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.
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.
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
CGT Fund at 52% dividend tax
CGT Fund at 28.75% dividend tax
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
CGT Fund at 52% dividend tax
CGT Fund at 28.75% dividend tax
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
CGT Fund at 52% dividend tax
CGT Fund at 28.75% dividend tax
The results of this experiment are pretty clear:
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