Which is better, gross roll up or CGT investments?

Deemed disposal was introduced in 2006 as the Revenue wanted to get their hands on people’s savings. People were simply saving too much and for too long. Because dividends and profits were reinvested without any tax liability, the Revenue weren’t getting any income. So they brought in a rule where you have to pay tax on funds every 8 years. A way to invest in funds but avoid deemed disposal, was to invest in US ETF’s, but that has fallen foul of recent European regulation. People are unhappy with being forced to pay tax on assets they haven’t realised. But which is better, to have your money grow without any tax liability but have to pay tax every 8 years and pay it at 41% or pay the lower rate of CGT at 33% but have to pay tax on dividends? We put it to the test.

The Investment Scenario

We invested €100,000 for 20 years under three scenarios.  We assume the investment grows by 5% each year and a dividend of 5% is also paid each year. Any taxes paid are deducted directly from the investment and the remainder is reinvested.

1. Invest in a fund and pay deemed disposal every 8 years. Dividends and growth are reinvested each year without a tax liability. The tax rate every 8 years and at the end of the 20 year term. The tax on profit is 41%.
2. Invest in assets that pay CGT at 33% at the end of the 20 years term. Dividends are taxed at the marginal rate each year, including PRSI and USC. The total tax deducted each year on dividends is 52%.
3. Invest in assets that pay CGT at 33% at the end of the 20 years term. You are a lower rate taxpayer along with PRSI and USC, the total tax deducted each year on dividends is 28.75%.

After 8 Years

The investment fund has been reinvesting its dividends tax free for 8 years, while the two CGT investments have been paying income tax, PRSI and USC before being reinvested. Below are the values of the three different investments.

Deemed Disposal Fund

1. Fund Value after 8 years – €218,287
2. Tax deducted – €48,498
3. Net value – €169,789

CGT Fund at 52% dividend tax

1. Fund Value after 8 years – €178,613
2. Total tax deducted on dividends – €28,539

CGT Fund at 28.75% dividend tax

1. Fund Value after 8 years – €195,495
2. Total tax deducted on dividends – €16,490

After 16 Years

After 16 years, deemed disposal is due again. The way this calculated is that you assume no tax was deducted after 8 years. In our example, we add the €48,498 to the fund value and deduct 41% tax from this amount. We then get a tax credit for the €48,498 already deducted in year 8.

Deemed Disposal Fund

1. Fund Value after 16 years – €370,629
2. Tax deducted after 16 years – €82,344
3. Total tax deducted – €130,842
4. Net value – €288,285

CGT Fund at 52% dividend tax

1. Fund Value after 16 years – €319,027
2. Total tax deducted on dividends – €79,514

CGT Fund at 28.75% dividend tax

1. Fund Value after 8 years – €195,495
2. Total tax deducted on dividends – €48,728

After 20 Years

We have reached the end of our investment term and we want to cash in our investment. We will have to pay CGT on two of the investments. We get a small exemption of €1,270 on these two.

As with the 16 year deemed disposal, we have to add back in the tax paid when calculating the final tax bill but then credit the tax already paid.

Deemed Disposal Fund

1. Fund Value after 20 years – €429,928
2. Total tax deducted – €187,276
3. Net value – €369,494

CGT Fund at 52% dividend tax

1. Fund Value after 20 years – €426,368
2. Tax deducted on dividends – €118,482
3. CGT deducted – €107,282
4. Net value – €319,086

CGT Fund at 28.75% dividend tax

1. Fund Value after 20 years – €534,363
2. Total tax deducted on dividends – €75,008
3. CGT deducted – €142,921
4. Net value – €391,442

The Results

The results of this experiment are pretty clear:

1. CGT fund at 28.75% dividend tax – €391,442
2. Deemed Disposal Fund – €369,494
3. CGT fund at 52% dividend tax – €319,086

If you are paying income tax at the lower rate, you should avoid the gross up type fund and avail of paying CGT and the lower income tax. If you are at the higher rate, the gross roll up works out more beneficial to you…unless you have capital losses. You cannot offset losses in a gross roll up fund but you can offset them against CGT investments.

Deemed disposal funds come in for a lot of criticism as people are forced to pay tax on them even if you don’t want to access the money. But as we have seen, the compounding effect of the tax free reinvest is actually more beneficial to most.

If you have any questions, drop me a line at steven@bluewaterfp.ie