Calculating Capital Gains Tax on Unit Trusts & OEICs: Adjusting Costs & Pool Calculations, Lecture notes of Technology

Download Calculating Capital Gains Tax on Unit Trusts & OEICs: Adjusting Costs & Pool Calculations and more Lecture notes Technology in PDF only on Docsity! 1. Calculating the gain (or loss) on disposal or calculating the current unrealised gain (or loss) To calculate a gain (or loss), you deduct acquisition cost from disposal proceeds. For the most part, disposal proceeds are uncomplicated. Usually, it is the amount received from the sale or current market value, if considering an unrealised gain. Remember, switches are combinations of sale and purchase orders, so are no different from any other sale or purchase. You must also establish the correct date of disposal, as this will determine the correct period of assessment and the tax rules which apply. It may affect the rate of tax, relief for losses, annual allowances and so on. In general, it is the date of sale (and not, if different, the time when proceeds are actually received by the client). It is the other side of the calculation, establishing ‘acquisition cost’ (often called ‘base cost’) where things become more complex. In particular, you need to consider the type of units purchased and whether the investor has made multiple purchases of the same fund at differing times. 2. Calculating CGT ‘acquisition cost’ 2(i). Adjusting the acquisition cost of each unit within the fund holding To establish the acquisition cost of each unit, you begin with the purchase price paid for that unit, but then adjustments are made. This is an ongoing process which means costs often fluctuate over time and differ from the price paid at outset. Units often make an equalisation payment with the investor’s first income distribution (and only the first distribution). For CGT purposes, this is treated as a return of capital and is deducted from the price paid. Assume an investor paid 100p for a unit and then receives a distribution of 7p, of which 4p is taxable income and 3p is equalisation. The base cost of the unit is now adjusted to 97p. This only happens on the first and not subsequent distributions. However, it happens each and every time an investor purchases a new unit. So, if income is being reinvested to purchase new units, those new units may then have an equalisation payment with their first distribution. Similarly, if further units are purchased either as a result of portfolio rebalancing or generally, they too may then have an equalisation payment with their first distribution. All in all, this often means there are many equalisation payments within an overall holding of a fund. Disposal proceeds (or current market value for unrealised gains) CGT acquisition cost Less Although calculating gains or losses on unit trusts and OEICs can seem a straightforward process, it is actually rather complicated. This article looks at the methodology for UK resident and domiciled individuals, trustees and personal representatives for UK-authorised unit trusts and OEICs. The ways in which our industry has changed over the past few years now creates many more Capital Gains Tax (CGT) disposals and CGT transactions than seen previously and has increased the complexity yet further. First, the adoption of model portfolios and rebalancing creates a plethora of CGT events. Technology makes the portfolio rebalance process straightforward, but beneath that overtly simple rejig lies many individual sale and purchase transactions, each with CGT consequences. Secondly, the move to facilitated adviser fees and explicit platform charges means that small amounts of investment are often now constantly being cashed-in to meet fees. With that unfolds many CGT transactions not seen previously in the days of commission. Finally, we must consider situations where an investor switches between types of unit of the same underlying fund. For example: between income and accumulation units and vice versa, or between differing AMC share classes. Taxing calculations: Capital Gains Tax Calculating gains and losses on unit trusts and OEICs This item is for investment professionals only, and should not be relied upon by private investors. Accumulation units Accumulation units do not make income distributions. Instead, the net income amount that would have been distributed with an income unit is automatically reinvested in the fund. No new units are issued, but the value of the existing unit is increased. It is however, a requirement that the investor is subject to income tax on this income, on an annual basis. Thus, the investor is advised of this income amount, called a ‘notional distribution’, which is subject to income tax at the rate relevant to the investor, according to the income type. For CGT purposes, notional distributions are treated as allowable expenditure and are added to the acquisition cost. For example, assume an investor pays 100p for an accumulation unit and at the end of year one the unit price is at 110p. Let’s also assume that the net notional income distribution (which is subject to income tax) was 4p. We can see that the overall increase of 10p represents both the reinvested income of 4p and capital growth of 6p. It would arguably be ‘unfair’ to tax the whole 10p increase to CGT and by adding the amount that has been subject to income tax (the notional distribution) to the acquisition cost, this prevents this ‘double taxation’. So, in this example, as the net notional distribution was 4p, the acquisition cost is adjusted to 104p. The adjustment for notional distributions must be made each and every time there is a notional distribution. Where funds provide good annual yields, the total sum of all the notional distributions on accumulation units can amount to considerable sums over the years. Not adding these is one of the most common mistakes I see and can lead to considerably overstating a gain. Finally on accumulation units, a word of warning. The first notional distribution from accumulation units may include an equalisation payment, in addition to the income amount subject to income tax. This does cause confusion, but trust me, the simplest way of dealing with the calculation is to simply add the net notional taxable income and ignore the equalisation element. Income units – reinvested income If income is being reinvested, this is treated as a new purchase of new units at that time and the reinvestment from the distribution does not affect the acquisition cost of the original units from where the distribution arose. (Save, of course, any adjustment needed to be made to the original holding, to account for any equalisation where it is the first distribution from that original holding). 2(ii). Pooling the fund holding – the pooling rules These rules establish the ‘acquisition cost’ for each individual unit. However, units within a fund holding are often not all purchased at the same time, for the same price or all disposed in one sale. Assume an investor has continually purchased 1,000 units in a fund on 1 January each year for the past 10 years, so now has a total of 10,000 units. Each tranche will have likely been purchased at different prices and each of the units will have been adjusted in the way described above for any equalisation payments or notional distributions. Let’s assume the investor now wishes to sell 3,000 units of the overall 10,000 units. The CGT framework now has to cope with how we establish the acquisition cost of the 3,000 units being sold, from an overall holding of 10,000 units. A number of differing approaches have been used over the years, but I shall concentrate only on the current system. What the investor cannot do is stipulate which of the 10,000 units they are selling. They cannot, for example, say they want the 1,000 units purchased on 1 January 2014, the 1,000 units purchased on 1 January 2015 and the 1,000 units purchased on 1 January 2016 as treated as having been sold. Instead, an averaging mechanism is used, whereby the total acquisition cost for all units (having been duly adjusted, as described in 2(i) above) is divided by the total number of units to give the average acquisition cost for each unit. This is what’s known as the ‘Section 104 pool’ (s.104). This average cost is used as the acquisition cost of units sold to calculate the gain or loss. The table below illustrates a simple s.104 pool calculation for a holding of accumulation units in a fund. Units of a different class of the same fund are pooled separately. s.104 Pool (example of accumulation units) Income units REDUCE cost Equalisation payment National distributions Acquisition cost Accumulation units INCREASE cost Date Units bought Unit price paid Acquisition cost *(duly adjusted for net notional income distributions) Running total units Running total costs 10 March 2012 2,000 1.00 2,000 + 250* = 2,250 2,000 2,250 15 June 2013 1,800 1.20 2,160 + 180* = 2,340 3,800 4,590 6 August 2014 2,500 0.75 1,875 + 100* = 1,975 6,300 6,565 13 May 2017 4,000 1.15 4,600 + 200* = 4,800 10,300 11,365 Cost per unit 1.1034 Sales proceeds 6,000 Acquisition costs (3,000 units at 1.1034) 3,310.20 Realised Gain 2,689.80 SELL 14 Dec 2017 3,000 units (3,000) Sale Price of units 2.00 (3,000) (3,310.20) Continuing pool after sale 7,300 8,054.80 Cost per unit remains at 1.1034