Struggling with the concept of Equalisation

ffacoffipawb

I hold a SIPP invested in funds on Hargreaves Lansdown. As SIPPs are tax free, this is more relevant to taxable accounts for understanding.

INCOME UNITS
This is easy, I think. I buy £10,000 of Fund X. The first dividend is £30 dividend plus £15 equalisation.
The £30 is taxable income.
The £15 reduces the base cost to £9,985 and when you sell it is taxed as capital gain by increasing the gain by £15. This £15 shows as a credit in the income account.
I think I understand this.

ACCUMULATION UNITS
This is where I get confused I think. I buy £10,000 of Fund Y. There is no dividend.
A few weeks later I check my purchase cost and it is shown as, say, £9,975.
The £25 is shown as a corporate action, fair enough.
This reduces the base cost to £9,975. However there is no corresponding credit of £25 in the income account nor in the capital account.
So when I sell the purchase cost is £9,975 and I potentially have to pay CGT on an extra £25 that I have not received because I actually paid £10,000 for the units and not £9,975.

As an aside I have held accumulation units in Insurance Company pensions for many years and never seen an equalisation adjustment so Hargreaves Lansdown seem strange in this respect.

Linton

Equalisation solves the following problem.....
Say there is a fund which pays out a dividend once a year on the 1st July.  The fund receives dividends throughout the year, from July 1st to June 30th.  You buy the fund on the 1st Jan and 6 months later get a full year's dividend.  What tax do you pay?

Fund dividend tax  is based on when the dividend is paid into the fund from each share held.  But you can only be charged tax for the dividends received during the time you held the fund. So in the first year your dividend is split into 2 - "equalisation" for the dividends received before you bought the fund and "dividends" for those received after you bought the fund.  When you bought the fund it actually held the dividends covered under equalisation and so equalisation is treated as return of capital.

It works exactly the same for Inc funds when you actually get a dividend and Acc funds when, for tax purposes, you are assumed to get a dividend at the same time.  For CGT since from a tax viewpoint you never paid the equalisation amount it is deducted from your assumed purchase price. For Inc funds this means that equalisation is treated as a capital gain rather than a dividend. When you calculate CGT for ACC funds you add the total dividend received (including equalisation!) to the purchase price so the net effect of equalisation is that the dividends received prior to buying the shares are regarded as  part of your original purchase for both dividend tax and CGT**.

If you hold the fund in a Pension or ISA you dont pay any tax anyway and so will never meet equalisation.

** Correction made later

bowlhead99

Linton said:

It works exactly the same for Inc funds when you actually get a dividend and Acc funds when, for tax purposes, you are assumed to get a dividend at the same time.  For CGT since from a tax viewpoint you never paid the equalisation amount it is deducted from your assumed purchase price. For Inc funds this means that equalisation is treated as a capital gain rather than a dividend. When you calculate CGT for ACC funds you add the total dividend received (including equalisation!) to the purchase price so the net effect of equalisation is that the dividends received prior to buying the shares are regarded as  part of your original purchase for both dividend tax and CGT**.

** Correction made later

I had to read that a couple of times before it clicked as I had skimmed OP's post ; I don't know what you had written before you corrected it but at face value the bolded stuff sounds a bit off - if it were being read by someone in general terms without the knowledge of what this particular investment platform was doing with OP's investment portfolio reports. 

You say 'for ACC funds you add the total dividend received (including equalisation) to the purchase price'. 

Really for ACC funds as a general rule you add the notional dividend received (just the taxable dividend element, not including equalisation) to 'whatever you originally paid for the investment', so that the carrying cost of your investment is increased by the income that was reinvested on your behalf after it had been received internally within the fund since you acquired the investment.

In OP's case it sounds like the Hargreaves Lansdown platform will edit the investment costs of people's holdings of Inc and Acc funds to show a lower cost than they actually paid for the investment (by the amount of equalisation). This would be handy for Inc funds because the system is showing your effective cash cost of investment accounting for the fact you got some of your cost back as part of the dividend distribution process. You can then compare your expected selling price of the unit with your system-adjusted cost of the unit to see what capital gain you would make if you were to sell tomorrow. 

However for Acc funds it doesn't help with that process, because in an Acc fund the relevant cost is whatever cash you paid to buy the investment plus whatever income-taxable dividend was received and internally reinvested.  By 'helpfully' deducting the equalisation element from the cash cost you paid, even though it was not paid to you in cash and was internally reinvested, your cost showing on the platform against that investment is now further away from what your allowable cost for CGT purposes is!   

So instead of them leaving the cost showing on your portfolio summary against that investment at your actual cash cost, so that you could add the income-taxable element of the reinvested dividend to it, and get your allowable CGT cost... you instead need to add both the income-taxable element of the reinvested dividend, and the reinvested equalisation amount, to get your allowable CGT cost.  So adding the whole 'notional distribution' rather than just the 'taxable dividend element of the notional distribution'.

This has the potential to be a PITA for Acc investors who are diligently keeping their income tax records and are tracking how much taxable income or interest they have earned and had internally reinvested... because they would like to be able to simply add that taxable reinvested income number onto the cash cost of their investment, and get the allowable CGT cost in a disposal, which is straightforward.  Instead, as HL have reduced the cost of investment in the online records to below the cash cost, they have to add that taxable income number (which they were already tracking) to another number (the amount of equalisation reinvested, which was not something needed for their income tax records) before adding it on to the carrying cost of investment that HL are showing.

I suppose some people it may be OK to have your investment cost for the ACC fund in your investment table track lower than the actual cash cost, because then you could just independently look on the fund manager's website and find out that total amount of (theoretical) distribution per unit and add that on to your reduced carrying cost, to get the allowable CGT cost without worrying about how much of that distribution was income vs equalisation.  But you do need the split of income vs equalisation to be able to do your income tax records.  So HL are not really creating efficiencies for you here.

IMHO it would be better for HL to either:

- only adjust your base cost when you actually get a cash distribution that reduces your base cost (i.e. only for Inc funds), or 

- adjust your base cost properly to CGT-allowable cost at each declared distribution event ( i.e. downwards for Inc funds if you get equalisation, and upwards for Acc funds when there is reinvested taxable dividends)

I suppose the way they do it like they do is (a) easier because they can just apply a system process to Inc and Acc in the exact same way, without caring that the information is counterproductive for some investors, and (b) avoids them saying they are giving you numbers that are definitely good to use directly in a tax return, because by leaving you some work to do yourself it's clear that you can't pin any liability on them.   

Many brokers don't try to help you with CGT calcs at all, because they don't know what holdings of the same shares or units you might hold on other platforms and it will be cheaper and easier for them to leave you on your own to figure it out yourself than give you figures that they have to caveat.

EthicsGradient

Linton said:

It works exactly the same for Inc funds when you actually get a dividend and Acc funds when, for tax purposes, you are assumed to get a dividend at the same time.  For CGT since from a tax viewpoint you never paid the equalisation amount it is deducted from your assumed purchase price. For Inc funds this means that equalisation is treated as a capital gain rather than a dividend. When you calculate CGT for ACC funds you add the total dividend received (including equalisation!) to the purchase price so the net effect of equalisation is that the dividends received prior to buying the shares are regarded as  part of your original purchase for both dividend tax and CGT**.

** Correction made later

" you add the total dividend received (including equalisation!) to the purchase price" would be confusing; you only 'add equalisation' to the purchase price if you're then going to subtract it, because you want to subtract it in the way you subtract it from the purchase price of an income unit.
See https://forums.moneysavingexpert.com/discussion/comment/74336511/#Comment_74336511 for a thread in which this was looked at before. The end result is that if you buy an accumuation fund for £100, and they tell you in the first year there was £4 income and £6 equalisation assigned to you, then you are liable to pay income tax on the £4, and your cost for purchasing your holding has become £104.

Asghar

ffacoffipawb said:

I hold a SIPP invested in funds on Hargreaves Lansdown. As SIPPs are tax free, this is more relevant to taxable accounts for understanding.

This reduces the base cost to £9,975. However there is no corresponding credit of £25 in the income account nor in the capital account.

I'm not a fan of the way HL do this for Accumulation Units, maybe other platforms work the same way.

They should take off the Equalisation payment if they want, so it's on record, but then add it back on again. It's totally irrelevant inside a SIPP or ISA.

I message them every so often and they reset the Equalisation payment's to zero, so the cost price shows the actual price I paid for the units.

bowlhead99

EthicsGradient said:
"you add the total dividend received (including equalisation!) to the purchase price" would be confusing; you only 'add equalisation' to the purchase price if you're then going to subtract it, 

yes, it's confusing when Linton's comments are read on a standalone basis, but in context, for the OP his platform (HL)  has counter-intuitively 'already subtracted it' so unfortunately you do need to manually add a number that includes the equalisation that they 'helpfully' subtracted for you.   

tax doesn't have to be taxing, as the saying goes. Though HL's attempt to be consistent between inc and acc equalisations in their investment portfolio tables (when an inc equalisation has been sent to the investor in cash, but an acc equalisation has not been), does not seem very useful to people who don't understand what the hell's going on.

Linton

My explanation comes from Old Mutual  which seems to match HL:
1) "For CGT purposes (for Acc units) when calculating any gains or losses the total payment (of distributions) should be added to cost of the units"
2) "For CGT purposes, when calculating any gains or losses it (the equalisation payment) should be deducted from the cost of  the units."
But yes, equalisation, like PAYE and no doubt many other areas of tax, is very difficult to describe clearly to a complete outsider.

bowlhead99

I suppose it's easier for OM to put in their explanation something along the lines of
'whether it's an Inc or an Acc fund, always take your equalisation off your cost, even if you didn't receive it'.

And then because they've done that, and the Acc investor will have reduced his cost by an amount of equalisation money he never received (stage 1) they then have to tell Acc investors, 'always add on anything reinvested, even if no cash changed hands', so that the Acc investor will effectively be adding back the reinvested equalisation to get him back to where he started (stage 2), and then be adding on the reinvested taxable dividend or interest to get to the right place (stage 3) in the end.

Their description combines stage 2 and stage 3 in one movement by saying add the 'total payment' to your cost.

So to follow along with the HL/OM method to get to the correct allowable CGT cost base as an ACC investor you need to
- extract the equalisation from the total payment;
- subtract that equalisation from the cost you'd originally paid; and then
- add the total payment to the adjusted reduced cost.

The net result ends up at the same place as if you'd ignored the equalisation part and simply
- extracted the income part from the total payment; and then
- added that income on to the cost you'd originally paid.