Equalisation and Accrued Dividend

[edwills46]

Dear Financial Cognoscenti, thank you in advance for your considerations.
When I buy income units of a fund into a dealing account there is usually an equalisation payment (EqP) when I next receive a dividend. I understand that the EqP corresponds to the cost of the dividends accrued within the fund at the point of purchase (so the amount used for purchase is reduced by the EqP when I come to calculate CGT).
However, when I sell income units at any time, I never see a partial dividend or 'reverse' EqP. The whole sale amount is used to calculate CGT. And, on the other hand, any accrued dividend is part of the sale value.
It sounds like some accrued interest is being converted into capital. Do I understand correctly? If not, the following may be irrelevant.

I have something over 100K in a dealing account, all in equities, and I don't need to do self-assessment (well under the 40% tax band). Given that the dividends may exceed the 2K limit (which would require SA) and the capital gain in any one year has been less than the CGT allowance, I was considering the strategy of:

Each September, sell all my Vanguard Dev World ex-UK Income Units (they go ex-div later in the year) and buy HSBC All World.
Each new financial year, sell the HSBC and buy Vanguard, avoiding the HSBC June dividend payment.
I'm not worried that the fund underlying investments are somewhat different and, since I get two deals per quarter free, the dealing cost is zero.

This would avoid any dividend income and should allow me to avoid exceeding the CGT allowance unless the pound sinks below the horizon.

Will this turn out to be a Baldrick-type cunning plan or should it work for the limited scenario that applies?

Yes, I do know about ISAs and SIPPs, but they are not relevant in this case.
The tax man (via Web Chats) has told me that I only need to enter SA if I receive 2K+ divis or exceed the CGT allowance (so the gross sales amount does not matter even though, if I already did SA, I would have to complete the CGT section).

[JohnB]

If you are doing a tax return, you need to quote all transactions over 4*CGT threshold, ie 44.4k, even if that doesn't lead to a taxable gain/loss. Don't know if that alone is sufficient to trigger a SA return though.

[nmdhqbc]

Seems like a good idea. I was waiting to see if anyone saw any flaws in it. I can't see any but I'm not so well versed in these things. Them paying dividend once a year helps a lot. You could just be out of the market for a day or two but I don't think that lets you spread out your capital gains for tax purposes. I think you need to be out for a while before you get back in. I presume switching to a different fund bypasses this. Can anyone confirm this?

I always thought it was stupid how they go to great complicated lengths to get the dividend / cap gains exact for the buy but then completely ignore it for the sell. If indeed they do. I think they do but if not that could be a stumbling block. They should just scrap that whole system and keep it simple like a normal share.

[helfordpirate]

My understanding on equalisation is a little different - but with the same outcome!

Equalisation is not a process intended to deal with you buying/selling accrued income, it is a process that is used in open ended funds to make sure existing investors are not disadvantaged by the creation or redemption of new units. The price of a fund is unitised and represents the value of the underlying assets plus the income account (dividends received and equalisation payments -see later!) divided by the number of existing units (ignoring fees and spreads). When you buy new units at this unitised price, the subscription is split into a capital payment (which is used to buy more underlying assets) plus an equalisation payment (which is effectively the dividend that would have accrued to you if you had owned the units since the last distribution). The equalisation payment is put in the income account. When a distribution is made, all units receive the same amount - being the income account divided by the number of units. The equalisation payments in the income account make sure that everyone can receive a sum representing the income that would have been generated by the underlying assets in the period. However, if you bought units in the middle of the period you never were entitled to the income, instead you are just receiving a repayment of the equalisation payment that you made i.e a return of capital.

The issue of does this convert income to capital etc. is not really relevant. Authorised investment funds are generally opaque to income tax - which means that income received at a fund level i.e dividends, is not "income" in the hands of the investor. It only becomes income when it is declared as a dividend and the investor becomes legally entitled to it. The same is true of company profits and dividends - profit is not an investors income till it is declared as a dividend.

(Note some funds are transparent for income tax e.g some Luxembourg ETFS and you have to declare income as an when the fund receives. Contrast also with the treatment of accrued interest on gilts - if you sell gilts above a de minimis you have to pay income tax on the accrued interest i.e the difference between the dirty and clean price.)

But anyway I think you're approach works - but I would not be so dismissive of the issue of whether the two funds are tracking the same index and hold the same assets. For your strategy to work well, you need to make sure that the funds are receiving their income at the same rate and time otherwise you risk selling out of one that say has not received income from its "Miners holdings and buying one that has. So I would want funds that hold substantially the same assets.

[nmdhqbc]

The issue of does this convert income to capital etc. is not really relevant. Authorised investment funds are generally opaque to income tax - which means that income received at a fund level i.e dividends, is not "income" in the hands of the investor. It only becomes income when it is declared as a dividend and the investor becomes legally entitled to it. The same is true of company profits and dividends - profit is not an investors income till it is declared as a dividend.

So am I right in saying that the equalisation system is not really designed for getting the unit holders taxation of divi/cap gains exactly right but more for the admin of the fund? Hence they don't bother with any such "reverse equalisation" when you sell. But I guess since all that info is there anyway for the buy they utilize it in your tax returns. But then they must consider it not worthwhile doing the same purely for the personal taxation. Which leaves this weird inconsistency. Well if so it helps avoid some tax anyway which is good.

[edwills46]

Thank you for the opinions and clarifications.

As regards ETFs: they would allow a better match (e.g. swapping between HSBC FTSE All World Index investment fund and Vanguard All World Index ETF (VWRL)). But the more frequent dividends would require too much diligence on my part to avoid receiving them and to avoid holding an ETF when its Excess Reporting Income is incurred. With the right broker though (e.g. Hargreaves who allow you to sell and buy without waiting for settlement, so I seem to remember) one could eliminate time out of the market. ETFs are all (?) domiciled overseas and there would have to be another chat with HMRC re when foreign dividend income mandates SA.

I'll stick to UK Registered/UK Reporting investment funds. But I see that Vanguard's FTSE Global All Cap Index fund may be an alternative to VG Dev World ex-UK.

Once again, thank you.
Ed