Help understanding equalisation units & accumulation distrubution

londoninvestor

simoneva wrote: »

For income tax I state the "dividend paid" figure on the annual statement.

Yes correct, HL's "dividend paid" number excludes the equalisation and is exactly what oyu need for income tax.

simoneva wrote: »

For CGT I match equalisation transactions to the purchases to get my base cost. Can't do it exactly because the equalisation can appear 12 months later and there may be multiple purchases! So I estimate - not expecting HMRC to audit and if they did it would not be significantly wrong. I deduct the equalisation from the purchase price.

This seems in the spirit of the rules, and HMRC don't provide detailed guidance (they could do with worked examples for more complex scenarios than they currently quote).

However I think it can be done more simply.

Given that when you sell, you don't identify a sale with a particular purchase, you sell from your accumulated (section 104) holding at its average base cost, you shouldn't need to apportion your equalisation back to individual purchases.

When you receive some equalisation for income funds, you should just be able to deduct it as of the dividend date from the base cost of your accumulated holding - so it will then impact the CGT payable on any subsequent sales. Compared with a methodology that tries to apply equalisation back in time to individual purchases, this is much easier to implement on a spreadsheet.

You're left with a couple of edge cases:

• Equalisation you receive when you no longer have a holding, i.e. when you disposed of your last shares after XD date but before payment date. It seems reasonable then to treat the equalisation as having been received on the XD date.
• Cases where you sell and buy back within 30 days... I always avoid doing that so I haven't considered how you'd deal with complications there (e.g. getting some equalisation after the sell and before the buy)

simoneva

> deduct it as of the dividend date from the base cost of your accumulated holding

Sounds sensible but HL don't show the dividend date on the equalisations so would have to be looked up separately.

londoninvestor

simoneva wrote: »

> deduct it as of the dividend date from the base cost of your accumulated holding

Sounds sensible but HL don't show the dividend date on the equalisations so would have to be looked up separately.

It's not on the tax statement but you can get it this way:

londoninvestor wrote: »

OK, so if you use HL, and your funds are all income units, here's how to see it.

Go to "Stocks", click on the fund in question, then click the "Income History" tab. For each dividend date you'll see:

• a line item "UT Cash Payment" - this represents the dividend (in my terminology) and is the amount you need to pay income tax on
• a line item "Eql - UT Cash Payment" - this represents the equalisation

Note that the cash you've received is the total of those two numbers.

You'll also see that if from the "Stocks" tab you click on the fund in question, there will be a transaction called "Corp A" which reduces the base cost by the amount of the equalisation.

If you want to see that data across all funds, you can get there through the "Transaction History" tab too.

One thing to add is that if you're using the "Stocks" tab and you've completely divested from the fund, you need to click "View old holdings" to get to it.

simoneva

Unfortunately that doesn't really work because the equalisation needs to be applied on the purchase date of the shares. The equalisation payment can be over a year later. For example (real example from my history):

1/11/16 ex-dividend date
19/12/16 bought shares
29/12/16 dividend paid (but not to me because I bought after the ex-dividend date)
15/3/17 sold some of the shares before tax year end to realise gain
1/11/17 next ex-dividend date
29/12/17 equalisation paid more than one year after the shares purchased!

The equalisation needs to be applied before the sale on 15/3/17.

EDIT: clarified

londoninvestor

simoneva wrote: »

The equalisation needs to be applied before the sale on 15/3/17.

But does it though?

I see how the rules could be read that way, but it leads down some paradoxical avenues:

• Matching back to individual purchases isn't how CGT works generally. When you determine the cost basis for a sale, you take your total cost to date of your s104 holding, and prorate that by what % of your holding your selling - you don't match directly to the costs of individual purchases. So it's a bit odd to have to take an equalisation cashflow and tie that back to individual purchases.
• Also, matching back to individual purchases isn't how equalisation is paid:
  • You get an equalisation payment by virtue of holding group 2 units on the ex-div date, not (only) by virtue of having made purchases since the previous year's ex-div date. In your example, say you'd sold your entire holding before 1/11/17 - you'd have received no equalisation at all, because you never held shares on an XD date. So there's a good argument that equalisation shouldn't be applied back to before the dividend date (or at worst the XD date)
  • Likewise, you get an equalisation payment on your remaining holding of group 2 units on the XD date - it isn't apportioned by the fund manager back to individual purchases. Let's say you bought 1000 units on 19/12/16; you sold 300 on 15/3/17; and then to extend your example a bit, you bought another 500 on 15/5/18. So you made 1500 units worth of purchases between the 2017 and 2018 XD dates, but you'll receive equalisation for 1200 units on 29/12/17. How much of that do you apportion to the 2017 purchase (and hence it's part of your CGT calculation) and how much to the 2018 purchase (which has no sale after it, so hasn't impacted CGT yet)? You could split it 2:1 according to the ratio of the purchases, but that isn't really the basis on which the fund manager paid it.

As I said earlier, some non-trivial worked examples from HMRC would be nice! I don't think there is explicit guidance they give that would let them fault you for the way you do it - but it does add complexity.

bowlhead99

simoneva wrote: »

Unfortunately that doesn't really work because the equalisation needs to be applied on the purchase date of the shares

Equalization can't be applied on the purchase date. At the purchase date, your purchase cost is genuine, and should be untouched by any administrative decisions made by the fund manager. Equalization cannot and should not be applied before the ex-div date of the shares - the point at which you have qualified for a payout.

Say a fund starts the year at 100p. Due to income received from its investments, it gradually increases in value to 105p during the course of the year. You choose to buy in August when it's worth 103p per share, and that's what you pay to buy 100 shares: buying £100 of underlying investments and £3 cash in the fund's bank account collectively worth 103p/share, for £103.

Later, just prior to ex div date, it's worth 105p and your shares are worth £105.

On ex div date they officially owe all the owners of all the shares 5p per share so they owe you £5.

For you personally, as you are a 'group 2 investor' who didn't own the shares all year, only £2 of the £5 cash they send you is dividend income (the income made after you became an owner of the shares) and the other £3 is a return of your cost.

So:
At the start of this first year in January the shares would have cost you £100, though you didn't choose to buy them yet.

In August the shares cost you £103 to buy.

In December pre ex div date the shares are worth £105, but they still cost you £103. If you wanted, you could make a capital gain of £2 by selling them for £105 when they only cost you £103. However, you chose not to do this and instead hold until ex div date.

On and after ex div date the shares are worth £100 instead of £105, because £2 dividend income was released to you and £3 of your cost was returned. At that point in time the cost of the shares to you is also £100, because although you paid £103, you have just got back £3 of it as a return of cost, along with the £2 of income.

So, after ex div date it is fair to say that your cost base should be adjusted downwards because by holding at ex div date you have qualified to have £3 of your cost returned to you and that will reduce you base cost from £103 to only £100.

But at no point do you go back in time and say your holding in the fund in August only cost £100 or was only worth £100 in August. It cost you £103 in August, and that cost only reduced to £100 when (during the dividend process, immediately prior to ex div date) they formally agreed to return £3 of your cost.

The equalisation payment can be over a year later. For example (real example from my history):

1/11/16 ex-dividend date
19/12/16 bought shares
29/12/16 dividend paid (but not to me because I bought after the ex-dividend)

Ok, quite straightforward so far. At this point your base cost of your entire holding of shares is whatever you paid on 19/12/16.

15/3/17 sold some of the shares before tax year end to realise gain

Ok, so at this point - let's say you had bought 100 shares and now sell 40 of them: the fraction of your shares you bought which you have now sold was 40%, and you retained 60% of the shares (60 shares):

The base cost of the shares you sold is 40% of the cash you paid on 19/12/16

The base cost of the shares you have not yet sold is 60% of the cash you paid on 19/12/16

1/11/17 next ex-dividend date
29/12/17 equalisation paid more than one year after the shares purchased!

Equalization will be paid on the 60% of shares you still own on ex dividend date. It will not be paid on any shares you no longer own.

With effect from ex-dividend date, the new base cost of those 60 shares is whatever you had paid for them, less the amount of the equalization.

So, as of 31/10/17 the 60 shares you own had a cost of £x. This £x is the same number you had calculated back on 15/3/17, when you worked it out as 60% of what you paid for the whole 100 shares back in December 2016.

But if you don't choose to sell them on 31/10/17, and instead hold them overnight to 1/11/17 when they will be trading without the right to the dividend or equalization payments (because you will be receiving the dividend or equalization payments for yourself), the cost of the 60 shares will drop:

From '£x' on 31/10/17
To '£x less equalization amount' on 1/11/17

None of this involves going back in time to a year earlier and amending your records from when you bought the shares. And it doesn't involve going back in time to reconsider your gains made when you sold 40 of the shares.
It simply involves amending the carrying cost of your 60 shares, per your records at 31/10/17, to the new carrying cost of the 60 shares after the equalization which you qualified for at 1/11/17.

The annoyance is that on 1/11/17 you don't necessarily know what the equalization being allocated to you on those 60 shares is going to be.You only find out on 29/12/17 what it was. There is a window of almost 2 months during which -if you sell your shares in Nov or Dec '17 - you don't quite know what your cost of those shares is going to be, because you're not sure what fraction of the distribution being paid to you on 29/12/17 is going to represent return of cost rather than income.

Still, it's only going to be a few percent at the most(because it's less than a year's dividend; in this example, a lot less, because the shares were actually owned almost a year so most of the distribution will be a dividend rather than equalization payment) so easy enough to err on the side of caution if planning how much to sell within your annual CGT exemption.

But this window is only just under a couple of months. Not a year.

The equalisation needs to be applied before the sale on 15/3/17.

The equalization doesn't need to be applied before the sale on 15/3/17. At 15/3/17 you know exactly how many shares you bought (100 back in Dec 2017), how much you paid each, and how many of them you are selling (40), and what cost remains for the unsold ones (40%, £x, for 60 remaining shares).

Later in 2017 (November, if you hold that long), you may qualify to get some money back through the equalization process on your remaining 60 shares and then your cost of those 60 shares would be '£x less equalization'. If you don't hold that long, it's not a factor. And it's never a factor for the CGT calculation on the 40 shares you sold in March 2017 *way* before they decided to do an equalization in November 2017.

Tom99

bowlhead99 wrote: »

Still, it's only going to be a few percent at the most(because it's less than a year's dividend; in this example, a lot less, because the shares were actually owned almost a year so most of the distribution will be a dividend rather than equalization payment) so easy enough to err on the side of caution if planning how much to sell within your annual CGT exemption.

[FONT=Verdana, sans-serif]Is that how the split of equalisation/dividend is calculated though?[/FONT]
[FONT=Verdana, sans-serif]I thought, from previous discussion on the forum, that the equalisation/dividend split was calculated from the pot of all purchases, still owned, made by anyone since the last ex-div date.[/FONT]
[FONT=Verdana, sans-serif]So all those purchases by everyone get exactly the same %age split of equalisation/dividend for each applicable share. The split in not calculated per individual.[/FONT]
[FONT=Verdana, sans-serif]Therefore it does not matter whether you bought that share on the day after the last ex-div date or the day before the next ex-div date the %age split will be the same.[/FONT]

bowlhead99

Tom99 wrote: »

[FONT=Verdana, sans-serif]Is that how the split of equalisation/dividend is calculated though?[/FONT]
[FONT=Verdana, sans-serif]I thought, from previous discussion on the forum, that the equalisation/dividend split was calculated from the pot of all purchases, still owned, made by anyone since the last ex-div date.[/FONT]
[FONT=Verdana, sans-serif]So all those purchases by everyone get exactly the same %age split of equalisation/dividend for each applicable share. The split in not calculated per individual.[/FONT]
[FONT=Verdana, sans-serif]Therefore it does not matter whether you bought that share on the day after the last ex-div date or the day before the next ex-div date the %age split will be the same.[/FONT]

You're right, in reality there is only one equalization rate using the weighted average of all the net new shares that were created in the year and you don't get a personalised equalization portion based on your specific dates.

In this basic example for simplicity I was just assuming that Simoneva was the only person to have subscribed for shares during the year between the two ex div points, and using the example dates he gave us, as an illustration of why he was getting money back and with what effective date.

To be honest, the concept of how and why equalization works in both an inc and an acc fund was resolved back in May (and other previous threads); for some reason, simon wanted to open it up again to tell us what we should do and how he does it.

In my experience if you are trying to explain the how and the why, it is simpler to use basic numbers and pretend the person is the only person joining or leaving the fund.

If you tell someone with a worked example that they joined the fund three quarters of the way through the year and so only a quarter of the distribution can be their income and the other three quarters must be the return of assets they bought, which the fund had received before they got there, they are usually ok with it. If you tell them they joined the fund 2/52 of the way through the year but only a quarter of the distribution is their income and the other three quarters is the return of assets they bought, which is nothing like 2/52ths because of the distortive effects of other people in the fund whose transactions aren't even in your example, it can be a lot to take in.

So, easier to try to get the basics down before going into what alternate effects you might see if there are other people subscribing during the year or if the fund is Acc instead of Inc etc.

My point in the paragraph you quoted is simply that the amount we are talking about for equalization is small because it will always be less than the dividend payment (or interim dividend as the case may be) which is only a few percent of the shares value at most (because most funds only yield a few percent per year or per dividend period); and it might be substantially lower than that small percentage if most of the divs were genuinely 'earned' by the new shares rather than those new shares being issued late in the financial year.

Granted, that early in the year/late in the year concept for the new shares applies to all 'group 2' new shares as a whole, collectively, and does not recognise your specific date of entry, just whether your shares were 'new shares' or 'shares that were already owned the previous time we had an ex div date'. So perhaps I should not have drawn attention to it at all.
:beer:

The point is just that as it is only a small percentage, it's not much hardship to take a conservative estimate if you want to do some CGT planning during that period of a few weeks or couple of months between ex date and payment date. It's not like it's a large percentage of your overall share value, and it's not like the 'window of not knowing" is a year or more.