Capital gains on bond funds and ETFs: taxed as income or capita gain?

The rules on deeply discounted securities are set out quite clearly here: https://www.gov.uk/hmrc-internal-manuals/savings-and-investment-manual/saim3020 It is therefore straightforward to understand when a bond is a DDS, and when capital gains are taxed as capital gains, and when as income. My question is: how about bond funds or bond ETFs? Is the capital gain on those always taxed as capital gain? Or is there a look-through to the underlying assets? E.g. if I make a capital gain on an ETF holding only gilts, is that capital gain tax exempt, just like the capital gain on the underlying gilts would be? How about when the fund contains a mix of DDS and non-DDS? To my knowledge, funds and ETFs do not disclose this breakdown. Should the capital gain therefore be taxed ... how exactly? Lastly, to what extent is this open to interpretation, and to what extent is this set out clearly in statute or in HMRC manuals? Thank you!

Hi,

When it comes to Capital Gains Tax (CGT), UK domiciled ETFs are treated the same way as other investments like stocks and shares. Gains from the sale of these ETFs are subject to CGT, provided they exceed the annual exemption limit.

Dividends and interest distributions from UK domiciled ETFs are also subject to Income Tax, with different rates depending on the investor’s tax bracket. 

Thank you.

Thank you. However, in practice, UK domiciled ETFs do not exist (e.g. the justetf portal doesn't list any, nor have I ever come across any): most ETFs are domiciled either in Ireland or Luxemburg, and only a handful in other EU countries. Does your answer apply also to EU-domiciled ETFs, as long as they have UK tax reporting status? I understand that, for these, one must report the Excess Reportable Income and that, if the ETF is accumulating, to adjust the capital gains calculation to take into account the taxes already paid on income reinvested and not distributed - to be clear, this is not the question, I just want to confirm if capital gains are always taxed as capital gains. Also, does your answer (ie that capital gains on ETfs are never taxed as income) apply also to ETFs which track overnight rates, like CSH2 and XSTR? They are both Luxembourg-domiciled ETFs with UK tax reporting status [Admin removed link] Finally, could I please ask if there is an explicit reference in the HMRC manuals confirming this point that capital gains on ETFs with UK tax reporting status are always taxed as capital gains? I would like to ensure there isn't a degree of interpretation on the matter. Thank you!

Hi,

Ireland and Luxbembourg are popular for ETFs for their favourable tax regimes.  
Please have a look at the guidance at:

STSM101060 - Introduction to Collective Investment Schemes: Exchange Traded Fund - Overview

The taxation of an ETF depends on the asset class: Bonds, equities and commodities.  Bonds are taxed as income & CGT, equities are taxed as dividends & CGT and commodities taxed as capital gains.

Thank you.

Thank you for providing the link, but I'm not sure it answers the question. Let me rephrase it: Let's suppose I hold an EU-domiciled bond ETF, with UK tax reporting status, in an investment account (not a SIPP, not an ISA). It is a distributing, not an accumulating, ETF, so it distributes the coupons it receives, without reinvesting them. These distributions are taxed as income. Let's suppose this bond ETF holds 4 bonds, of which 2 are deeply discounted securities (DDS) and 2 are not. Let's say I buy the ETF in January; in April rates go down and the price of the ETF goes up. In May I sell the ETF for a profit. If I had held those 4 bonds individually, buying them in January and selling them in May, the capital gain from the 2 DDS would have been taxed as income, while the capital gain from the 2 non-DDS would have been taxed as capital gain, right? The question is: how is the capital gain on the bond ETF taxed? Is it taxed always as a capital gain, even if some of the bonds it holds are DDS? If the answer is yes, then there is a discrepancy on the taxation of DDS held individually vs held inside a bond ETF. if the answer is no, part of that capital gain is taxed as income, then there is no discrepancy but I have no idea how to break down the profit between capital gain and income because, to my knowledge, the asset managers managing bond ETFs do not disclose this information. Could you please clarify? Ideally providing references to guidance which covers this point EXPLICITLY? I note that STSM101060 does NOT address this point at all. Thank you!

Hi Charles,
We cannot comment on scenarios, only provide general information / guidance in this forum.
For an answer to a detailed question of this nature, you would need to contact our Self Assesment helpline on 0300 200 3310 or seek professional advice.
Thank you. 

I have a related inquiry. If a UK resident tax payer owns a non-uk domiciled, UK Reporting ETF, in a standard general investment account (no ISA, SIPP wrapper etc) then can you confirm the below statements are correct? - Distributions are treated as income for personal tax - Capital gains from selling ETF shares are taxed as capital gains if above the personal CGT allowance - Excess reportable income must be listed on the SA tax return only for ETF units held at the end of the ETF accounting period Therefore, only CGT may be due for such an ETF when it is bought and sold for a gain within the accounting period (zero holding at end of period) , where no distributions occur.

Hi,
Please refer to guidance at:- HS265 Offshore funds
Thank you.

Hi @tax_onomy did you ever find out conclusively if your interpretation of the taxation of uk reporting ETF's was correct? I was interested in XSTR LN which is classed as an offshore UK reporting bond fund I believe and wanted to check if i bought and sold in between the semi annual interest payments (and didnt hold over accounting period end) that any gain would be taxed as capital gains.

The link to H265 does not answer the question. Let me ask again: can you point to specific legislation or specific HMRC guidance which explains if the capital gains on a bond fund are taxed as income or as capital gain? HMRC Admin32 said that bond ETFs are taxed as income and CGT. C an you please kindly point to the specific HMRC guidance on this point?

I called up HMRC directly and they confirmed a bond etf would be taxed as CGT in between coupon payments so H265 does seem correct. (also H265 doesnt suggest any distinction between offshore reporting bond funds and offshore reporting non bond funds). What happens when I dispose of my shares/units in a reporting offshore fund? "If you dispose of your shares/units in a reporting offshore fund, you will be subject to capital gains tax on any gain you realise."

Hi ,
 

Please refer to :  STSM101060 - Introduction to Collective Investment Schemes: Exchange Traded Fund - Overview  .

Thank you .