Accrued Income Scheme
When interest-bearing securities are transferred from one person to another, the sale agreement will specify who is entitled to the next interest payment.
In cum-dividend sales the buyer will get the next interest payment and the transfer price will have been increased to reflect the value of that payment. In ex-dividend sales the next interest payment will be paid to the seller and the transfer price will have been reduced to take that into account.
The accrued income scheme determines the tax treatment of the interest spanning the date of sale, and applies to interest-bearing marketable bonds and loan stock, for example:
- British Government Securities (gilts)
- Local authority bonds
- Permanent interest-bearing shares in a building society (PIBS), or
- Company loan stock.
Transfers will be affected by the scheme unless the total holding of securities (not just those transferred) did not exceed £5,000 at any time in:
- The tax year in which the next interest due date falls, and
- The previous tax year
An individual investor who is a basic rate taxpayer sells £8,000 of 9% stock (on which interest is payable half yearly on 15 August and 15 February) to a buyer who is a 40% taxpayer. The stock goes ex-dividend on 1 August 2014.
If sold for settlement on 26 July 2015 (ie sold cum-dividend)
The buyer receives the full 6 months' interest on 15 August 2015. Interest accrued from 16 February is £720 x (161/365) = £317.59.
This is the amount by which the seller's taxable income is increased (accrued income charge). The seller will pay tax at 20% (£63.52). The buyer's taxable income is correspondingly reduced (accrued income relief) with a tax saving of 40% (£127.04).
If sold for settlement on 1 August 2015 (ie sold ex-dividend)
The seller receives the full 6 months' interest on 15 August 2015.
Interest accrued from 2 August is £720 x (14/365) = £27.62.
This is the buyer's accrued income charge, and the buyer will pay tax at 40% (£11.05). The seller's corresponding accrued income relief leads to a tax saving of 20% (£5.52).
The accrued income adjustments are made in the tax year in which the next interest payment date falls, 2015-16 in this example, and are recorded in the tax returns for that year.