1. How each thing is taxed: capital gains, dividends and coupons

Costs 5: Tax as a cost

The four levels before this one measured costs that end up in the pocket of an intermediary: the broker's commission, the market spread, a fund's ongoing charge. This one measures the cost that ends up in the state's pocket, and it runs on a logic unlike any of the others, because an enormous part of what it comes to depends not on how much you are charged but on when the charge is triggered.

It is worth saying plainly before going any further: none of what follows is tax advice, nor does it pretend to be. The rules change, they differ from one country to another, and they turn on personal circumstances a course cannot know. What can be taught, and the only part that survives the reforms, is the mechanics: which specific event gives rise to the obligation to pay, on what amount it is calculated, and who decides the timing.

Two families of income the system does not treat alike

Almost any modern tax system splits savings income into two categories that the beginner lumps together:

• Investment income. What an asset hands you for the mere fact of owning it, without your transferring anything: the dividend on a share, the coupon on a bond, the interest on a deposit, the periodic payout of a distributing fund.
• Capital gains and losses. The difference between what you get on disposing of an asset and what it cost you to acquire. They exist only when there is a disposal: a sale, a redemption, an exchange.

The distinction sounds like bookkeeping and it is not: it decides who pulls the trigger on the tax.

The trigger: you control it in one case and not in the other

A share you bought at 40 and that now trades at 100 has handed you 60 of profit that shows up on your statement and does not exist for the tax authority. It is called a latent capital gain, or an unrealized one: it is wealth for every economic purpose, but the event that activates the tax, which is the disposal, has not happened. For as long as you do not sell, those 60 stay whole in the portfolio, earning a return on themselves. The day you sell, and only that day, the capital gain comes into being and the obligation with it.

The dividend works the other way round, and that asymmetry is the heart of this level. You do not decide whether it is paid: the board of a company that has never heard of you decides. When it pays out, the income accrues to you even though you did not want to receive it, even though you intend to reinvest every cent of it a minute later, and even though the share price has fallen by exactly the amount paid out, which is what happens on the day the share goes ex-dividend. A dividend does not create wealth: it moves part of your holdings from the price column to the cash column, and somewhere on that journey it runs into the tax authority.

Spain as a worked example

Take Spain as a concrete case, stated for what it is: an example, not a universal rule, and one subject to change. As this is written, both families of income — investment income and capital gains — are folded into what Spain's personal income tax (IRPF) calls the savings-income tax base, taxed on a rising ladder of bands that starts at 19% and steps upwards as the amount grows. Anybody wanting to apply this to their own case has to check the bands in force for the relevant tax year, because they have been changed several times in the space of a few years.

Two details of the Spanish mechanics that are often misread:

• Withholding is not the tax. When you collect a dividend, the payer withholds an amount on account and pays it in on your behalf. It is an advance, not the final settlement: the real calculation happens in the annual tax return, and there the withholding is deducted from what you owe. It can turn out to be too much or too little.
• The order of sale is imposed on you. If you have bought the same security on several dates and sell part of the holding, the Spanish rule decides which units count as sold: the ones acquired first are deemed to have been disposed of. You do not get to pick the most expensive lot in order to shrink the gain.

And remember what the macro track already explained: the tax is calculated on the nominal gain, with no correction for the inflation of the period.

Why accumulating and distributing are not the same product

This is where everything above turns into a concrete decision. An accumulating fund collects the dividends of the companies in its portfolio internally and reinvests them inside the fund itself. That movement never reaches your hands and, in jurisdictions such as Spain's, no income accrues to you. A distributing fund, with exactly the same portfolio and exactly the same ongoing charge, hands you that money. The moment it lands in your account, it is income for the tax year.

On the same gross return, the second loses a slice each year of capital that would otherwise have gone on compounding. One necessary warning: this is not universal. There are systems that attribute to the unitholder the income generated inside the fund even when it is never received, and there the advantage vanishes. It is exactly the sort of detail to check against the rules that apply to you.

A worked example: twenty years and two wrappers

Ten thousand euros, twenty years, 6% gross a year and a 19% rate to keep things simple.

• Accumulating. Nothing accrues along the way. The capital reaches some 32,071 euros. On selling, the gain is 22,071 and the tax some 4,194. Net: 27,878 euros.
• Distributing. Suppose 2 of those 6 points arrive as an annual payout, are taxed at 19%, and the net amount is reinvested straight away. The final capital is around 29,849 euros and, because each reinvestment lifted the acquisition cost to some 15,721 euros, the final gain is only 14,127 and the tax 2,684. Net: 27,164 euros.

The second pays considerably less tax at the end and still finishes 713 euros behind. That is the detail almost nobody sees: what was lost was not the tax paid, but everything that money would have earned over the years it still had ahead of it. The next module turns that idea into the central mechanism of the whole level.