Many funds have two different versions and picking the right one can have a big impact on your investment returns but also on your tax situation. Here we’ll explain everything you need to know about how tax works on ‘Inc’ and ‘Acc’ units.

WHAT’S THE DIFFERENCE BETWEEN INC AND ACC?

Funds that generate an income will usually have two versions. The fund name will be exactly the same but one version will be followed by Inc (standing for income) and the other by Acc (standing for accumulation).

Put simply, the income version means that any income generated by the fund is paid out to the investor, while the accumulation version sees that income reinvested back into the fund. Typically you’d buy the income version if you wanted to live on the income generated by the fund, while you’d buy the accumulation version if you didn’t need that income straight away.

HOW DOES THE TAX WORK ON THE INCOME UNITS?

If you own the fund through a pension or ISA then you don’t need to worry about the tax implications for either unit, as any income will be tax free, as will any capital gains. However, if you own it through a general dealing account you won’t get those tax benefits.

For the income unit you’ll pay tax on the income that’s paid out to you – which will either be paid as interest or dividend income depending on the fund you’re investing in and the asset classes it invests in.

If it’s counted as dividend income then it will go towards your £2,000 dividend tax free allowance, along with any other dividend income you earn. If you exceed that allowance then you’ll be subject to dividend tax, which is now 8.75% for a basic-rate taxpayer, 33.75% for higher-rate taxpayers and 39.35% for additional-rate taxpayers.

So, if you got a £3,000 dividend payout from a fund (and had no other dividend income that tax year) a basic-rate payer would face an £87.50 tax bill, a higher-rate payer would pay £337.50 and additional-rate payer would have a £393.50 tax bill.

However, if the income is counted as interest then the money will count towards your personal savings allowance. This is a tax break given to many taxpayers and includes any savings interest generated. Basic-rate taxpayers can earn £1,000 in interest a year before they have to pay tax, while higher-rate taxpayers can earn £500 a year. Additional-rate taxpayers have no allowance. If the interest paid out by your fund exceeds this allowance you’ll have to pay your usual rate of income tax on the interest.

HOW DOES THE TAX WORK ON THE ACC UNITS?

Even though the income isn’t physically paid out with an accumulation unit, it’s treated in much the same way as with income units. The income that’s rolled up into the fund is called a ‘notional distribution’ and is taxed in the same way as the income units.

Your platform will usually keep track of these notional distributions and will helpfully give you a summary of them at the end of the tax year, which you can then use on your tax return. You’ll just need to do the same process as above, setting it against the relevant tax-free limit depending on whether it’s paid out as income or interest.

WHAT ABOUT CAPITAL GAINS TAX ON BOTH OF THOSE UNITS?

Calculating the capital gains on the income unit is far simpler, because the income has been paid out. It means that you just need to deduct the amount you paid for the investment from the amount you’re selling it for and then work out if capital gains tax is due. Everyone can make £12,300 of gains in the current tax year before they have to pay CGT, but after that basic-rate taxpayers will pay 10% and higher and additional-rate payers will pay 20%.

With accumulation units the calculation is a bit trickier. You can’t simply subtract the amount you paid for the investment from the final value, as that would mean you’re counting the ‘notional distribution’ that you may have already paid tax on.

Instead, you need to add up any notional distribution paid out over the years and subtract that from the final value, along with the purchase price, to get your total gain.

For example, if you buy a fund for £10,000 and received £2,000 of notional income during the time you owned it in the accumulation unit, and then sell it for £20,000 you’ll only have a capital gain of £8,000 (the £20,000 sale price minus the £10,000 initial investment and the £2,000 income).

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