The danger with DIY investing is that you might miss something that gets you into trouble. Something you never knew you didn’t know. Ever heard of excess reportable income? Me neither. But you may well have earned it and owe tax on it.
If you hold offshore funds or ETFs (I’m just going to refer to funds from now on) outside of an ISA or a SIPP then you need to stay behind for some extra homework. Otherwise you can go and play outside.
Excess reportable income is the amount an offshore fund earns beyond income declared as distributions – whether that be dividends or interest.
This is additional income that can accumulate in your fund throughout the year and the taxman wants his slice.
You must ‘fess up to excess reportable income on your tax return, but it’s an easy one to miss because:
- It’s an obscure tax hit that’s little discussed.
- The information you need is tucked away in dusty corners of your fund manager’s website.
- Basic-rate taxpayers may think it doesn’t apply to them.
- Owners of accumulation funds or capitalizing / synthetic ETFs may similarly think they’re off the hook.
- You may not know where your funds are domiciled.
If your fund isn’t domiciled in the UK (the info should be on the factsheet) then it counts as offshore. This will affect many Monevator readers as most ETFs and a fair number of index funds are domiciled in Ireland.
If you own an offshore fund then you should make sure it has Reporting Fund tax status. If it doesn’t then your funds gains are taxed at income tax rates of 20%, 40%, or 45% rather than cuddly capital gains rates of 18% or 28% (not to mention you’ll miss the chance to use your capital gains allowance and reliefs).
Reporting Funds must produce an income report at the end of their accounting year. This report will show you:
- The income distributed per share (i.e. dividends or interest payments made) and on which dates.
- The excess of reportable income over distributions – this is the amount in question. It is the amount that the fund actually brought in per share over and above the distributions you’ve already received.
If the excess reportable income is £1 per share and you own 1,000 shares then tax may be due on £1,000.
How much tax?
You’ll pay income tax at your standard rate if your fund is invested more than 60% in fixed income securities (e.g. bonds and cash).
That’s because distributions count as interest (and are therefore liable to income tax) if the fund breaks the 60% fixed income threshold at any time during its accounting year.
But you’ll pay a gentler, Fairy Liquid rate of tax if your fund pays dividends – in other words if it’s largely an equity fund.
- Basic rate taxpayers will owe 20% tax on excess reportable income from bond funds. However, they won’t have anything to pay on equity funds because the effective basic rate tax on dividends is 0%, once the tax credit is taken into account.
- Higher rate taxpayers owe 40% tax on bond fund excess reportable income and a 25% effective tax rate on equity funds.
Note, it’s the amount of shares you owned on the last day of the fund’s accounting year that counts. Multiply that number by the excess of reportable income per share to discover your taxable amount. If you didn’t own any shares at that point, then you’re clean away.
You count as receiving the excess income on the fund distribution date, which occurs six months after the fund’s accounting year-end date. If the account period ended 31 December 2012 then you notionally took delivery of the swag on June 30 2013 and should note it on your tax return for 2013/14.
Google your fund provider along with search terms like ‘Reportable Income’ or ‘Income Report’ or ‘Reporting Fund Status’ or ‘Investor Tax Report’ to find the information you need.
Not every fund will earn excess reportable income but do check each investment you own every year.
It’s important to remember that excess reportable income applies to accumulation / capitalising funds, too.
In this case all fund income will fall into the excess reportable column as actual distributions are zero. This will be shown in your fund’s report.
The bright spots
You can at least deduct the value of excess reportable income from any declarable capital gains you make in any particular year from selling some or all your fund. (Otherwise you’ll suffer a double tax charge.)
Moreover, if your fund operates what’s known as a full equalisation policy then you can reduce tax due on the excess reportable income of shares you’ve bought in the current accounting year.
Normally a fund’s share price will include a bulge for the income accumulating inside the fund. Later on you’ll be taxed on the fund’s full income distributions including the accumulated portion you had to pay for when you bought in.
Full equalisation funds enable you to deduct an amount per share from your excess reported income or distribution obligations, so that you’re not taxed on income you didn’t benefit from in the first place but actually had to expend capital on.
If this policy applies to your fund then you’ll find an equalisation rate on your contract note or buried on your fund manager’s website.
I haven’t found any index trackers that operate full equalisation.
Consult a tax expert
At this late stage, we should point out that we’re not tax experts here at Monevator and we can’t provide tax advice. We’re DIY investors combing through information in the public domain. We heartily recommend you take advice from a tax professional if you’re in any doubt about what you’re doing.
BlackRock provides some additional Reporting Fund guidance, too.
Frankly, excess reportable income is another wasp’s nest of issues that I never wished to run into, so it’s worth reiterating you can avoid the whole shebang if any of the following apply to you:
- Your funds are UK domiciled.
- Are tucked up in a SIPP or ISA.
- You’re a basic rate tax-payer whose only funds outside of tax shelters are equity funds.
My co-blogger The Investor can’t resist adding, “Anyone who doesn’t use their ISA allowance because someone told them they won’t immediately save tax on dividends as a basic rate payer has been egregiously blindsided: Part 54,758. The benefits of tax-sheltering your money are myriad, and they compound over the years!”
Take it steady,