Of the 350 blogs that I have written so far, the most read and most commented ones are the articles about deemed disposal. People do not like paying tax and especially when they are paying tax on a gain that they have not realised. But how did we get to this situation?
Up until 2001, any investment product was taxed under the “net roll up” regime. That is, the tax due in the fund you were invested in was deducted at source by the life company you were invested with and paid over to the Revenue directly. Tax was paid at the basic rate (DIRT) which was 22% at the time. This meant that the fund value that you were provided for your investment was the amount that you would receive into your hand if you decided to cash in.
The tax treatment of Irish investments was out of sync with the rest of Europe, where gross roll up was the method used. That is, any gains or dividends were reinvested into the fund without incurring a tax liability and your fund accumulated in value in a tax free environment. You only pay tax when you cashed in your investment.
These investment products were being used by IFSC companies selling products oversea and they didn’t want a discrepancy between the domestic market and overseas market. From 2001, the gross roll up regime came into effect for all new investments taken out from that point. Investments made before then would continue under the old, net roll up regime.
With the introduction of the gross roll up regime, the Revenue imposed a tax of the basic rate plus 3%. The higher tax rate was to compensate the Revenue for the loss of the regular, annual income they used to receive from the life companies from people’s investments.
The Revenue under estimated how long people kept their investments for and they weren’t getting anywhere near the levels of tax that they used to. The investor was getting all the benefit, dividends being reinvested into the fund tax free, no capital gains tax on gains. Tax only paid at the end which could be in decades.
The Revenue weren’t having that and to be honest, you can see their point. So Deemed Disposal was introduced in the Finance Act 2006. Every 8 years, you paid the tax on your investment as if you had cashed it in. For those invested through life companies, the tax is deducted automatically from your fund and paid over to the Revenue. If you invested through fund platforms or stock brokers, you paid is through your tax return.
Of course, people wanted to avoid this as much as they could. How could this be avoided? You could buy direct shares yourself? But it is difficult to get diversification by trading yourself and most people don’t have the knowledge or skills of knowing what the right price would be for a particular stock. Investors looked to Exchange Traded Funds (EFTs) as the solution. EFTs were growing in popularity in Ireland and as they are traded on the stock exchange, they would be treated the same as a share, right? Wrong. The Revenue issued an update to the Investment Undertakings part of their Tax and Duty Manual saying that European domicile EFTs were subject to deemed disposal.
…but US and Canadian EFTs were not, they were taxed under the CGT regime. Why? Because the dividends paid out each quarter under these ETFs were subject to income tax so the Revenue were happy to be receiving tax income (there are European funds and ETFs that pay out dividend income but they are still subject to deemed disposal). Then PRIIPS legislation came into force mandating that a Key Investment Information Document (KIID) was provided to any investor before they placed a trade. Being domiciled in the US and Canada, the providers of these ETFs had no obligation to confirm to legislation in other states. While investors were hopeful that the large fund managers would produce these documents, they were disappointed. The fund managers made the point that they had European versions of most of their funds and these satisfy the PRIIPS legislation and their ETFs domiciled in other jurisdictions would not be adhering to EU regulations. While it is still possible to invest in these ETFs, they are not available through financial advisors or online trading platform.
Which leaves investors with the option of Investment Trusts, which I wrote about last week. For a lot of investors this would mean switching to active management, more investment risk and less choice.
The Revenue needs to update their approach to how people are taxed on investments. Investors see the options available in other countries and want in. They want the same options that are provided in other countries. Those options are mostly available if the Revenue updated their views.
Most investment funds have an accumulation and a distributing option. The accumulation option operates under the gross roll up regime. You can leave that subject to deemed disposal. But if investors choose the distributing option, tax those dividends as income tax each year and tax any gains under CGT, just like you would shares. It is not that difficult to do and would be a lot more equitable.
If you have any questions, drop me an email at steven@bluewaterfp.ie
Steven Barrett
22 March 2021