Vanguard Multi-asset funds & CGT

[Rajput1962]

Hello.

In Vanguard's 'latest thoughts' article of 15th Jan 2020 i am intrigued by the statement 'Multi-asset funds such as our LifeStrategy funds are not liable to CGT on the gains they make within the fund'.

I'm not quite understanding what a gain 'within' the fund means. How does a multi asset fund grow within itself?!

Surely it doesn't mean that i can sell multi-asset units and say the increase in value was >£12k and never worry about CGT?

[mc2fool]

Hello.

In Vanguard's 'latest thoughts' article of 15th Jan 2020 i am intrigued by the statement 'Multi-asset funds such as our LifeStrategy funds are not liable to CGT on the gains they make within the fund'.

I'm not quite understanding what a gain 'within' the fund means. How does a multi asset fund grow within itself?!

Surely it doesn't mean that i can sell multi-asset units and say the increase in value was >£12k and never worry about CGT?

Sounds like they're trying to trumpet a basic feature of pretty much all collective investment structures. Not sure why they're highlighting the "Multi-asset funds" aspect, other than just plain marketing....

All normal UK collective investment structures -- OEICs/UTs/ITs/ETFs -- don't pay CGT on the gains they make within them.

If the XYZ fund buys, say, HSBC and then sells it later for a stonking profit, it, the XYZ fund, will pay no CGT on that.

Of course, the value of the XYZ fund will go up as a result, and if you'd bought XYZ and sold it later you may (depending on your circumstances and the maths) be liable for CGT on the gain, but it's not XYZ's gain on HSBC that you'll be paying CGT on but your gain on XYZ.

[GeoffF100]

Suppose that you decide that you want to maintain 60% equities and 40% bonds. You could buy an equity tracker with 60% of your money and a bond tracker with 40% of your money. If the value of your equity tracker increases, you need to sell some equities to maintain 60% equities and 40% bonds. The capital gain that you make then becomes liable for CGT.

If you use LifeStrategy, the rebalancing within the fund does not generate a taxable capital gain. Nonetheless, bonds within an OEIC are taxed unfavourably, so holding LifeStrategy outside a tax shelter is not particularly attractive.

[Rajput1962]

Ah, so i can see now how a fund can make gains within itself. The whole Vanguard article is about 'How to reduce your capital gains tax bill' but it doesn't look like a cunning new ruse to avoid CGT then...

[Alaric]

The whole Vanguard article is about 'How to reduce your capital gains tax bill' but it doesn't look like a cunning new ruse to avoid CGT then...

A fund of funds can defer CGT as against investing and rebalancing directly. That may or may not be useful. Someone wanting to utilise a CGT allowance every year could do so with a holding in a fund tracking a popular index and each year switching to another fund doing the same.

[AppleCrumble]

Nonetheless, bonds within an OEIC are taxed unfavourably, so holding LifeStrategy outside a tax shelter is not particularly attractive.

Would you mind expanding on this?

Due to an inheritance I have quite a bit in unsheltered accounts and was planning on buying some LS funds.

[GeoffF100]

Most bonds are currently well above par. The running yield (they yield you are paid and pay income tax on) is well above the redemption yield (effectively the APR). You get extra income, but that is counter-balanced by a capital loss. You may be able to realise that capital loss when you sell the fund, but you may not be able to use it, Even if you can, you may begetting tax relief at a lower rate than you paid on the dividend.

If you buy a bank or building society bond guaranteed by the FSCS, you just pay tax on the APR.

If you want to hold index linked gilts, you can get them with a running yield of about 0.1%, so you do not pay much income tax. Capital gains are also tax free.

[AppleCrumble]

Most bonds are currently well above par. The running yield (they yield you are paid and pay income tax on) is well above the redemption yield (effectively the APR). You get extra income, but that is counter-balanced by a capital loss. You may be able to realise that capital loss when you sell the fund, but you may not be able to use it, Even if you can, you may begetting tax relief at a lower rate than you paid on the dividend.

If you buy a bank or building society bond guaranteed by the FSCS, you just pay tax on the APR.

If you want to hold index linked gilts, you can get them with a running yield of about 0.1%, so you do not pay much income tax. Capital gains are also tax free.

So, faced with a choice of holding either bonds or equities in unsheltered accounts, you would choose equities?

[GeoffF100]

So, faced with a choice of holding either bonds or equities in unsheltered accounts, you would choose equities?

Equities are the first priority for tax sheltered accounts. Hopefully, they will grow more than bonds and maximise the future size of the tax shelters. You can put your allocation of bonds in there too, if there is enough space. Otherwise, I would just put the money in bank and building society term accounts. I have also got an unsheltered holding of index linked gilts.

[Gan020]

This is how I believe it works: (I'm not covering zero rate taxpayers in my post)

Equities. Tax is payable on dividends and CGT on sale of equities.
Tax free allowance £2,000. Thereafter basic rate taxpayers pay 7.5% on dividends, higher rate 32.5% on dividends
CGT allowance is £12,000. Thereafter CGT charged at 10% for basic rate taxpayers and 20% for higher rate taxpayers

Bonds. Tax is payable on interest. CGT is not chargeable as "most" bonds and gilts are exempt from CGT (because if bond is issued at par and redeems at par, there is no overall gain. There will be winners and losers but in HMRC's they all add up to zero so least cost route for them is not to charge CGT)
Interest tax free allowance £1,000 for basic rate taxpayers, reducing to £500 for higher rate taxpayers. (note this is the overall rate for interest which includes bonds and bank accounts and building society accounts). Thereafter basic rate taxpayers pay 20% and higher rate taxpayers pay 40%

So, it depends what you are buying. If you are buying growth shares with low dividends, you would want to tax shelter the equities. If you buying no growth shares with high dividends you would instead want to tax shelter bonds if you could buy the bonds at par (which at the moment is almost impossible and 95% of the bonds that trade below par require a substantial risk appetite).

As Geoff points out as most bonds are trading above par, if not tax sheltered you have a capital loss at redemption you can't offset and in the meantime are paying tax on interest at the coupon rate, which is higher than your rate of return with the capital loss included

NB - if you buy a bond fund, these are treated as equities for taxation purposes.

[Lootman]

Bonds. Tax is payable on interest. CGT is not chargeable as "most" bonds and gilts are exempt from CGT (because if bond is issued at par and redeems at par, there is no overall gain. There will be winners and losers but in HMRC's they all add up to zero so least cost route for them is not to charge CGT).

I believe that only gilts are intrinsically free from CGT. Other types of fixed income instruments will be liable to CGT if they are sold or mature at a higher value than what you paid, adjusted for accrued interest.

As you note elsewhere, gilt funds do not enjoy that exemption.

Interest tax free allowance £1,000 for basic rate taxpayers, reducing to £500 for higher rate taxpayers. (note this is the overall rate for interest which includes bonds and bank accounts and building society accounts). Thereafter basic rate taxpayers pay 20% and higher rate taxpayers pay 40%

Something I discovered recently is that ETFs that contain only bonds or money market instruments have their distributions counted as dividends and not interest. Annoying since I easily use up my annual dividend allowance but not my interest allowance.

[Gan020]

Bonds. Tax is payable on interest. CGT is not chargeable as "most" bonds and gilts are exempt from CGT (because if bond is issued at par and redeems at par, there is no overall gain. There will be winners and losers but in HMRC's they all add up to zero so least cost route for them is not to charge CGT).

I believe that only gilts are intrinsically free from CGT. Other types of fixed income instruments will be liable to CGT if they are sold or mature at a higher value than what you paid, adjusted for accrued interest.

As you note elsewhere, gilt funds do not enjoy that exemption.

A couple of helpful articles if slightly out of date. This one shows taxation principles
https://monevator.com/bonds-and-bond-funds-taxed/

This one confirms retail bonds are not subject to CGT. (My apologies over other large corporate bonds. I don't own any due to the 100k mimimum trade size. I'm not sure how these are taxed)
https://www.whatinvestment.co.uk/invest ... s-2114031/

[Alaric]

Something I discovered recently is that ETFs that contain only bonds or money market instruments have their distributions counted as dividends and not interest. Annoying since I easily use up my annual dividend allowance but not my interest allowance.

That isn't always the case. For example ISHARES CORE GBP CORP BD UCITS ETF which is Dublin based was classified as "Overseas Interest" by Interactive Investor.

[Alaric]

This one confirms retail bonds are not subject to CGT. (My apologies over other large corporate bonds. I don't own any due to the 100k mimimum trade size. I'm not sure how these are taxed)

Retail Bonds and "large corporate bonds" should be the same thing really. It's my understanding that exemption from CGT is granted on a bond by bond basis. That would enable HMRC to exclude any bond issued at a deep discount.

[genou]

It's my understanding that exemption from CGT is granted on a bond by bond basis. That would enable HMRC to exclude any bond issued at a deep discount.

I don't think so. The controlling legislation breaks them into Qualifying Corporate Bonds, and non-QCB. QCB are exempt from CGT, and most bonds are issued to be QCB. All deeply discounted bonds are QCBs so that you can't get a capital loss on them.

[GeoffF100]

NB - if you buy a bond fund, these are treated as equities for taxation purposes.

No, that is not correct. See the Monevator article linked above. As I said, the distributions are taxed as income, not as dividends. Any capital gains are subject to CGT, even if the underlying bonds are not themselves subject to CGT. Capital losses can, however, be allowed against gains for CGT purposes, even if capital losses on the underlying bonds would not be.

[Gan020]

NB - if you buy a bond fund, these are treated as equities for taxation purposes.

No, that is not correct. See the Monevator article linked above. As I said, the distributions are taxed as income, not as dividends. Any capital gains are subject to CGT, even if the underlying bonds are not themselves subject to CGT. Capital losses can, however, be allowed against gains for CGT purposes, even if capital losses on the underlying bonds would not be.

Thanks. I agree. My apologies. The article refers to open end investment companies and unit trusts.

My error occurs because I was focussed on closed end investment trusts such as NCYF and IPE which pay dividends. HL refer to them as overseas dividend payments on NCYF. Of course strictly speaking NCYF and IPE are "mixed assets" as they hold a bunch of preference shares not just bonds, so the whole starting process for my statement was flawed as soon as it started. Once again my apologies.