We help with a query on the differences between types of passive product

I am considering an ETF to track the US market and intend to hold it outside an ISA. I am a basic rate taxpayer and UK resident.

Also, I have been looking at passive vehicles to track index linked bonds. Are there tax implications that would lead me to me favour simple UK-based open-ended funds in preference to ETFs? I believe most of these are domiciled in Ireland, or elsewhere outside of the UK.

I realise you cannot give tax advice. So, a statement of the relevant facts will suffice. 


Thank you in anticipation.

Bill


Reporter Yoosof Farah replies:

When purchasing a regular fund or an exchange-traded fund (ETF), two levels of tax should be considered.

Firstly, think about what tax rate the fund or ETF is incurring when buying the underlying holdings. And secondly you need to ask, what tax do I pay when buying or selling my fund or ETF?

Take American shares as an example. The US charges a withholding tax on dividend payments to international investors at 30%, however both Ireland and the UK have what is known as a ‘double tax treaty’ with the US.

This means funds or ETFs based in Ireland or the UK only pay 15% tax on the dividends they receive.

An example would be the Vanguard S&P 500 ETF (VUSA).

ETFs also exist that don’t buy the actual shares themselves. Instead they enter into what is known as a swap, where they receive the return of the market without purchasing stocks.

It is a complicated agreement, and carries some extra risk, but it has the advantage of attracting no withholding tax at all.

An example of this sort of product would be: Lyxor S&P 500 ETF (SP5C).

At the fund level, Irish, UK and Luxembourg funds are taxed the same for a UK-based investor, so the same rates of income tax and capital gains tax are applicable.

As for the index-linked bond question, for index-linked gilts any uplift to the principal as a result of inflation-linking is not taxable. Index-linked corporate bonds are slightly different; any profit you make from an increase in inflation when the bond matures is considered by HMRC to be income and not capital gains. Therefore you would be charged income tax on this profit.

This article is not intended as tax advice or a recommendation. It is worth talking to a suitably qualified tax adviser if you have any questions.


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