Investment Management Association

Facts about funds

How funds are taxed

This section covers the rules on how different funds - equity, bonds, PAIFs and TEFs - are taxed. The information is very technical.

It is the type of assets in the fund that determine how a fund is taxed. All funds must distribute all their net income. Whether a fund is a unit trust or an OEIC, and whether it is a UCITS or a NURS, does not affect its tax position.

But as a retail investor, the main things to consider is whether you owe income tax or capital gains tax on your investment, and whether you have used up all your tax-free savings allowance by investing in ISAs or personal pensions.

How equity funds are taxed

The default tax regime in the UK is that funds are subject to corporation tax at 20% on taxable income, ie. after expenses have been deducted. Since 1 July 2009, UK funds have not suffered tax on dividends from investments in foreign securities (and were already not subject to tax on UK dividends). So, after expenses, the amount of taxable income is generally zero for funds predominantly invested in equities.

Equity funds must distribute all net income as dividends, which then may be taxed further in the hands of the investors, depending on their tax position.

How bond funds are taxed

Bond funds are 60% or more invested in interest-bearing assets (eg. cash and bonds). They are not taxed on the income (net of expenses) that they distribute, which takes the form of interest. If the investors are UK taxpayers, then the fund must "withhold" 20% on the interest distributions, which it pays over to the UK government “on behalf of” the investor. However, if the investors are not taxpayers (eg. they are invested in ISAs or pensions), they should receive the distributions gross (ie. with no tax withheld).

What are PAIFs and how are they taxed?

Funds invested 60% or more in assets producing property income (whether land, ‘bricks and mortar’ or property securities, such as REITs) can "elect" to be ‘PAIFs’ (Property Authorised Investment Funds). Like bond funds, PAIFs do not suffer corporation tax. The PAIF’s distributions are ‘streamed’ between rental income, interest and dividends. For UK tax-paying investors, withholding tax applies to the first two streams. Non-taxpayers receive the distributions gross (ie. with no tax withheld).

What are TEFs and how are they taxed?

The TEF (Tax Elected Funds) regime is also elective and ensures that the fund does not pay corporation tax. A TEF can invest in a mixed portfolio of assets but cannot receive any income directly from UK or overseas real estate. A TEF makes two types of distribution – a dividend distribution (on which investors will pay tax at their dividend income tax rate) and a non-dividend distribution (on which investors will pay tax at their interest income tax rate). A TEF must withhold tax at 20% on the interest distribution for investors, subject to UK tax, and pay this to the tax man. Non-taxpayers do not pay tax on the dividends and can receive the interest distribution gross (ie. with no tax withheld).

When is Stamp Duty Reserve Tax (SDRT) paid?

Authorised funds are themselves investors. So, like other types of investors, they pay SDRT when they buy UK equities at the rate of 0.5%. They may also pay additional fund-specific SDRT if they invest in UK equities and other “non-exempt” assets. The headline rate of this fund-specific SDRT charge is also 0.5%, but because the actual charge is reduced according to the proportion of exempt assets held in the fund and the proportion of unit redemptions relative to unit purchases, the effective rate is only about 0.05%, and some funds pay no additional SDRT charge at all.

Provided it is stated in the Prospectus, the manager may make a charge on investors to provide for SDRT. In these cases, the manager will either require payment when units/shares are bought or will deduct a payment when units/shares are sold.