Do Accumulation and Income ETFs pay the same tax in a GIA with dividends reinvested/withdrawn?

bobfredbob

After all the recent tax changes (CGT, dividends, etc.), I am trying to understand if Acc and Inc pay the same tax in a GIA after a number of years with dividends reinvested.

Currently (for my Vanguard acc fund in GB) I get a yearly CTC, double check no ERI, then copy the dividend figures for my self assessment.  When I eventually sell, I'll deduct current price and dividends from purchase price, do something with equalization, and pay CGT.

But, with the rise of "free" ETF brokers, and decrease in allowances, I'm thinking of how tax works long term, especially with a new buy-and-hold ETF investment.

For example, say you buy 10k ETF shares at 1 pound each.  It gets 1k dividends every year and also increases in price by 2k.

I'm trying to calculate if tax would be different after, say, five or ten years.

So, on Acc and Inc, I pay tax on the dividends/assumed dividends (using CTC).

I'll ignore that Inc would get a slightly different buy price on reinvestment due to being out of the market for, say, a week while dividends are distributed/reinvested, and rounding/fx (if fund underlying currency is USD but dividends are in GBP).

On an Inc, the average book cost would be different at the end of the ten years since there are numerous investments, and extra required bookkeeping.  Whereas on an Acc, there is only the original purchase price.

Does that cause the eventual CGT to be different on a partial or full sale?  For better or worse?

If the Acc dividends are withdrawn, do they get (effectively) double taxed if, say, the withdrawn dividends were greater than the CGT allowance?

So, if one year's dividends were 4k, on an Inc you pay only dividend tax and choose not to re-invest and keep the 4k, but on an Acc it's (effectively) reinvested and you pay the dividend tax and also a CGT tax on the amount above the CGT allowance for selling 4k of shares?

Finally: do you prefer Acc or Inc, and why?

Thanks.

DRS1

I have no idea but I thought the usual advice was to avoid the Acc version in a GIA?  Because of the complicated CGT calculations.

EthicsGradient

bobfredbob said:

After all the recent tax changes (CGT, dividends, etc.), I am trying to understand if Acc and Inc pay the same tax in a GIA after a number of years with dividends reinvested.

Currently (for my Vanguard acc fund in GB) I get a yearly CTC, double check no ERI, then copy the dividend figures for my self assessment.  When I eventually sell, I'll deduct current price and dividends from purchase price, do something with equalization, and pay CGT.

You have an Acc ETF that is consistently showing no ERI? That's unusual. Is it a very specialist ETF? (Re-reading, by "fund" here do you mean an OEIC, rather than Exchange Traded Fund? If so, I can understand the "no ERI" bit)

But, with the rise of "free" ETF brokers, and decrease in allowances, I'm thinking of how tax works long term, especially with a new buy-and-hold ETF investment.

For example, say you buy 10k ETF shares at 1 pound each.  It gets 1k dividends every year and also increases in price by 2k.

I'm trying to calculate if tax would be different after, say, five or ten years.

So, on Acc and Inc, I pay tax on the dividends/assumed dividends (using CTC).

I'll ignore that Inc would get a slightly different buy price on reinvestment due to being out of the market for, say, a week while dividends are distributed/reinvested, and rounding/fx (if fund underlying currency is USD but dividends are in GBP).

On an Inc, the average book cost would be different at the end of the ten years since there are numerous investments, and extra required bookkeeping.  Whereas on an Acc, there is only the original purchase price.

To work out the acquisition cost of an Acc ETF, you add each year's ERI to the original purchase price.

Does that cause the eventual CGT to be different on a partial or full sale?  For better or worse?
Reinvesting all your dividends from an Inc ETF should have the same effect as holding the Acc version; both income tax and CGT should work out the same (with the simplifications you mention).

If the Acc dividends are withdrawn, do they get (effectively) double taxed if, say, the withdrawn dividends were greater than the CGT allowance?
What do you mean by "withdrawn"? Do you mean selling some shares in the ETF to get you about the same amount of cash that the Inc version (Inc ETFs have dividends, Acc do not) would have given you?

So, if one year's dividends were 4k, on an Inc you pay only dividend tax and choose not to re-invest and keep the 4k, but on an Acc it's (effectively) reinvested and you pay the dividend tax and also a CGT tax on the amount above the CGT allowance for selling 4k of shares?
That seems to mean you are deciding in that year to sell some Acc shares. As a sale, you do have to find if you've made a gain, and put it in your overall CG calculation. This would not be a "double tax" on the dividends, however; it's a (potential) tax on the overall acquisition cost - if you sell 3% of your total holding, the cost is 3% of the total cost of those up to that point.

Finally: do you prefer Acc or Inc, and why?
If you are thinking that in some years you want to get some cash from the investment, then the Inc version would be simpler, because in some years that dividend may be the amount of cash you want. Use Acc if you want to keep all the money concerned in this investment - "as it says on the tin".

Thanks.

Comments in bold for various things you've said.

bobfredbob

Yes, I've often seen that advice too, though it was after I'd bought my Acc fund many years ago, and I wasn't wise enough to use my CGT allowance to sell the Acc and buy the Inc.  And, back in the day, i figured I'd never hit the (much larger) CGT allowance so it was a future problem that probably didn't matter.

I've never seen anyone explain why the calculation is more complicated for an Acc.  With Inc you'd have to keep track of numerous dividend reinvestment buys through the years and on every partial sale you work out your average price, whereas with Acc you have to just keep a running tally of dividends paid?  I also don't know how well the broker's pricing history/average price works if you move brokers.

EthicsGradient

bobfredbob said:

Yes, I've often seen that advice too, though it was after I'd bought my Acc fund many years ago, and I wasn't wise enough to use my CGT allowance to sell the Acc and buy the Inc.  And, back in the day, i figured I'd never hit the (much larger) CGT allowance so it was a future problem that probably didn't matter.

I've never seen anyone explain why the calculation is more complicated for an Acc.  With Inc you'd have to keep track of numerous dividend reinvestment buys through the years and on every partial sale you work out your average price, whereas with Acc you have to just keep a running tally of dividends paid?  I also don't know how well the broker's pricing history/average price works if you move brokers.

The idea is that using an Inc version (for an OEIC, or an ETF) is simpler if you don't reinvest in the same investment. It's reinvesting (which is automatic for an Acc fund, of either type) that is complicated from a CGT perspective, as is regular investing.

However, it should be noted that Inc ETFs (or foreign-domiciled OEICs, for that matter) can still potentially end up with a small ERI in a tax year, so to be accurate in your return, you still have to check for this each year, and record it, if it exists, for later CGT calculations.

GeoffTF

bobfredbob said:

I've never seen anyone explain why the calculation is more complicated for an Acc.

The calculation is simpler for the accumulating version.

bobfredbob said:

I also don't know how well the broker's pricing history/average price works if you move brokers.

You lose the history, which is useless anyway because it does not include the ERI.

bobfredbob

EthicsGradient said:

bobfredbob said:

You have an Acc ETF that is consistently showing no ERI? That's unusual. Is it a very specialist ETF? (Re-reading, by "fund" here do you mean an OEIC, rather than Exchange Traded Fund? If so, I can understand the "no ERI" bit)


Yes that's right, my existing is not an ETF but a GB-ISIN Vanguard Global All Cap, chosen as a buy-and-hold with a lump sum.
  
It seems Vanguard only has ERI for Ireland ISINs. 

To work out the acquisition cost of an Acc ETF, you add each year's ERI to the original purchase price.

Thanks.  I'll note that down.  Do Inc ETFs also have ERI?

What do you mean by "withdrawn"? Do you mean selling some shares in the ETF to get you about the same amount of cash that the Inc version (Inc ETFs have dividends, Acc do not) would have given you?

Sorry, poor choice of words by me.  Yes, by withdrawn I did mean sell some Acc shares or partial shares to get roughly the equivalent amount.  So, if the dividend were 4k, selling shares to return approx 4k.

That seems to mean you are deciding in that year to sell some Acc shares. As a sale, you do have to find if you've made a gain, and put it in your overall CG calculation. This would not be a "double tax" on the dividends, however; it's a (potential) tax on the overall acquisition cost - if you sell 3% of your total holding, the cost is 3% of the total cost of those up to that point.

So, with both Acc and Inc you pay the dividend tax.  But with Acc, since you're selling shares to get the dividends value as cash, you may get hit by CGT tax due to the 3k CGT allowance (which may well be much lower in the future), so an Acc effectively reduces the amount you can each tax year tax free.


Finally: do you prefer Acc or Inc, and why?
If you are thinking that in some years you want to get some cash from the investment, then the Inc version would be simpler, because in some years that dividend may be the amount of cash you want. Use Acc if you want to keep all the money concerned in this investment - "as it says on the tin".

Thanks.

Comments in bold for various things you've said.

(I couldn't figure out how to unindent, so comments above).

EthicsGradient

To answer a couple of things:
" Do Inc ETFs also have ERI?"
Potentially, yes, though if they do, it's typically very small. The most I had in a year was from Vanguard Developed Asia ex Japan, which was 0.3%, but about half the time for my Vanguard ETFs, it's zero, and when it is something, 0.03% would be more typical.

"But with Acc, since you're selling shares to get the dividends value as cash, you may get hit by CGT tax due to the 3k CGT allowance (which may well be much lower in the future), so an Acc effectively reduces the amount you can each tax year tax free."
What works out best for you depends on how much you sell, and if there are other sales of other investments you're also doing each year that would also benefit from the CG allowance.

Since, when you sell, you'd expect the original purchase price to be usually lower than the effective "reinvestment price" that the accumulation happened at in subsequent years, then you would be making more of your gain in a year that you sell. But that should also mean there's less gain stored up in the holding in the years after that. If you expect to sell it all eventually (ie before you die), it might turn out better to have been selling in many years, making use of the CG allowance. But if you're already using the allowance for something else, that doesn't help.

Linton

The problem with  ACC funds in taxable accounts is that just like the INC versions you pay tax on dividends and interest.  That is straightforward. To calculate CGT you have to factor out any increase in capital value arising purely from the addition of reinvested income.  So you need to keep detailed records of all reinvested income for as long as you hold the investment if you dont want to pay excess CGT when you eventually sell.

With INC funds, increases in capiital value are exactly as expected, you just need to know purchase and selling prices.

The total tax charged is the same, its just more effort to keep the records for ACC funds.

GeoffTF

Linton said:

The problem with  ACC funds in taxable accounts is that just like the INC versions you pay tax on dividends and interest.  That is straightforward. To calculate CGT you have to factor out any increase in capital value arising purely from the addition of reinvested income.  So you need to keep detailed records of all reinvested income for as long as you hold the investment if you dont want to pay excess CGT when you eventually sell.

With INC funds, increases in capiital value are exactly as expected, you just need to know purchase and selling prices.

The total tax charged is the same, its just more effort to keep the records for ACC funds.

The problem is that you have to do that for distributing ETFs too, because of the ERI. Similarly, for foreign domiciled open ended funds. It is only for UK domiciled funds that the record keeping is easier for distributing funds. Nonetheless, for the reasons already explained, the distributing funds will usually be the better choice outside a tax shelter, even for foreign domiciled funds.

EdSwippet

My own distaste for holding accumulation units in a taxable account would primarily be having to pay tax annually on money not actually received. To add further insult, raising the cash to pay that tax may mean selling some of those accumulation units, leading to painful CGT calculations and a possible CGT liability on top.

Personally I hold any accumulation units in SIPPs and ISAs, but outside, only income units of UK domiciled funds.