Investments outside a tax shelter

[mrodent]

My father died in 2022 and my brother and I have finally started getting money paid to us. This is several hundred thousand pounds each. I'm planning to put some of this at least into my SIPP but for the moment it's all going to go into index funds. I've already used up my ISA allowance 23-24 so this will be added to my existing non-tax-shelter investment account. I want to minimise liabilities for both Dividend Tax and CGT.

Avoiding CGT probably means selling off some stuff in March and then buying new on April 6 (never bothered hitherto: but there is info about this strategy available online).

But I'm mainly interested in advice about avoiding dividend tax: is it the case that some index trackers produce more dividends than others? I presume that depends on the underlying companies: in a typical global index fund you'll find Apple, Google, etc., i.e. all the usual suspects. Is there some way of choosing to invest in index funds which are particularly growth-oriented rather than dividend-paying? I have a lot of BRK.B, and this is a company (not a US investment fund, which would be tax-bad), and also famously Buffett and Munger never pay dividends. So I'm tempted to put something into that.

But does some with knowledge have things to say about strategy if I want to put most of these funds into index trackers?

PS I am 62 but haven't currently the slightest intention to use my SIPP in any way for the foreseeable future (although I'm aware that maximising tax efficiency wrt SIPPs is pretty important).

[monabri]

.Read up on Excess Reportable Income( ERI) aka (PITA). Like you, I've used my ISA allowance and would consider trackers but for the hassle of ERI in taxable accounts.


viewtopic.php?p=595094#p595094

[EthicsGradient]

Are you currently a basic rate taxpayer, or higher rate? If the former, then the tax on dividends, at 8.75%, is lower than either CGT rate, and so it may not be worth looking for capital gain if the latter is going to get taxed eventually (at "several hundred thousand", it's likely your capital growth will be more than the £3k CG allowance from 24-25 onwards, though maybe large SIPP contributions will cut the capital down).

If you are currently a higher rate payer, then it does make more sense to minimise dividends for now - especially if you will be a basic rate payer after retirement, which would put capital gains realised then at just 10%.

[mrodent]

@monabri. Thanks, have had a first look at that link. At least I now know another depressing acronym: ERI, not PITA (which I knew). If you don't mind me asking: you seem to be in a similar predicament? So what have you chosen to do with such funds (if applicable)? O the burden of riches.

@EthicsGradient. Thanks. Higher rate. Nasty stuff. O the burden of riches.

I'm now starting to wonder whether in my situation "other investment classes" might in fact become more attractive: higher rate Dividend Tax is not funny at all. I mentioned BRK.B: I'm about 99.9% sure that, although growth in this could certainly lead to CGT liabilities, it could never give rise to any Dividend Tax liabilities (I checked on this extensively about a year ago). So seems potentially a pretty good bet.

Or potentially other ACTIVE managed (UK) funds, which are very consciously targeting growth stocks. But if there are any other passive equivalents... that'd be preferable, as I'm a tightwad and no great fan of swingeing OGCs.

[kempiejon]

Any profitable strategy and the problem of tax is a nice one to have but one can try to minimise it, I'd avoid REITs unsheltered. Selling enough each year to stay within CGT threshold is worthwhile but like dividend income allowances have been falling fast.
We had a thread about investing without tax wrappers available.
https://lemonfool.co.uk/viewtopic.php?f=56&t=41702

On first glance my thoughts would be to fill a SIPP and ISA every year where you can invest however suits you, tax free, with impunity. Premium bonds are exempt as are capital gains on UK government gilts and legal tender gold coins. Then if picking trackers global and USA are lower dividend yield than UK. Distributing versions, monabri rightly draws attention to ERI.
Are you in a position at work to salary sacrifice into a pension for a few years, maybe drop a tax bracket and live off the windfall? Could that work?

[mrodent]

@kempiejon
Thanks. This seems spot on advice: diversifying asset classes, etc. That link is packed with ideas: will study it!

This thing about tax brackets and salary sacrifice doesn't unfortunately apply. I'm a micro-company owner (just me) and always have been. I pay myself just enough to pay about £10 of higher rate tax each year, and put everything above that into my SIPP (as a director's pension contribution). Max SIPP contribution is £60k, but you'll probably have understood that I deliberately don't earn that much. Lots of retained profit in my company.

At the risk of sounding smug I don't in fact work that many hours a month, and I work at home, so working less doesn't really apply either. Mortgage paid off. Not much stress or whatever. Government gilts: interesting. Obviously bond **funds** have just crashed, as in the biggest crash ever. But **short-term** gilts, and these being exempt from CGT: that's quite interesting. I mean the return will presumably be rubbish. But in the context of this embarrassment of riches tax efficiency changes the perspective a lot.

Maybe I should buy an expensive car. Except that I don't own or need a car. I own two bicycles. Maybe I should invest in a third bicycle.

[SalvorHardin]

Premium Bonds are a decent tax avoiding alternative to long-term deposit accounts. The "winnings" are tax-free and the overall interest rate is very competitive for higher rate taxpayers once you take the tax-free bit into account (and have a large holding so that your returns are more consistent). Quite a few people own the maximum amount possible and treat them as an alternative to long-term deposit accounts.

To avoid dividend tax on shares held outside ISAs, avoid shares which pay dividends. That's the middle and both ends of it. There are quite a few shares (particularly Americans), ETFs, OEICs and Investment Trusts which don't pay dividends. Of the shares which I own, the non-dividend payers are the specialist Indian Investment Trusts, Berkshire Hathaway (which IMHO will pay dividends after Warren Buffett retires), AeroVironment (military drones, with a PE ratio that makes the "Magnificent Seven" tech stocks seem cheap), Atlanta Braves Holdings (Professional Baseball team, a trophy asset that some multi-billionaire will buy one day for a fortune), Madison Square Garden Sports (New York Knicks (Basketball), as per Atlanta Braves) and Sphere Entertainment (the Las Vegas sphere).

Antiques, Coins an Stamps are an option, though the dealing costs are huge, it's easy to overpay (or be ripped off) if you lack knowledge and they can be highly illiquid assets (you get fire sale prices when you are desperate to sell). There's a thread on here about Watches as an investment which mentions quite a few of the pitfalls. Antiques, coins and stamps are popular amongst tax evaders; over the years I've heard many stories about how a deceased's house is stripped of antiques and other chattels by the relatives before the probate is calculated. Even a flock of sheep and a tractor!

An alternative is to not let the metaphorical tax tail wag the investment dog and accept that you're going to be paying some tax. That's what I've done over the years; due to some excellent returns in the early 2000s on small oil companies I am never going to be in the position where I can get everything into ISAs. I never invest in anything where the primary aim is to avoid tax (and have paid capital gains tax on shares in nineteen of the last twenty-one tax years).

I've seen many people over the years jump through metaphorical flaming hoops in order to avoid tax, only to discover that they have ended up in a worse position than if they had stuck to similar but taxable investments. Business Expansion Schemes involving companies with very little investment merit were very popular ways to avoid tax in the late 1980s and 1990 (and then lose most of all of what was invested). Friendly Society policies used to be quite popular back then, their being tax-free was a brilliant selling point (never mind that the tax-free return was all too often lower than the after-tax return of similar investments). Becoming an Angel investor in theatre projects is another possibility, though bear in mind that those in the business will have had their pick of the proposals so what gets offered to the public is unlikely to be a top notch opportunity.

In the 1990s a firm where I worked had some dealings with a person who was paranoid about avoiding capital gains tax. This was a big issue because he had a large holding in a small company which had been turned into a property developer in the 1970s, whose share price then rocketed in the 1980s. It was his largest asset by some way (ISTR about twice the value of his very desirable house), but he refused to sell any shares because he would have to pay some CGT. He was still holding the lot when the company went bust in 1992. As I said to his accountant, 60% of something is worth a lot more than 100% of nothing.

[SalvorHardin]

Something I've just remembered is buying zero dividend preference shares in combination with a temporary annuity. We used to do a lot of these for clients in the early 1990s; they were really good for clients who never used their capital gains tax allowance and were higher rate taxpayers. This was in the days before the split capital investment trusts scandal (which didn't really affect the zeros anyway but the supply somewhat dried up afterwards).

You buy a holding of split capital investment trust zero dividend preference shares which on maturity would repay all of your capital. What capital wasn't used on the zeros was instead used to buy a temporary annuity with a term approximately equal to the remaining term of the zeros. Bed-and-breakfast the zeros along the way to use the capital gains tax allowance and much of the annuity is not taxable because it is deemed to be the return of capital.

You could do the same thing using stripped gilts (gilts where the capital and interest have been separated), though I haven't a clue about the current tax treatment (or of a zero div prefs scheme).

[mrodent]

Premium Bonds are a decent tax avoiding alternative to long-term deposit accounts. The "winnings" are tax-free and the overall interest rate is very competitive for higher rate taxpayers once you take the tax-free bit into account (and have a large holding so that your returns are more consistent). Quite a few people own the maximum amount possible and treat them as an alternative to long-term deposit accounts.

Noted. Again the changed perspective when large amounts of higher rate tax loom.

Berkshire Hathaway (which IMHO will pay dividends after Warren Buffett retires)

Gulp. Coming from someone who is so obviously knowledgeable that's a bit ominous-sounding. I have some serious unsheltered investments already in BRK.B. Care to say what makes you think that? I shudder to think how hard a UK taxpayer will get hit when declaring US dividends.

... the dealing costs are huge ... Even a flock of sheep and a tractor!

Well last year, after my father died, I did splash out on an expensive piano. And yes, you inevitably buy a Steinway from a dealer and will inevitably sell (if you do) to another dealer. It is of course an investment, in happiness, probably not money. Much like a flock of sheep perhaps?

An alternative is to not let the metaphorical tax tail wag the investment dog and accept that you're going to be paying some tax. That's what I've done over the years;

Got it.

Becoming an Angel investor in theatre projects is another possibility, though bear in mind that those in the business will have had their pick of the proposals so what gets offered to the public is unlikely to be a top notch opportunity.

Ah, the "The Producers" strategy. Their strategy (to make a huge loss) failed of course.

Thanks for all that. Great advice.

[monabri]

@monabri. Thanks, have had a first look at that link. At least I now know another depressing acronym: ERI, not PITA (which I knew). If you don't mind me asking: you seem to be in a similar predicament? So what have you chosen to do with such funds (if applicable)? O the burden of riches.

At the time ( a couple of months ago) I invested into (a) Preference shares (will have to pay tax on these) and (b) index linked short dated Gilts. The IL Gilts will, on bond maturity, be used to fill next years ISA. If we'd been discussing this a month or so ago, maybe low coupon Gilts ( not index linked) might be a consideration. Have a look/consideration at Gilts..there might might something if interest.

One might also consider Premium Bonds or a 'n' year fixed rate bond where the interest at maturity does not exceed the £1k allowance ( of course, this allowance might change).

[Lootman]

Gulp. Coming from someone who is so obviously knowledgeable that's a bit ominous-sounding. I have some serious unsheltered investments already in BRK.B. Care to say what makes you think that? I shudder to think how hard a UK taxpayer will get hit when declaring US dividends.

It has been said a few times over the years that BRK would start paying dividends when Buffett retires or dies. That has been speculation rather than anything coming from the company itself, that I know of anyway.

I am not so sure. It would ultimately be something the shareholders might feel strongly about (either way). And given that many shareholders like the fact that there are no dividends, for tax deferral purposes, it may be that the current situation will be maintained.

Such a decision would also be a statement by BRK that they do not think they can continue to invest well and make good deals in the future, which is not a confident message.

But do not be too scared of the tax on US dividends. Assuming you have signed up for 15% withholding then the dividends effectively come with a tax credit.

[SalvorHardin]

Gulp. Coming from someone who is so obviously knowledgeable that's a bit ominous-sounding. I have some serious unsheltered investments already in BRK.B. Care to say what makes you think that? I shudder to think how hard a UK taxpayer will get hit when declaring US dividends.

Before the American Motley Fool changed its discussion boards earlier this year, there was a very active Berkshire Hathaway forum which was populated by a lot of private investors. Collectively the forum's knowledge was extremely good. The general opinion was that Berkshire would eventually pay dividends after Warren Buffett "retired" because the new management wouldn't have the same level of confidence, contacts or experience to generate sufficient reinvestment opportunities. Caution would also play a role, in that the management would be wary of making bad investments.

The expectation was that the dividend would not be huge, probabably between 0.5% and 1% per year (a small dividend, similar to when Microsoft started paying dividends in 2003).

You lose 15% of American dividends as withholding tax (30% if you haven't completed the W-8BEN form). Due to double taxation treaties the withholding tax counts towards your UK income tax liability on the American dividends. So for higher rate tapayers the withholding tax should take care of 15% of the 33.75% UK dividend tax, leaving you with 18.5% tax to pay. So you're no worse off receiving an American dividend than if it was a UK dividend.

As to the sheep and tractor, the story I heard was that they were "taken on holiday" from a farm by a relative around the time that the Inheritance Tax Act 1984 was passed (there was some uncertainty regarding the tax treatment of part of the farm).

[DrFfybes]

In the same situation 20 months ago age 55, I did...

Set up a second GIA for the new money so it didn't impact my investment spreadsheets.
Bought a lot of BRKB and VEVE. Learnt all about ERI and discovered VEV didn't declare any last year.
Put some as cash, increased MrsF's salary sacrifice to the max to keep her earning minimum wage, and lived on the inheritance instead.
Opened and made monthly contributions to (J)ISAs for the younger relatives.

Paul

[mrodent]

@DrFfybes

Thanks... could you give a link or suggestion to how I start to educate myself about ERI for specific funds or ETFs? It seems like this varies from year to year, so ideally it seems like it'd be good to find tables over the past few years.

Googling on this helps, e.g. viewtopic.php?t=38298 ... so it seems like fund companies may not want to make it too easy for us, if I understand correctly. But I get the earlier thing above about lower divs generally with Global or US index funds (covers most of mine). That's a start at least.

[monabri]

@DrFfybes

Thanks... could you give a link or suggestion to how I start to educate myself about ERI for specific funds or ETFs? It seems like this varies from year to year ... so ideally it seems like it'd be good to find tables over the past few years ...

Vanguard report ERI on their funds.

This looks to be useful https://fund-docs.vanguard.com/uk-repor ... nd-faq.pdf

[mrodent]

@monabri

Yes, I'd found that from that other Lemon Fool thread. In fact you have to follow the link on p. 3 of that "FAQ" document, which takes you here: https://www.ie.vanguard/product-documen ... -reporting

... So OK in the Excel file for 2023 for "Vanguard Funds", column J shows "Excess of reporting income over distribution". Presumably we're looking for funds with the lowest figures there.

But in fact I've tended to move away from Vanguard recently: their "LifeStrategy" funds appear to tend to be over-weighted towards the UK, and also their OGCs are higher than some other funds. I have a lot in this: https://www.morningstar.co.uk/uk/funds/snapshot/snapshot.aspx?id=F00000TXY8, HSBC FTSE All-World Index Fund Accumulation C. Morningstar doesn't appear to provide any ERI data. No doubt if I search I shall find re ERI...

... and in fact I find that this fund has been discussed recently on this very site, and in this post https://www.lemonfool.co.uk/viewtopic.php?p=473283#p473283 someone says "The HSBC fund is UK domiciled, so there is no excess reportable income." I think that poster meant "when it is in an ISA".

... hmmm, I can't seem to locate ERI info for that HSBC fund that easily...

[tjh290633]

My immediate thought is to get as much into tax shelters as you can, if you have another half, you could get up to £80,000 sletered in ISAs doing it before and after 5th April. You also have the SIPP option.

Which investment vehicle you use is your choice. Were it me, I think that I would head for the big global ITs, like FCIT, ATST and WTAN for example. However the choice is yours.

TJH

[TedSwippet]

... I have a lot in this: https://www.morningstar.co.uk/uk/funds/snapshot/snapshot.aspx?id=F00000TXY8, HSBC FTSE All-World Index Fund Accumulation C. Morningstar doesn't appear to provide any ERI data. No doubt if I search I shall find re ERI...

... hmmm, I can't seem to locate ERI info for that HSBC fund that easily...

There won't be any.

ERI is only a thing for offshore reporting funds. Because all the ETFs in use in the UK are 'offshore' -- usually Ireland or Luxembourg domiciled -- it's a bugbear for practically all ETFs. Also for some funds and OEICs.

The specific HSBC fund you mention though is UK domiciled. You can tell that from its ISIN, which begins with "GB". Not being 'offshore' means no tangling with ERI. I hold several of these regional HSBC OEICs outside ISAs and SIPPs, and all are completely free of ERI hassles.

[mrodent]

@TedSwippet

Blimey! OK apologies for my naivety (in my defence I only learnt the acronym ERI earlier in this thread).

About 95% of my investments are funds rather than ETFs... and off the top of my head I believe that (apart from BRK.B) all the holdings I have in "general" (unsheltered) accounts are in funds. I'll have to double-check that these are GB... rather than IE... .

But the thing I don't then understand is: surely all, or virtually all, the companies in which fund X invests are generating dividends, whether in the UK or abroad. Does HMRC take no interest in these dividends? I mean, in the case of an accumulation fund (for the sake of discussion)? You seem pretty sure of your stuff.

I'm doubly or trebly discombobulated about this HSBC fund which, although UK-domiciled, as you say, is a "global" index fund.

Are you saying that no fund whose ISIN starts "GB ..." can possibly generate any Dividend Tax liabilities, even when not in a tax shelter (ISA or SIPP)?

PS I'm pretty sure that over the past 3 or 4 years, when doing my self-assessment form, I have consciously looked up any dividend income for funds in my "general" (non-ISA) investment account and duly included this in my form. We're not talking huge amounts here, but are you saying that I may have overpaid some Dividend Tax due to that?

[TedSwippet]

I'm doubly or trebly discombobulated about this HSBC fund which, although UK-domiciled, as you say, is a "global" index fund.

What the fund contains is irrelevant. What matters is whether, and how, the fund distributes to holders what it receives from those things as dividends.

Are you saying that no fund whose ISIN starts "GB ..." can possibly generate any Dividend Tax liabilities, even when not in a tax shelter (ISA or SIPP)?

Not at all. These funds pay you a dividend, and you then have the joy of paying tax on those.

What you get to escape if you avoid 'offshore' funds, though, is the pain of uncovering any ERI -- which is by definition the (usually small) extra element of returns that was not paid to you when the fund distributed dividends -- paying tax now on that as if received, and then later factoring it out for CGT purposes.

PS I'm pretty sure that over the past 3 or 4 years, when doing my self-assessment form, I have consciously looked up any dividend income for funds in my "general" (non-ISA) investment account and duly included this in my form. We're not talking huge amounts here, but are you saying that I may have overpaid some Dividend Tax due to that?

Probably not. Your broker or platform should have issued a 'consolidated tax certificate' in any case, covering the dividends you'd been paid, and you'd use those figures. Anything you looked up for yourself should have matched those numbers (although, beware the wrinkle of equalisation payments).