2020.pdf

@February. There’s been lots of discussion on this elsewhere (https://forums.moneysavingexpert.com/discussion/comment/73461090#Comment_73461090) so I’ll let you read the arguments. In short though, maybe, maybe not. I wouldn’t. Can you bed and spouse?

I have a query. I have one fund in an unsheltered account.

I chose an income fund, based on advice from a previous post here, so this should simplify things.

I invested with a flat fee broker. From reading @FM’S experience with the platform selling to pay fees and the 30 day rule, I may have got lucky here with my choice of platform.

My choice of fund was LifeStrategy 80, chosen mainly so it didn’t need to be rebalanced. I’ve started to get a little concerned about the UK bias and I’ve realised I could have rebalanced by adjusting my ISA holdings to balance across the two accounts (GI/ISA).

My query is whether I’m likely to have tax return headaches with the split of equities/bond (dividends/interest) in the LS fund as briefly mentioned by @Foxy. Although @Matt the Newbie did mention that this was only an issue if bonds/cash are 60% or greater in with the fund. Do I also have to account for interest or just dividends?

Any thoughts/comments/experiences are greatly appreciated.

Thanks, J

Just trying to nail down how to handle accumulating ETFs…

If I hold some VHVG (Vanguard FTSE Developed World UCITS ETF GBP Accumulating) I’m looking for the (notional) dividend and any ERI. Where do I look?

I have managed to find some data for the USD version (ISIN IE00BK5BQV03) in their UK Reporting Fund Status document (https://www.vanguardinvestor.co.uk/content/documents/legal/vf-plc-excess-reportable-income-30-june-2020.pdf) which shows no income but ERI of 0.8994 (presumably USD).

The equivalent distributing fund shows distributions of 1.1304 and ERI of 0.0733.

Is there effectively no dividend for the accumulating fund just the ERI? Or do I need to look somewhere else?

@Matthew and others, brokers statements cannot be relied upon and it would be impossible for them to properly work out your tax situation unless they knew everything about you. Simple example, lets say I hold an investment with 2 different brokers. When I sell part of a holding, what is the CGT liability? The broker cannot know that unless they know the combined cost of the holding across both brokers and any other gains made in the financial year. If the investment was then bought back at the other broker within 30 days, the calculation would be within the 30 day rule, which neither broker would know about.

Personally I prefer to hold income paying ETFs outside tax shelters instead of OEICS as OEICS have the extra complexity of equalisation payments to deal with. Excess reportable income does still need to be taken account of for income tax and CGT on disposal though. Swings and roundabouts, but that way I only have one type of anomaly to worry about.

@Tim Hughes, yes $0.8994 per share is your income, considered to have been paid on 31 December 2020. You need to convert that to pounds, which you can do using the official HMRC exchange rates here

https://www.gov.uk/government/publications/hmrc-exchange-rates-for-2020-monthly

Remember as well to add the excess reportable income into your cost of purchase to reduce your eventual CGT liability. With accumulating ETFs this may make a material difference.

In case you did not already know, these ETFs are offshore investments, so strictly speaking you need to include them into the offshore pages in your tax return. It makes no difference to your tax liability though as there is no withholding tax.

Thanks @Naeclue.

I have no problem handling the GBP/USD conversion, the ERI increase to base cost for CGT, and the offshore-ness (already having to cope with these for other investments…).

Just wanted to check there were no “internal” dividends as you’d get with Vanguard accumulating funds.

I think this article is wrong with regards to equalisation payments when it comes to calculating capital gains tax.

So my understanding is that a “total dividend” payment is split into 2 parts. The first part is the “real income” on which you pay dividends tax and the second part is the “equalisation payment” on which you don’t pay dividends tax.

“Real income” increases the cost basis of your purchase.
“Equalisation payment” decreases the cost basis of your purchase.

So:
total_income = real_income – equal_paym =>
real_income = total_income + equal_paym

Therefore you calculate your capital gains tax the following way:

CG = Disposal_value – Total_Cost
= Disposal_value – (Acquisition_cost + real_income – equal_paym)
= Disposal_value – (Acquisition_cost + total_income + equal_paym – equal_paym)
= Disposal_value – (Acquisition_cost + total_income)

Hence for Accumulation funds you only need to remember to add the total notional income to your acquisition cost (which should also include transaction fees) and you can completely ignore equalisation payments.

Equalisation payments are only relevant for Distributing funds where you don’t add the “real income” of a dividend payment to your cost basis (since you actually receive the money).

In your example you essentially subtract the equalisation payment twice ending up paying an additional £100 in capital gains tax.

The following article agrees with what I said above as well:
https://techzone.abrdn.com/public/investment/Guide-Taxation-of-Collectives#anchor_7

Eh, I shouldn’t be typing when half asleep. I obviously screwed up the maths above since “total_income = real_income + equal_paym” !!!

However, the other article I linked to suggests that equalisation payments can be ignored on accumulation shares since you never receive the income. So I’m confused at this point.

Hi Illias – I read that piece along with several others including some very dull HMRC tax manuals when researching this piece.

It’s wrong to say “In your example you essentially subtract the equalisation payment twice ending up paying an additional £100 in capital gains tax.”

If you look at the income unit example in the article you link to they add the equalisation payment to the cost of purchase to increase the capital gain upon which tax is paid.

That’s because the equalisation payment is a return of capital that negates the part of the purchase price that was inflated by dividends to which you were not entitled at the time of purchase. The payment is designed so you pay the proper amount of capital gains i.e. more, not less because your purchase price included dividends you hadn’t earned because you didn’t own the fund as those divis rolled up.

There are a number of different ways of showing how it works which all get to the same place. I think the Abrdn example is just confusing because they just disregard the equalisation payment for acc shares. It makes life easier for whoever wrote that piece but I can send you links to alternative pieces that include fully worked accumulation fund examples for anyone who’s received notice of an equalisation payment for their acc fund.

As I say, there are different ways of calculating the same thing that all get to the same piece. I chose the one that I thought was clearest. Let me know if you’d like me to send you some of the links I mentioned.

@Accumulator
You are absolutely right and I am wrong. And I think the accumulation example in the Abrdn page I linked to is wrong as well. They can’t just completely disregard the equalisation part.

A quick example I can think of to verify this is the following. Say you bought shares of an Acc fund just before the Ex-Dividend date and then you received a notional dividend of £100 a few days after that, where 100% of this dividend is the equalisation payment (since you bought just before XD date). Then you sell all your shares (assume the price didn’t move at all). If you disregard the equalisation payment and do the math the way the Abrdn link suggests (only accounting for notional income) then you could claim a £100 capital loss! Which of course doesn’t make sense. If you do the math the way you suggest then your capital gains is exactly £0, which makes sense.

The way I will be thinking about it is this. The book cost of your shares is increased by all notional income you received and decreased by all equalisation payments you received (which is exactly what you say in your article basically xD).

Please do send the links you mentioned!

Mogul

@ Illias – your example is excellent and really helps illuminate what the equalisation payment is for. Thank you for that.

Here’s some links I found helpful. What complicates matters is that not all funds opt in to ‘full equalisation’ and HMRC guidance on accumulation units is vague.

https://www.adviser-edge.bmogam.com/wp-content/uploads/2021/03/4.-understanding-equalisation-payments-final.pdf

https://www.jameshay.co.uk/media/1579/capital-gains-tax-on-investment-by-individuals-in-uk-stocks-and-shares.pdf

https://www.vanguardinvestor.co.uk/content/documents/general/ga-uk-reporting-fund-guide.pdf

https://forums.moneysavingexpert.com/discussion/2370299/cgt-calculation-for-accumulation-units

Here is an example which hasn’t been covered to date and for which ‘I” have been unable to find a definitive answer or example for online.

Scenario
Given that when this article was first posted online, the person who took out and sold the unit trust in the example you gave was still alive. I don’t know if that person is still with us but I know that persons cousin. He too took out a Unit Trust at the same time but unfortunately has now passed away. His personal representatives now have to figure something out and were hoping you could help. The details of which are laid out below:

Unit Trust Fund (Acc units) taken out by cousin of that person (now deceased)
– Dividends re-invested automatically after tax deductions.
– In possession of statements and Tax vouchers.
– Equalisation not applicable
– Unit Trust cashed-in(100%) during administration period by personal representatives
– No increase in the number of units

– Purchased for £10,000
– Date of death value for Probate is £16,000.
– IHT has been paid and the Unit Trust formed part of estate
– Net proceeds: £20,000
– Accumulated Income(net) till date of death is £3000
– Accumulated Income(net) from date of death till cash-in(100%) is £500

For your formula:

Capital gain = Net proceeds minus original acquisition cost minus accumulation income plus equalisation payments

– Original acquisition cost: is this £10,000 or £16,000 ?
– Accumulation income: Is this £3500 or £500 ?

1. How to calculate the Capital gain for this product by the personal representatives?
2. How to determine if CGT is due or not on gains on disposal of this Unit Trust ?

I think some of the confusion here comes from how brokers represent the information on tax statements.

As @TA says, the basic formula is:

(1) Capital gain = Net proceeds minus original acquisition cost minus accumulation income plus equalisation payments

Importantly, “accumulation income” here needs to be interpreted as the sum of the full dividends across the period you held for (i.e. the dividend that a long-term holder would have received, even if we’re talking about the first period that you held the fund).

We can rewrite this as:

(2) Capital gain = Net proceeds minus original acquisition cost minus (total accumulation income minus equalisation payments)

Adopting terminology from @Ilias, let’s define “real income” as the income subject to income tax. Then:

(3) Real income = total accumulation income minus equalisation payments

And so:

(4) Capital gain = Net proceeds minus original acquisition cost minus real income

Now, the source of some confusion I think is that some brokers’ tax statements tell you the “real income” and not the “total accumulation income”. Lloyds do that (and so I’d assume that Halifax and iWeb probably do too) and HL also do it. Not sure about other brokers.

**If** your broker has already calculated the real income for you, then as formula (4) shows, you don’t need to use the equalisation amount in your own calculations. In those circ*mstances, it’s sort of true that “equalisation payments can be ignored on accumulation shares” and that’s where that idea probably comes from.

Another thing that surprised me when I first learned it. The equalisation calculation isn’t personal to each investor – it’s common to everyone who acquired units during a dividend period.

At each ex-dividend date, unit holdings are classified as “Group I” (those that were held before the previous XD date) and “Group II” (those newly acquired since the previous XD date). A given investor (for example, someone who’s investing into the fund regularly) might have some units of both types.

Group I units receive all the income as “real income” (in the terminology used in earlier comments). Group II units get a mixture of “real income” and equalisation – but that mixture is the same for every holder of Group II units, whenever they were bought.

So let’s imagine we have a fund that goes XD on 1st March and 1st September. Eddie Early bought 1000 units of the fund on 2nd March, and Lisa Late bought 1000 units on 31st August.

On 1st September, a dividend of £1 per unit becomes payable. For Group II units, the fund manager calculates it to be split into 60p of real income and 40p of equalisation. Now, both Eddie and Lisa will receive £600 of real income and £400 of equalisation. In some sense, Eddie should have “earned” virtually £1000 of real income and Lisa should have “earned” virtually £0 – but that isn’t taken into account in the calculation.

(I should thank Hargreaves Lansdown, who patiently explained this to me in a situation where I was Lisa Late.)

The horror, the horror…

I dutifully started declaring Acc dividends on my tax return as soon as I spotted them on my platform’s tax certificate.

Now I’m checking the impact for capital gains after a disposal of some holdings of an Acc fund several years later. The thing I can’t figure out now is how to do this calculation when I have held different numbers of units in different years and have only sold part of the holding now.

Not sure how to allocate the dividend income and equalisation from different periods. I thought about working out the per unit dividend and equalisation for each payment (thankfully this is Vanguard LS 60% so annual) and then using those.

That seems to make sense since it’s the equivalent of how base/book cost is worked out, but I haven’t seen any source explaining how to do it.

Additionally complicated by gifting some of the holding to my wife before disposal – aagh!

I don’t think I’ve underreported any tax, but it does illustrate the point that Acc funds (aren’t they meant to be the easy, leave them alone class?) are a problem because of our arcane tax system tail wagging the dog.

I thought I’d switch to income class with automatic reinvestment only to find that for the majority of my current funds, ii does not do automatic reinvestment (don’t know why yet).

Yes, of course, it should all be in ISAs and SIPPs, but these go back a ways and it’s now harder than ever to dispose of them tax efficiently to move funds into ISA etc with capital gains allowances rapidly going the way of the dodo.

I think I found the answer to my question above by reading this all again, the comments and following a few links to relevant act (Taxation of Capital Gains Act 1992 as amended by various Finance Acts since).

Tim D makes a really interesting and valuable contribution above highlighting that switches between fund classes are not usually a chargeable event (see his links and section 103F of the Act). I say “usually” because there’s of course some detail in the language which could conceivably mean this doesn’t always apply.

The Reddit link explains that to work this out, you treat each income taxable dividend (even if you didn’t pay tax because of other reliefs (see the 103F and 127 of the Act)) as an additional expenditure on the distribution date.

So in answer to my question, the base cost of my fund holding increased each time a dividend was issued and my per unit base cost can be recalculated on that basis….I think.

Maven

Mogul

With thanks to @TA for updating this very useful piece (& my further thanks also to @londoninvestor #48 for his very clear breakdown and explanation).

Per @Stuart B #51, 52: detailed intricacies of this (tax manuals, TCGA treatment) are indeed enough to recall the closing words of Joseph Conrad’s “Heart of Darkness.”

As @Al Cam #24 notes perhaps the easiest way through this is to try and avoid the complications entirely. Building upon that:
– Max out your ISA and SIPP and fund these as required (subject to CGT exposure) by selling GIA holdings.
– If you still need a GIA (above and beyond ISA and SIPP) then use it for non dividend and non income producing investments like Commodities, Gold and many (non dividend paying) listed PE trusts.
– A partial exception is ILGs. These are free of CGT and although the coupon is taxed (at highest marginal IT rate) their coupons can be tiny (e.g. 0.125% of par value, although distribution yield to redemption may be higher for ILG’s whose clean price is below par value).
– If this still should leave any unsheltered dividend paying investments where dividends are >£500 p.a. (the allowance for unsheltered divis); then (as @Al Cam suggests) go for income over accumulation units in the GIA.

@ Paul – the equalisation payment is not income i.e. dividends or interest. It shouldn’t be counted as such, so yes if you receive a wedge of dividend plus equalisation payment then there’s no need to declare the equalisation payment element on your tax form. Usual caveats apply about me not being a tax professional etc

@ B. Lackdown – I very much enjoy the simple pleasure of watching dividends roll in too

Useful discussion – I think so many people believe ACC income is not taxable.

However, I think your explanation of the order of taxation and its application to the various personal allowance is not correct. Yes – the order of income is non-savings, savings and then dividend. But you are entitled to apply the personal allowance to each of these income types in any order you want – indeed the legislation in S25(2) Income Tax Act 2007 specifically says …

“At Steps 2 and 3, deduct the reliefs and allowances in the way which will result in the greatest reduction in the taxpayer’s liability to income tax.”

HMRC give an example here…
https://www.gov.uk/hmrc-internal-manuals/savings-and-investment-manual/saim1110

where, despite high non-savings income, the tax payer allocates some of their PA to dividends and interest such that the residue is exactly covered by their personal saving and interest allowances.

Tax software such as TaxCalc optimise the use of the PA. HMRC’s own online software did not initially – but may do now.

Mogul

Mogul

@ helfordpirate – the gov example seems slightly inefficient to me. Can you tell me what I’m missing? The example shows:

£47,500 income subject to income tax (46K employment + 1.5K interest)
£5,000 dividend income

Higher rate tax kicks in at £50K therefore re: dividends:

£2.5K subject to basic rate tax @ 7.5%
£2.5K subject to higher rate tax @ 32.5%

Use personal allowance to wipe out the latter £2.5K so no higher rate tax.

The basic rate portion of dividend income meanwhile:
£2.5K – £2K dividend allowance = £500 @ 7.5% tax

The example uses £500 of personal allowance to wipe out this liability.

When it could have been used to wipe out another £500 of employment income taxable at 20%.

Am I making an obvious mistake?

BTW, I still agree that you’re right about how the allowances can be used. I’m just scratching my head about why the example seems slightly off.

Mogul

Thinking about it, it’s not as if you can deploy personal allowance to preferentially wipe out higher rate tax on your employment income first and then work your way down to the basic rate.

So it looks like you have to apply personal allowance to the first part of your remaining dividend income and only then can you extend it to reach the higher rate liability.

Yes I believe the allowances (PA, savings or dividend) have to be applied to the first part of either non-savings, savings or dividend income. You cant just zap the higher rate part unfortunately!

Some more examples here… (2016/17 rates)
https://www.accountingweb.co.uk/tax/personal-tax/any-answers-answered-use-of-personal-allowance

It is ridiculously complicated! But the second example is a very likely situation for FIRE types who have no non-savings income yet and can optimise things to make sure they dont overuse the PA on either interest or dividends and so waste either the savings band or the savings or dividend allowances. This is the situation I have been in last few years.

I wonder if synthetic ETFs are a solution (of sorts) to this headache…

I’m not an expert but I’m guessing an ETF using a total return swap to track an index, as the name suggests, receives the index’s capital and income return in a single payment so there isn’t a dividend to worry about it?

In effect, from a tax perspective the income portion of the index return would seem to become a capital gain as it is wrapped up in the return on a swap rather than being paid as cash on physically held shares.

So practically for someone who wanted an ‘accumulating’ index tracker in an unsheltered account but didn’t want the tax complexity of the dividends, a synthetic ETF would seem to wrap it all up as a capital gain and you just have to worry about CGT when you come to sell.

Interested if anyone has a view on this as I can’t find anything to definitely confirm this understanding is correct. I recalled from one of his articles Finimus is a swap guru I wonder if he would be willing to opine!

Mogul

@ helfordpirate – Thank you for the examples. I will bend my brain with those at some point 🙂

@ AoI – You make a really good point but if a synthetic ETF pays a dividend then tax will be due. For example, see Invesco’s synthetic, accumulating FTSE 100 ETF:

https://www.invesco.com/uk/en/financial-products/etfs/invesco-ftse-100-ucits-etf-acc.html

You can download the reportable income doc from that page and see that the ETF comes with significant excess reportable income. That’ll need to be declared as dividend income on your tax form (assuming outside of ISA / SIPP).

On the same doc, you can compare Invesco’s synthetic S&P 500 UCITS ETF in Acc and Inc form.

The Inc version distributes its dividends and shows zero excess reportable income.

The Acc version retains dividends and declares a large wedge of excess reportable income.

I’ve got a headache after reading this.

What makes this even worse is on the HMRC forums, their staff say it doesn’t need to be declared:

https://tinyurl.com/32c8dmfr

Look at the question from johngold1 and the reply from HMRC admin!