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. So, in this article, I’m going to cover the methodology for calculating gains and losses for UK resident and domiciled individuals holding UK authorised unit trusts and OEICs.

I’ll also consider how allowances and losses can be used to reduce any gains made and when clients need to report capital disposals to HMRC. Finally, I’ll also give some hints and tips for capital gains management within an Investment Account.

The methodology for calculating a gain or loss

As I alluded to, this can seem very simplistic. After all, it is just the value of the disposal proceeds less the acquisition cost of those assets.

The disposal proceeds

For the most part, disposal proceeds are uncomplicated. Usually, these are the amount received from the sale – or the current market value if you are considering an unrealised gain. It’s important to establish the correct date of disposal, as this determines 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 is the date of the sale – not the date when the individual receives the funds or the date the proceeds are used to purchase other assets.

Establishing the acquisition cost

While establishing the value of disposal proceeds is straightforward, it’s the other side of the equation – establishing the acquisition cost – where things become more complex. You 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. However, adjustments are then made. The first potential adjustment is what is known as an “equalisation payment”. This may occur after the first income distribution following the purchase of new units. 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. It acts as a return of some of the price paid (or capital) and so reduces the original purchase cost.

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.

Please bear in mind, this can crop up outside of the first income distribution as a result of switches or platform transfers. In such cases, the equalisation is not treated as a return of capital and no adjustment is made.

The next potential adjustment is what are known as “notional distributions” for any holdings held in accumulation units. Accumulation units do not make income distributions. Instead, the income 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. Where a fund doesn’t hold reporting status, then any gain or loss is subject to income tax and 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 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 with 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’s 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 can give you the information you need in just a few clicks.

How capital gains and losses are calculated

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. 

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 repurchased 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: 

1. Any acquisitions of the same asset on the same day
2. Any acquisitions of the same asset in the 30 days following disposal
3. Any acquisitions in the Section 104 pool that I referred to earlier.

It should be noted 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 losses are aggregated throughout the tax year to arrive at the overall position for the individual at the end of the tax period. For example, if an 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 gain 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 can 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. Losses can be reported either through self-assessment or by writing directly to HMRC.

The taxation of capital gains

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. This is £3,000 for the 2024/25 tax year. If the gain is over the annual exemption 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. The corresponding rates are 18% and 24% (reduced from 28% from 6 April 2024) for individuals with residential property gains.

One point to note is that the transfer of assets can also result in a gain, such as a disposal through a stock transfer of assets from one individual to another. An 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 help to reduce any capital gains tax that may be payable, if this could be at 10% rather than 20%.

Another point 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.

Reporting requirements

Any capital gains subject to tax need to be reported to HMRC, either through self-assessment or by writing to HMRC. While there is no tax if the gains are within allowances, there is still a need for individuals to report capital disposals to HMRC where they are registered for self-assessment and the total amount of disposals for the tax year is greater than £50,000.

Capital gains and Investment Accounts

The way capital gains work, the allowances available and the ability to carry forward losses means skilful financial planning can maximise the benefit of investing within an Investment Account. For example, when selecting assets for a Bed & ISA exercise, targeting specific assets to move to an ISA allows you and the client to focus on gains or losses (depending on their circumstances).

A final 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 Fidelity gives 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 through utilising our Cash Management Account. More on fee-funding our our platform.

That just about covers everything you need to know about capital gains and Investment Accounts. For more technical insights on all the product wrappers we offer – including pensions and ISAs – simply visit the Technical matters area of our website.