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Accumulation units – tax on reinvested dividends UK

Are reinvested dividends taxable in the UK? Sadly, yes. Fund accumulation units attract income tax  [1]on dividends and interest at the same rates as their more transparent ‘income unit’ cousins.

Which means that you owe dividend income tax [2] (or income tax on interest in the case of bond funds) even though you don’t physically receive a payout to your bank account.

Indeed the taxman still wants his cut despite many accumulation class funds showing zero dividend distributions on their webpages.

But it gets worse. Some investors are probably paying tax twice on their accumulation unit income! That’s because they don’t properly account for the effect of dividends on their capital gains tax [3] bill.

Let’s sort this mess out with a quick summary of the reinvested dividend tax rules.

++ Monevator minefield warning ++ Everything below applies equally to dividends and interest but we’ll mostly only refer to dividends because life is short. It also equally applies to accumulating / capitalising ETFs, as well as the accumulation units of OEIC and Unit Trust funds. We’ll pick out the occasional exception where it exists.

What are accumulation units again? And how do they reinvest dividends?

Many investment funds come in two varieties (or share classes) that differ only in the way they treat dividend payments:

You can tell how a fund deploys its dividends by checking its name:

Reinvesting dividends increases the capital value of a fund composed of accumulation units. That has implications for capital gains tax. We’ll show you how to work this out below.

At the same time, dividends reinvested into your fund’s accumulation units are known as a ‘notional distribution’.

The notional distribution is taxable – in just the same way as income units.

Tax on accumulation funds – HMRC’s view

Some people think you don’t have to pay tax on reinvested dividends in accumulation units. And some claim you don’t owe taxes on accumulating fund distributions until you sell.

However, here’s the HMRC proof [6] that shows you owe tax on accumulation funds just the same as if they were income funds:

Amounts reinvested are taxed as income accruing to investors in the same way as if they had been distributed.

The reason for this treatment is to ensure that tax is not a factor which might distort investors’ choices and it prevents investors delaying payment of income tax through long-term accumulation of income.

Tax on accumulation funds – when do you not have to pay?

You owe income tax on ‘accumulated’ dividends unless:

Any investment vehicle that has over 60% of its assets in fixed income or cash at any point in its accounting year counts as paying interest, not dividends.

Meanwhile anything less than 60% means distributions count as dividends.

Do you pay capital gains tax on reinvested dividends in the UK?

You do not have to pay capital gains tax on reinvested dividends in accumulation units. You’re already paying income tax on those.

So when you come to fathom the capital gain on your accumulation funds (and as your resultant psychic scream reverberates around the universe), make sure you deduct any notional distributions from the total gain. Otherwise, the reinvested dividends inflate the value of your fund and you’ll overpay CGT.

Here’s the formula to correctly calculate capital gains tax on accumulation funds:

Capital gain = Net proceeds1 [11] minus original acquisition cost minus accumulation income2 [12] plus equalisation payments

Here’s a worked example for an acc fund sold for £20,000. It’s accumulated £500 income over the years since it was purchased for £10,000:

Net proceeds: £20,000

Less acquisition cost: £10,000

Less accumulation income: £500

Plus equalisation payments: £100

Capital gain = £9,600

If you haven’t received any equalisation payments from your fund then ignore that step. See below for more on equalisation.

Equalisation payment effect on accumulation units

You’ll notice in the example above that accumulation income reduces your capital gains tax bill. Meanwhile, equalisation payments raise it.

Equalisation payments may be made by your fund when you purchase units between dividend payment dates.

They’re paid because part of your purchase price included dividends that inflated the capital value of the fund – before those dividends were distributed (or reinvested).

You weren’t entitled to the dividends that accrued before you invested. The equalisation payment is effectively a return of your capital. It cancels out the extra you paid on the purchase price due to the embedded dividends.

So you don’t owe income tax on equalisation payments.

With accumulation units, treat equalisation as per the capital gains tax formula above.

The effect of dividends you weren’t entitled to is then cancelled out from your fund’s capital value.

Where are my equalisation payments?

Equalisation payments should show up on your fund’s dividend statements via your broker – after the distribution or at the end of the tax year.

You’ll receive multiple equalisation payments if you invest regularly in a fund with an equalisation policy.

Note: not all funds make equalisation payments.

Vanguard has published a guide on how to work out equalisation payments on its funds [13].

Also, please see Monevator reader @londoninvestor’s excellent comment [14] on the confusing way that some brokers layout the relevant information on their statements.

Accumulation unit dividends – how to find them

Of course you can only make the necessary accumulation fund tax calculations if you’ve been recording the dividends you’ve received over the years.

And who doesn’t do that…? Right?

The problem is accumulation unit distributions are more stealthy than income unit payouts. You don’t get to do a little dance every time those dividends turn up in your trading account.

So where can you find out about them?

Note down the amounts you’ve received in accumulation unit dividends on your tax form. Don’t include any equalisation amounts.

The date you received the dividends determines which tax year they fall into.

Are accumulation units worth the hassle?

The main advantage of accumulation funds compared to the Income variety is to skip the cost and effort of reinvesting dividends.

This cost saving is rendered superfluous if your fund isn’t saddled with trading fees or a high regular investing minimum. In that case you can just reinvest the dividends yourself.

With that said, accumulating funds mean that your income is reinvested straightaway, without time out of the market or you having to lift a finger. So they might still be worth your while if you prefer the hands-off approach.

Some people prefer to hold income units when investing outside of a tax shelter for other reasons, too. The dividend payouts can be used to rebalance [18], or to pay tax bills without you having to sell units and trigger capital gains woes if you breach your exemption allowance.

Whichever way you go, just remember that any accumulation units in your unsheltered portfolio  [19]are not immune to income tax.

As (nearly) always, making full use of tax shelters – by investing within your ISAs and pension – saves you hassle as well as money, by enabling you to sidestep all the above malarkey.

But where that’s not possible, start recording those reinvested dividends.

You could do it just for the fun of seeing what you’re earning in income. Even if you don’t have to pay tax on them!

[Note from The Investor: You might well have a different definition of ‘fun’ to The Accumulator…]

Take it steady,

The Accumulator

  1. The amount you sold for. [ [24]]
  2. i.e. dividends or interest. [ [25]]