In comparison, income shares distribute income as either interest or dividends. There is no adjustment needed for CGT if the income is paid to the investor and not rolled up within the fund; however the impact of equalisation payments should be factored in.
However, some investors may choose to have their income reinvested and this is achieved by purchasing additional shares/units in the fund.
Each new purchase will be added to the section 104 pool and will affect the average cost used when shares are sold. This means that, to accurately calculate the gain, the number of shares purchased and their cost for each income distribution will need to be identified.
Equalisation payments
There are fixed dates when income shares pay out. A new investor who invests between distribution dates (but before the ex-dividend date) will still receive the full distribution for the period, even though they were only invested for part of the period for which it relates.
The investor is only assessable to income tax on the part of the payment which reflects their period of ownership. The balance is treated as a return of their original capital and is known as an ‘equalisation payment’. This amount is not taxable but has the effect of lowering the acquisition cost of the shares purchased.
Example:
The ABC UK Equity OEIC pays dividends twice a year. Dan invests £10,000 in income shares and after two months he receives his first distribution of £750, which represents income earned over the past six months.
This will be treated as follows:
Dividend income: 2/6ths x £750 = £250
Equalisation payment: 4/6ths x £750 = £500
Consequently, as a result of this return of capital, his acquisition cost for the shares is reduced to £9,500 (that is, £9,500 will be added to the cost pool, and not £10,000).
What to do with the proceeds
If the client has not earmarked the capital realised by crystallising gains within the annual exemption for a specific purpose, a tax efficient home for the funds should be considered.
Immediate reinvestment into the same fund could undo the planning undertaken.
Share matching rules
There are rules that treat the sale and immediate buy back of shares differently. This is to prevent investors benefiting from crystallising gains within the annual exemption when they have in reality never been without the shares for a significant period.
These ‘share matching’ rules mean that, where the same shares are sold and repurchased within 30 days, the full gain built up over the total time that the shares were owned is not crystallised. Instead, the repurchase cost becomes the acquisition cost for the shares disposed of and the gain/loss is calculated using this figure.
Example:
