When you buy units in a unit trust or shares in an OEIC part way through a distribution period, part of the price you pay is income the fund has already earned. That part, called equalisation, comes back to you with your first distribution. It is not income and not a capital distribution: HMRC treats it as a return of part of the price you paid, so you deduct it from the capital gains base cost of those units instead of paying income tax on it.

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Why do funds use equalisation?

HMRC’s Investment Funds Manual at IFM02230 explains that equalisation makes sure existing investors’ share of the fund’s income is not diluted when new units are issued or old ones redeemed, while every unit still receives the same distribution. The offer price of new units includes the income accrued in the fund up to the date of purchase, and that accrued income element is the equalisation.

Units held from the start of a distribution period are Group I units and receive a full share of the period’s income. Units bought part way through are Group II units and are entitled only to income accruing after purchase. Equalisation is therefore paid only on Group II units. IFM02220 notes that under FCA rules a distribution period cannot exceed a year and is normally six months, so most investors buy Group II units every time they invest.

How is the first distribution split?

The distribution per unit is the same for Group I and Group II units. For Group I units it is all income. For Group II units it is two amounts: income that accrued after purchase, and the return of the equalisation, which IFM02230 calls a return of capital.

HMRC’s example in IFM02230 shows the arithmetic. A fund has two unit holders, A and B, with one unit each. The capital value is £1,000 and income accrues at 8% a year over a six month distribution period. After three months C buys a unit for £510: £500 of capital value and £10 of accrued income, which is the equalisation. At the end of the period £60 is available, £50 of income plus the £10 equalisation. Each holder receives £20. For A and B that is all income. For C it is £10 of income and £10 of returned equalisation. In practice funds calculate this daily, not monthly.

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How is equalisation taxed?

CG57705 in the Capital Gains Manual states the position for unit trusts directly. The equalisation payment is not income. It should not be treated as a capital distribution under the rules at CG57800. It is a return of the initial price paid and should be deducted from the price paid when computing the gain on the eventual disposal. IFM02230 says the same for authorised investment funds generally: because returned equalisation is not part of the income distribution and is a capital receipt, it is deducted from the unit holder’s cost.

That gives three consequences:

  • only the income element of the first distribution goes on your tax return as a dividend or interest distribution (see how savings and dividend income stack);
  • the equalisation is not a part disposal, so no gain is computed when you receive it; and
  • the base cost of the units falls by the equalisation, so a later gain is larger, or a loss smaller, by the same amount.

Overall, the equalisation escapes income tax but is brought into capital gains tax when you sell.

How does it change the section 104 pool?

HMRC’s helpsheet HS284 states that units in a unit trust are treated as shares in an ordinary company, and that the same rules apply to OEIC shares. Units of the same fund and class bought at different times therefore join a single section 104 holding, subject to the same day and 30 day rules explained in share matching rules.

Because the pool holds one combined cost, the practical way to apply CG57705 is to reduce the pool’s allowable cost by the equalisation when you receive it. Each new purchase made part way through a period can carry its own equalisation, so regular savers may have several small reductions each year. HS284 also covers monthly saving schemes, and these are where equalisation adjustments are most often missed.

If you redeem units, IFM02230 explains that the redemption price reflects income accrued up to the date of redemption and the full price is the disposal proceeds. There is no separate income element to strip out on a sale.

What about accumulation units?

With accumulation units no cash is paid out. HS284 explains that notional distributions subject to income tax are allowed as additional expenditure on the units. The equalisation on Group II accumulation units is not income (IFM02230), so it is not taxed and is not part of that addition; under CG57705 it remains a return of part of the price paid and reduces cost. The net result is that only the income element of the first accumulation is added. The wider rules are in accumulation units and excess reportable income.

Does the same apply to offshore funds?

Offshore reporting funds follow their own rules. IFM12543 explains that a reporting fund may operate equalisation arrangements, full equalisation arrangements or none. Under IFM12545, a fund operates full equalisation only if it states the equalisation amount for each newly issued unit, either in real time or as an average for the reporting period, in a statement or report to investors. Without that information the investor has no equalisation figure to use. How reportable income and equalisation interact is covered in offshore funds reporting status.

How might the numbers look?

Illustration only. Sam buys 10,000 income units in a UK fund for £20,000 halfway through a distribution period. At the end of the period the fund distributes 2p per unit, £200 in total. Sam’s tax voucher shows 1.2p per unit as equalisation and 0.8p as income.

Item Amount
Income to report for the tax year £80
Equalisation returned £120
Original cost £20,000
Adjusted base cost £19,880
Later sale of all units £24,000
Gain £4,120

Without the adjustment Sam would report a gain of £4,000 and income of £200, which overstates income and understates the gain. The gain is then reduced by any unused annual exempt amount, as explained in how capital gains tax is calculated.

What mistakes come up most often?

  • Declaring the whole first distribution as income.
  • Forgetting to reduce the base cost, which understates the gain on sale.
  • Treating the equalisation as a small part disposal and computing a gain on it.
  • Losing the first tax voucher after each purchase. It is often the only record of the equalisation figure.
  • Assuming every offshore fund reports equalisation. Only funds operating full equalisation give investors a figure.

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Reviewed by Christine Anderson, Broker, Solar Protect. Last reviewed 19 October 2026. Part of Accountapedia, the Solar Protect guide to UK tax and accounting. This page is general information, not personalised advice.