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How are gains & income distributed between Investment Club members when generating Form 185(New)

Form 185(new) is used to proportion income and gain between investment club members when preparing tax returns for the UK HMRC. Two of the commonly used methods for proportioning gain between investment club members in the UK, are based on 'Simple Unit Holding' and a 'Time Weighted Average Unit Holding'. A third method referred to as 'Time Based Allocations' is also discussed and we are currently debating that adaptation of this approach and we would love to hear any comments on this that you may have (click here to contact us).


TimeToTrade provides you with the option of selecting to either use the 'Simple Unit Holding' or 'Time Weighted Average Unit Holding' method to apportion income and gain when generating Form 185(new). The following provides a simplified example of how the various methods are calculated to high light the difference between them.


Test Case

Let us consider an example, where by you have a club that initially only has one club member called Tom. Starting the 6th of April, Tom puts £100 pound in a trading account each month. In July the unit value doubles from £1 to £2. In October another person called Harry joins the investment club and also starts contributing £100 per month. In January the unit value increases from £2 to £3 and then remains consistent for the remainder of the tax year. The following tables provide an overview of the resulting transactions:


Proportioning gains 1-1.png


Using the 'Simple Unit Holding', 'Time Weighted Average Unit Holding' and 'Time Based Allocation' methods we will now calculate the proportion of income and gains that each club member would have to pay.


Method 1: Simple Unit Holding (End of Year)

The 'Simple Unit Holding' method proportions income and gains between investment club members, based on determining the number of units that each club member owns at the end of the tax year. This number is then represented as a percentage of the total number of allocated units between the investment club members. The weakness in this approach is that if for example a club member joins a club at the end of the tax year and buys an equal unit holding in the club based on the end of year unit value, they would be expected to pay tax on gains that they do not benefit from.


In the above example Tom would own 700 units and Harry would owns 250 units at the end of the tax year. The total number of allocated units in the club is 950 units, therefore Tom's proportion of the taxable income or gains would be approximately 74% (700 divided by 950) and Harry proportion of the taxable gains and income would be approximately 26% (250 divided by 950) as illustrated in the following table:


Proportioning gains 1.4.png

Method 2: Time Weighted Average Unit Holding (Year Average)

The 'Time Weighted Average Unit Holding' method, builds upon the Simple Unit Holding method, by weighting the number of units held each month based on the value of the units at each point in time over the tax year. By doing so it more closely determines the proportion of gains that a club member would have had to pay if the gains were realised at that point in time. The weakness in this method is that the proportion of gains is based on realised and un-realised gains.


To calculate the Time Weighted Average Unit Holding over the tax year, complete the following steps:

1. On a monthly basis calculate the number of units held by each member and the value of those units based on the unit value for the given month.

2. At the end of the tax year, total up the sum what each member was worth each month and then divide by 12 to get the average member worth for the year

3. On a monthly basis calculate the total number of units in the club and multiply the monthly total by the corresponding unit value.

4. At the end of the tax year, sum up the total club monthly unit valuations and then divide by 12 to get the average club unit value.

5. Divide the result of step 2 by the result from step 4 to get the percentage for proportioning gains and income to each member.


Using the Time Weighted Average Unit Holding methodology Tom's Monthly Average Unit Holding value would be £1,025 and Harry's would be £213. The Club Monthly Average Unit Holding would be £1,238, therefore Tom's proportion of the gains and income would be approximately 83%, whereas Harry's would be approximately 17%, as illustrated in the following table:


Proportioning gains 1-2.png


Method 3: Time Based Allocation

The 'Time Based Allocation' method proportions gains to each member based on their percentage unit ownership at each point in time when taxable income or gain is realised. For the apportionment of gains, this approach can be 'shoe horned' in to Form 185(New) by calculating the total taxable income or gain for each member at the end of the tax year based on realised income and gain, and representing it as a percentage of the overall realised income and gain.


Let us assume that in the Tom and Harry example, each time the unit value changed it related to a realised gain. If you compare the accumulated subscriptions for each club member against the accumulated realised gains in proportion to their percentage unit holding, in this example at the end of the tax year, Tom would have realised a gain of £900 on his subscription and Harry would have realised a gain of £150 on his subscriptions. To proportion these gains when generating Form 185(New), Tom would have to pay approximately 86% of the taxable gains and income and Harry would have to pay approximately 14% as illustrated in the following tables:


Proportioning gains 1-3.png


Conclusion

As you can see from the above example there is a significant difference between proportionment of gains and income using the 'Simple Unit Holding' method and 'Time Based Allocation' method, however the is only a small difference between the 'Time Based Allocation' method and the 'Time Weighted Average Unit Holding' method.


When generating Form 185(New) from within the 'Reports' tab in TimeToTrade, clubs can select to apportion gains and income based on the 'Simple Unit Holding' or 'Time Weighted Average Unit Holding' method; alternatively the gains and income can be apportioned manually.


When generating Form 185(New) to apportion gain and income based on the 'Simple Holding Method' please select 'End of Year' from the Member's Share drop down menu as illustrated:


Form 2-4.png


To apportion gain and income using the 'Time Weighted Average Unit Holding' method please select the 'Year Average' option from the Member's Share drop down.


Lastly if you have an alternative method for apportioning gains and income, you can manually enter each club Member's Share as a percentage, as illustrated in the following screen shot:


Form 2-5.png



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