Inc v Acc ETF investment outside tax wrapper

Aidanmc

Is an income Fund (mainly talking ETF) better than Acc regarding taxation?

The intention would be that the dividends from the Income fund would be reinvested into the fund again whenever possible.

InvesterJones

Depends what you mean by 'better' - the tax due is the same, but inc is more straightforward.

Aidanmc

InvesterJones said:

Depends what you mean by 'better' - the tax due is the same, but inc is more straightforward.

I would mean more tax efficient

EthicsGradient

It's easy to find out the income you get from an Inc version, since it turns up in an account. But with an Acc version, this will be Excess Reportable Income (ERI), and it varies where it is recorded (some providers put it on their own website, some on the KPMG website for ERI). Though even Inc versions can sometimes have small amounts of ERI, so if you're being diligent, you have to search for it anyway.

ERI also applies to the shares you hold at the end of the reporting period, but doesn't count, for income tax purposes, until 6 months after that. But if you sell in the meantime, the ERI is counted, for capital gains purposes, as happening right before the sale. This could be before it's been published. So you can, as I am now, find yourself having sold (part of) an ETF, but not knowing what the exact capital gain on it was for a few months. With an Inc version with little or no ERI, that's not (much of) a problem. But with my Acc version, I'm going to have to wait a few months before I can then continue to sell things, if I want to stay under, but close to, this year's CG allowance.

InvesterJones

Aidanmc said:

InvesterJones said:

Depends what you mean by 'better' - the tax due is the same, but inc is more straightforward.

I would mean more tax efficient

OK, inc are not any more tax efficient.

dales1

Note that if you buy (and hold) the acc ETF shortly before the end of the reporting period, you'll be on the hook for a year's worth of ERI even though you only held the share for a month.

(And conversely in the year of sale).

So you need to watch your timing to avoid disadvantage.

Obviously in both cases you can treat the ERI as an expense in your CGT calcs, so no difference between the two.

Reinvesting the dividends yourself will obviously incur extra dealing charges compared with the acc (but these are also offset as an expense in CGT calcs.

People sometimes like to reinvest dividends as part of rebalancing / realigning their portfolio; so acc. is a drag on this process.

No real difference then, it's down to practicalities and preference.

ColdIron

This is why I hold all my ETFs wrapped in a SIPP or ISA. I only keep investment trusts unwrapped, as it's as simple as it gets

GeoffTF

InvesterJones said:

Depends what you mean by 'better' - the tax due is the same, but inc is more straightforward.

That is incorrect. There is a nasty catch with the accumulating ETFs that is not at all obvious. Assume that you buy £100K of both the distributing and the accumulating shares. Assume that the share prices have doubled when you receive your first £2K dividend. Consider the two cases:
Distributing. The capital value falls to £198K on the XD date. You pay dividend tax on £2K, assuming that there is no ERI. You need £4K income, so you sell £2K of stock. The CGT base cost for the sale is £100K * £2K / £198K = £1.0101..K. Your capital gain is £0.989989..K.
Accumulating. After dividend reinvestment the capital value is £200K. You pay dividend tax on the ERI of £2K. You need £4K income, so you sell £4K of stock. The CGT base cost for the sale is £100K * £4K / £200K = £2K. Your capital gain is £2K.
The problem is that when a dividend is reinvested within the accumulating ETF, it joins the same Section 104 pool as previous investments in that ETF. If the pool already had a large capital gain, the reinvested dividend will also have a large capital gain. You will have to pay CGT if you sell enough shares to recover the dividend (assuming that you have already used up your allowance). (This is despite having to pay dividend tax on the same dividend.) The same problem occurs with OEICs and Unit Trusts.

EthicsGradient

GeoffTF said:

InvesterJones said:

Depends what you mean by 'better' - the tax due is the same, but inc is more straightforward.

That is incorrect. There is a nasty catch with the accumulating ETFs that is not at all obvious. Assume that you buy £100K of both the distributing and the accumulating shares. Assume that the share prices have doubled when you receive your first £2K dividend. Consider the two cases:
Distributing. The capital value falls to £198K on the XD date. You pay dividend tax on £2K, assuming that there is no ERI. You need £4K income, so you sell £2K of stock. The CGT base cost for the sale is £100K * £2K / £198K = £1.0101..K. Your capital gain is £0.989989..K.
Accumulating. After dividend reinvestment the capital value is £200K. You pay dividend tax on the ERI of £2K. You need £4K income, so you sell £4K of stock. The CGT base cost for the sale is £100K * £4K / £200K = £2K. Your capital gain is £2K.
The problem is that when a dividend is reinvested within the accumulating ETF, it joins the same Section 104 pool as previous investments in that ETF. If the pool already had a large capital gain, the reinvested dividend will also have a large capital gain. You will have to pay CGT if you sell enough shares to recover the dividend (assuming that you have already used up your allowance). (This is despite having to pay dividend tax on the same dividend.) The same problem occurs with OEICs and Unit Trusts.

But I think that, while in that year your realised capital gain for Acc shares was about £1,000 more, the gain included in your remaining holding would be about £1,000 less (since you've sold another £2k's worth, and about half of that was capital gain). So this is a problem if you're constrained in one year by capital gains, but will be able to sell in some future year within the allowance, but if you're going to end up paying the CGT sooner or later, it doesn't make a difference.

Since the OP said "the intention would be that the dividends from the Income fund would be reinvested into the fund again whenever possible", they're not really in the situation of wanting more cash out of the fund each year than the dividend. Indeed, that reinvestment would join the same Section 104 pool, just like in the Acc version.

Alistair31

For the first time I am in a position/contemplating investing outside an ISA but must admit I am totally confused/put off by the reporting/tax treatment of gains. I wish there was a simple explainer somewhere. 

EthicsGradient

Alistair31 said:

For the first time I am in a position/contemplating investing outside an ISA but must admit I am totally confused/put off by the reporting/tax treatment of gains. I wish there was a simple explainer somewhere. 

The simplest collective investment outside a shelter is an investment trust - your acquisition cost is what it cost (including the 0.5% stamp duty, which will be shown on your contract note), and if you just buy it once, and take your dividends as income into your platform cash balance or current account, then the only other figure in the calculation is your net sale proceeds. It's buying the same thing more than once (eg a regular investment) that complicates things - plus equalisation for OEICs, and ERI for ETFs.