Okay, there’s no way to sugar this: I’m writing about tax on bonds, so I’ll keep it short, if not exactly sweet.

Bond taxation is confusing and life is fleeting and so – double-quick – here’s what you need to know to keep on the right side of the taxman:

• Bonds are not taxed the same as equities.

• Offshore bond funds are not taxed the same as onshore ones. (In other words, the treatment may be different if your bond fund sits outside the UK.)

• Exchange-Traded Funds (ETFs) are not taxed the same as bond funds.

The following two tables sum up the income tax and capital gains tax treatments and differences between the main types of bond vehicle.

Further explanation lies beneath.

Tax on bonds: interest

	Bond fund (OEIC, Unit Trust)	Bond ETF	Individual gilt	Individual bond
Tax on interest	Income tax rate (e.g. 20%)	Income tax rate	Income tax rate	Income tax rate
Interest paid gross or net of tax	Gross	Gross	Gross	Gross
ISA / SIPP shelter	Exempt	Exempt	Exempt	Exempt

 

Note: Bond funds have paid income gross since 2017.

 

 

Tax on bonds: capital gains

	Bond fund (OEIC, Unit Trust)	Bond ETF	Individual gilt	Individual bond
Capital gains tax (CGT)	Payable	Payable	Exempt	Payable unless a qualifying corporate bond
Non-reporting fund (offshore)	CGT payable at income tax rate	CGT payable at income tax rate	n/a	n/a
ISA / SIPP shelter	Exempt	Exempt	Exempt	Exempt

 

That’s the tax on bond and bond fund sitch in a nutshell.

Now let’s look at the details.

Where should you stash your bonds and bond funds?

If your fund is more than 60% invested in fixed interest and cash at any point during its accounting year then its distributions count as interest payments – not as dividends.

Distributions / excess reportable income will therefore be liable for income tax at your standard rate, rather than softie dividend tax rates.

You can avoid income tax on bonds and bond funds by tucking them away inside your ISA / SIPP – or by being a non-taxpayer.

Since 2017, bond funds registered as OEICs or Unit Trusts pay their income gross – that is, with no tax deducted. A welcome simplification.

The tax rate you’ll pay on bond income will depend on your overall income tax status.

Non-reporting bond funds may pay interest gross. More on non-reporting funds below.

To hold an individual bond in your ISA or SIPP it must be listed on the stock exchange or issued by a listed company. 

Individual gilts are immune from capital gains tax. 

Gilt funds, however, pay tax on capital gains.

Following the great bond rout of 2022 – which scythed through gilt prices – the absence of CGT on individual gilt gains could make holding low-coupon gilts with high redemption yields the most tax-efficient option for you. Do your sums carefully.

Offshore bond funds

If an offshore fund / ETF does not have UK reporting status then capital gains are payable at income tax rates.

That’s bad news because capital gains tax rates are much friendlier than income tax. The £6,000 tax-free capital gains allowance – falling to £3,000 from 6 April 2024 – would count for nought in this instance. And higher-rate taxpayers would pay (income) tax on their capital gains at 40% instead of 20% in CGT.

Make sure your offshore bond tracker says it’s a reporting fund on its factsheet. HMRC also publish a list of reporting funds.

Offshore bond funds / ETFs are subject to withholding tax just like equity funds.

If your bond fund is domiciled in the UK then reporting status and withholding tax isn’t an issue.

Index-linked Gilt ETF vs Index-linked Gilt Fund taxation

Some UK-based index-linked gilt funds are exempt from income tax on the inflationary component of interest payments.

In other words, if inflation shot up 5% in a year and the gilt paid 1% interest on top of that, then you’d only pay income tax on the 1% and not the other 5%.

However, offshore index-linked gilt ETFs will generally impose income tax on the whole interest payment (including the inflation-based element) because they do not enjoy the same exemption as an onshore fund.

So if you’re stocking up with an index-linked gilt fund then look for a tracker fund that’s based in the UK. (Email the provider to make sure they’re packing a tax exemption on inflation-linked interest.)

Take it steady,

The Accumulator

Note: This article on tax on bonds is an updated version of our 2015 original. Comments below may refer to old information, so double-check anything before acting. We’ve left old comments intact as there’s some good tidbits as usual.

Stocks-for-the-long-run type charts commonly plot the marvellous growth story of the US market. Sometimes you’ll also get the UK thrown in for good measure.

However you rarely see much mention of our great European frenemies: Germany and France.

Partly that’s because our cultural conversation is dominated by the US.

But it’s also because the continentals’ stock market history isn’t such a wonderful advert for investing. In fact if long-term US stock returns were similar to theirs, I suspect investing wouldn’t be anywhere near as popular as it is in the Anglosphere.

So let’s turn to our near neighbours to discover what a torrid equities experience looks like. 

(All charts show inflation-adjusted total returns, reported in local currency.)

German stock market returns 

Data from JST Macrohistory1 and MSCI. March 2024.

• Average real annualised return = 4.0%
• Cumulative growth of 1DM/euro = 426.7
• Best annual return = 149.7%, 1923
• Worst annual return = -90.0%, 1948
• Volatility = 31.4%

The German graph looks remarkably similar to the UK experience, with three main exceptions. Namely 1920s’ hyperinflation, the aftermath of World War 2, and Germany’s comparatively smooth sailing through the 1970s.

You can’t help but stare in wonder at the priapic spike driven by the stock market frenzy that accompanied hyperinflation from 1921 to 1923.

We’ve all heard of the wheelbarrows full of worthless money in Germany back then. In that climate, the stock market was a rare place you could protect your wealth – at least for a time.

Even in after-inflation terms, the market rose 722% between 1921 and 1923. It then imploded – falling by 92% over the next two years.

By 1931, in the midst of the Great Depression, the index had been set back 50 years, to levels last seen in 1881.

War hammered

From that nadir, equities rose by double digits for five years in a row. By which time the Nazis were firmly in power.

After a slight wobble in 1938, markets advanced again from 1939 to 1940 in lockstep with German tanks. Stocks were largely domestically-owned and the 30% increase in 1940 speaks to the string of victories scored on the battlefield.

The market continued to rise, even as the Germans were stopped outside Moscow. But then the Nazi government imposed a stock price floor from 1943 as its fortunes deteriorated. This move essentially froze prices for the remainder of the war. Traders declined to buy stocks that were kept aloft by artificial gravity.

1948’s vertiginous 90% drop accompanied the revaluation of the German currency to 10% of its former value.

At that point, German stocks were worth 33% less than they had been in 1871.

So much for ‘stocks for the long run’.

The only way is up

However this uncompressed calamity was followed by a 121% rebound the following year, as the post-war Wirtschaftswunder2 began to take hold.

By 1958 your stocks would have made 2021% if you’d bought into the German market in 1948.

How many people could or would have done that? Vanishingly few, I suspect.

Elsewhere the UK’s worst stock market crash still lay ahead. Our home market tombstoned -72% from 1973 to 1974.

But in contrast the German market only declined 24% during the same period.

And now, if you look back 50 years, German returns average 5.9% annualised. That compares to 6.2% annualised for the UK and 7.1% for the US.

Nevertheless, the catastrophic German war experience has left its imprint in the country’s relatively subdued overall market return of 4% annualised over the very long-term.

French stock market returns

Alas, as the French chart shows, there are other roads besides defeat in war that lead to stock market perdition:

• Average real annualised return = 1.2%
• Cumulative growth of 1F/euro = 6.58
• Best annual return = 115.9%, 1954
• Worst annual return = -46.0%, 1945
• Volatility = 21.8%

Japan is the cautionary tale commonly used by seasoned investors to scare the younglings – but it should be France.

Unlike Japan, the French market is still 33% below its World War 2 peak some 80 years later.

French equities lost 96% of their value from 1942 to 1950. But the slide didn’t stop there. The market continued to crumble for another 27 years, until 98% had been lost peak-to-trough.

Paradoxically, the French economy and people enjoyed a 30-year boom after World War 2 – a period that came to be known as Les Trente Glorieuses.

But the benefits weren’t felt by French investors.

Returns were undermined by industrial nationalisation and high inflation. It wasn’t until 1983 that the market was defibrillated back into life by Mitterand’s tournant de la rigeur economic reforms.

By then, the stock market had been a disaster area since 1914. That long era of investor sorrow has saddled French equities with a bond-like 1.24% long-run annualised return.

Yes, the past 50 years have seen French shares recover to a perfectly respectable 5.3% annualised. Even so I still believe the gallic experience is the best riposte to home bias imaginable.

The German and Japanese downturns are clearer illustrations of investing risk.

But France’s lost years demonstrate that equity rewards do not necessarily flow from economic success (something we’ve seen again more recently with certain emerging markets).

UK and US stock market returns

By way of contrast, here’s the growth charts for UK and US equities:

Real total return data from JST Macrohistory3 and FTSE Russell. March 2024.

• Average real annualised return = 5.3%
• Cumulative growth of £1 = 2,521.55
• Best annual return = 103.4%, 1975
• Worst annual return = -57.0%, 1974
• Volatility = 17.5%

Data from JST Macrohistory 4 and Aswath Damodaran. March 2024.

• Average real annualised return = 6.8%
• Cumulative growth of $1 = 24,640.33
• Best annual return = 60.9%, 1933
• Worst annual return = -41.0%, 2008
• Volatility = 18.4%

International long-term returns

And for completeness here’s how our foursome compare when you plot them all on the same chart:

I wonder how many people look at the blistering US performance and decide to go all-in on an S&P 500 ETF?

Especially after US stocks’ recent stunning results.

Or how about a bet on nordic tigers Sweden and Denmark? They’ve enjoyed US-level returns over the past 150 years.

Me? I don’t think any regime can last forever so I’m sticking with my global tracker fund.

Take it steady,

The Accumulator

1. Òscar Jordà, Katharina Knoll, Dmitry Kuvshinov, Moritz Schularick, and Alan M. Taylor. 2019. “The Rate of Return on Everything, 1870–2015.” Quarterly Journal of Economics, 134(3), 1225-1298. [↩]
2. ‘Economic miracle’. [↩]
3. Òscar Jordà, Katharina Knoll, Dmitry Kuvshinov, Moritz Schularick, and Alan M. Taylor. 2019. “The Rate of Return on Everything, 1870–2015.” Quarterly Journal of Economics, 134(3), 1225-1298. [↩]
4. Òscar Jordà, Katharina Knoll, Dmitry Kuvshinov, Moritz Schularick, and Alan M. Taylor. 2019. “The Rate of Return on Everything, 1870–2015.” Quarterly Journal of Economics, 134(3), 1225-1298. [↩]

What caught my eye this week.

The UK’s largest investment trust Scottish Mortgage ​announced​ a £1bn share buyback plan on Friday. (Disclosure: I own some).

Appropriately enough, it’s the biggest buyback ever undertaken by a trust. Meaningful even set against Scottish Mortgage’s £11bn-plus market cap.

Traders seem to think size matters. Scottish Mortgage shares ended the day up 6%.

That’s a punchy move considering that in theory a share buyback – even a £1bn one – is just a capital rejig decision from the ‘look-through’ perspective of a shareholder.

Simplifying, cash that was on the trust’s balance sheet – money each shareholder has a notional claim on – is simply converted via a buyback programme into shares repurchased by the trust that, at least initially, are also held on its balance sheet, though they are often cancelled thereafter.

In practice, however, stuff changes.

In the case of Scottish Mortgage, it is buying into its own portfolio at a wide discount – 15% to Net Asset Value (NAV) when the news broke – which is by itself accretive to its NAV.

Moreover the managers presumably have maximum faith in their own portfolio, versus any new investment the trust could have made with the money instead. So in that sense a buyback is a de-risking move.

On the other hand, a trust may increase borrowings to do a share repurchase. That increases risk.

Share buybacks do reduce the number of shares in issue. As the trust shrinks, the expenses of running it are spread across fewer shares in total. This slightly increases the costs for ongoing shareholders.

Finally, liquidity can improve for shares in companies executing a sizeable buyback. That’s because there’s a new big buyer in the market – itself!

Improved liquidity can make shares more attractive to trade, and this might narrow the discount a bit too.

Trust us, we’re professionals

The main impact of a big buyback though is surely psychological.

Alongside declaring the availability of £1bn to buy back its own shares, Scottish Mortgage said its:

[…] public and private portfolio is delivering strong operational results, evidenced in part by free cashflow from the portfolio companies having more than doubled over the past year.

Investors have fretted since the crash of 2022 about the valuations of private companies. There was a big correction in the valuation for listed growth firms, but there’s obviously no marked-to-market price for unlisted ones. You have to believe a fund manager’s valuations.

Scottish Mortgage has claimed its holdings are doing fine before. I guess the words have more weight with £1bn behind them.

To some extent then, yesterday’s 6% share price jump represents investors leaping out of their chairs and declaring themselves believers.

However it’s worth noting that the trust already bought back £353m of shares over the past two years. The increased buyback scope is huge. But it’s not a wholly novel development.

Indeed I suspect the timing of this announcement was triggered by Scottish Mortgage’s portfolio reaching a level where it could buyback £1bn of shares without breaching its limits on the proportion of private companies in that portfolio – given some of the £1bn warchest will presumably come from selling its listed equities, which will increase the percentage in unlisted ones.

Win or lose

All told it’ll be interesting to see if this little rally holds.

In Monevator Moguls, we’ve been running the Geiger counter over discounted investment trusts for a while. To me it appears to be one of the clear opportunities for active investors right now.

Everyone has a favoured theory as to why discounts have widened so much in the past 18-24 months.

I always tend to favour sentiment. Other factors fingered include the ongoing merger of smaller wealth managers that leaves less appetite for interesting stock picking, unfair cost disclosure regulation, and capital flowing out of the London market at a record pace.

Investors focusing on any individual trust – or sector – have their own pet peeves too. The unlisted holdings I mentioned for growth trusts, say, or a lack of transactions in the commercial property market driving REIT discounts or, again, the shunning of UK equities that may be behind the discounts on once-revered UK equity income trusts.

Again, I suspect it’s nothing that a prolonged bull market wouldn’t solve. But I have no crystal ball.

Naughty active investors who enjoy the thrill of the hunt – despite knowing better – are welcome to join us on Moguls. I’m sure we’ll look at more cheap-seeming trusts in the months ahead.

Finally it has to be said that investment trusts are largely a UK market peculiarity.

Perhaps – sadly – the writing is on the wall for them?

A cool £1bn from Scottish Mortgage says not, but will this news mark a reversal in the decline of the sector or perhaps a last futile throw of the dice? Time will tell.

Have a great weekend!

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