Hello and welcome to this video on Capital Gains and Investment Accounts.
At face value, calculating the gains or losses on unit trusts and OEICs may seem a straightforward process. However, in reality it can be quite complicated.
In this video, I will first consider the methodology for calculating gains and losses for UK resident and domiciled individuals holding UK authorised unit trusts and OEICs.
I will then look at how allowances and/or losses can be used to reduce any gains made, before we consider any tax that may be due. I will also highlight when individuals need to report capital disposals to HMRC, and also give some hints and tips for capital gains management. So, let’s start with the methodology of calculating a gain or loss. As I mentioned earlier, this can seem very simplistic, after all, it is simply the value of the disposal proceeds, less the acquisition cost of those assets.
For the most part, disposal proceeds are uncomplicated. Usually, it is the amount received from the sale, or the current market value if you are considering an unrealised gain.
It is important to establish the correct date of disposal, as this will determine the correct period of assessment and the tax rules that apply. This may affect the rate of tax, relief for losses, capital gains allowances and so on.
In general, the date of disposal will be the date of the sale, and not the date when the individual receives the funds, or the date the proceeds are used to purchase other assets.
So, while establishing the value of disposal proceeds is uncomplicated, it is the other side of the equation, which is establishing the acquisition cost, where things become more complex.
In particular, you will need to consider the type of units purchased and whether the investor has made multiple purchases of the same fund at different times.
To establish the acquisition cost of each unit, you begin with the purchase price paid for that unit, but then adjustments are made.
The first adjustment that may be made is what is known as an “equalisation payment”. This may occur after the first income distribution after new units are purchased. In broad terms, this is to account for the fact the individual will not have held the units for the full period covered by the first income distribution, and acts as a return of some of the price paid (or capital) reducing the original purchase cost.
Note this can crop up outside of the first income distribution as a result of switches or platform transfers, in which case the equalisation is not treated as a return of capital and no adjustment is made.
For example, if an investor paid 100p for a unit midway through a distribution period, and the first distribution is 4p, then 2p would be taxable income and 2p would be deducted from the acquisition cost making this 98p.
The next adjustment to consider is what is known as “notional distributions” for any holdings held in accumulation units. Accumulation units do not make income distributions. Instead, the income that would have been distributed with income units is automatically reinvested in the fund.
No new units are issued, but the value of the existing units is increased. However, the investor is subject to income tax on this income on an annual basis.
For offshore funds, that hold UK reporting status, this notional distribution is represented by the Excess Reportable Income figure that each fund has to report annually and can arise on both distribution and accumulation units.
Note where they don’t hold reporting status then any gain or loss is subject to income tax not capital gains tax. For CGT purposes, notional distributions are treated as allowable expenditure and are added to the acquisition cost.
For example, let’s assume an investor pays 100p for an accumulation unit and at the end of the year the unit price is 110p. Let's also assume that the net notional income distribution was 4p.
It would seem unfair to assess the whole 10p increase to capital gains tax as some of this was taxable income. So, adding the amount subject to income tax - the notional distribution - to the acquisition cost prevents double taxation. Therefore, in our example, the 4p income distribution is added to the 100p original purchase price to give a revised acquisition cost of 104p.
Where the investor has purchased income units, any income reinvested is treated as a purchase of new units, rather than an increase in the unit price as it does with accumulation units.
As in the same way when making regular contributions, this results in units being purchased at different prices, at different times. If the individual then wishes to sell some of their holding, you can imagine it is rather difficult to establish which units are being sold.
Fortunately, since the introduction of Section 104 pooling in 2008, this is now a relatively straightforward process. This is because the total acquisition cost for all units of the same class, purchased after 1st April 1982, are aggregated and divided across the units held to give the average acquisition cost for each unit.
As you can see, the process for establishing the acquisition cost can be quite complex. However, modern calculation tools, such as Fidelity’s capital gains calculator, can give you the information you need in just a few clicks.
So, now we have the acquisition cost and the disposal value, we can move on to how capital gains or losses are calculated on disposal, and when these are taxable to an individual.
The first thing to consider is the “Disposal Matching Rules” that were introduced in 2008 to prevent what used to be known as “Bed and Breakfasting”.
This is where assets are sold, and the same assets are quickly re-purchased to create a gain or loss, without the investor really being out of the market.
In simplistic terms, any sale of assets will be matched against acquisitions in the following order:
- First, they will be matched against any acquisitions of the same asset on the same day
- Second, they will be matched against any acquisitions of the same asset in the 30 days following disposal
- Finally, they will be matched against any acquisitions in the Section 104 pool that I mentioned earlier,
It should be noted that, if the same assets are purchased in an ISA or pension, these will NOT be matched against any assets sold in an Investment Account.
Each disposal of an asset will result in a gain or a loss, depending on the acquisition cost and the value of the proceeds. These gains and/or losses will be aggregated throughout the tax year to assess the overall position for the individual at the end of the tax period.
For example, if the individual sold one fund and made a £10,000 gain, and another fund that made a £10,000 loss in the same tax year, then for the purposes of capital gains tax the aggregated value of the capital gains is zero.
If the aggregated position results in a loss for the tax year, then of course no tax is payable. But it is very important to note this loss can be carried forward to offset any gains that may occur in future years.
There is no time limit for how long these losses can be carried forward. However, they must be reported within four years of the tax year in which the loss occurred, if they are to be carried forward beyond that.
This can be hugely beneficial, as these losses could be used to offset gains on other assets, for example, future sales of Investment Account assets or the disposal of a buy to let property.
Reporting losses can be done either through self-assessment or by writing directly to HMRC.
If the aggregated disposals result in a gain, this does not immediately mean that tax is payable. This is because each individual has an annual capital gains exemption allowance. For the 2023/24 tax year this is £6,000 and for 2024/25 this will be £3,000.
If the gain is over the annual exempt allowance, then the next step is to see if any carried forward losses can be used to reduce the gain further.
If the gains are greater than the annual allowance and any losses brought forward, then they are taxed at 10% for basic rate taxpayers and 20% for higher rate and additional rate taxpayers. There is an additional 8% charge if the gains were made on the sale of residential property.
Any capital gains subject to tax need to be reported to HMRC, either through self-assessment or by writing to HMRC
Whilst there is no tax if gains are within allowances, there is still a need for individuals to report capital disposals to HMRC, where they are both registered for self-assessment and the total amount of disposals for the tax year is greater than £50,000.
Another point on disposal proceeds, is that this is not necessarily just selling assets. It can include the disposal through a stock transfer of assets from one individual to another.
One exception to this is where the transfer is between spouses or civil partners who are living together. In this scenario, assets can be transferred, without giving rise to a disposal, between the partners.
This can be very useful for planning between couples to maximise annual exemption allowances as two allowances will be available. It can also to help to reduce any capital gains tax that may be payable, if this could be at 10% rather than 20%.
The final point on disposal proceeds is that capital gains tax is not payable on the death of an individual. Any gain or loss on assets held at death is ignored. If assets are transferred to beneficiaries, then they are deemed to have acquired the assets at the market value immediately before death.
The way that capital gains work with Investment Accounts, for example, the allowances available and the ability to carry forward losses, means skilful financial planning can maximise the benefit of these arrangements.
For example, when selecting assets for a Bed and ISA exercise, targeting selected assets to move to an ISA allows the adviser and client to focus on gains or losses, depending on the individual’s circumstances.
Another consideration for minimising capital gains is to think about how and where fees are taken from. The regular sale of assets to fund platform and adviser fees can make it difficult to control the capital gains on an ongoing basis.
This is one reason why we give a range of options on how fees can be taken, either by targeting a specific fund, holding cash within the account, or by taking all fees from outside of the Investment Account all together, through utilising our cash management account.
That’s all for now, but for more technical insights and information, please visit the technical matters area of our website.
Thanks for watching.
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