Best Domicile location for European ETF for pension

There is a hierarchy of three levels of tax to consider when investing in funds and ETFs.

First is within the ETF itself. The investment the fund is making in equities or fixed income and where those securities are domiciled relative to the domicile of the fund will impact on the taxes on income or capital gains within the fund.

Then there is tax relating to where the fund is domiciled. This will have an impact on the type and level of tax the fund might incur in the country in which it is domiciled.

At the investor level, tax on income and capital will be determined by the domicile of the investor and the type of investor, based on where the fund is domiciled, registered for sale, and the type of tax reporting undertaken by the fund.

Withholding tax inside a fund may be on income or capital gains. How these taxes are determined is based on the framework of tax treaties between the country where the fund is domiciled and the country where the fund’s investments, equities or fixed income securities are domiciled.

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ETFs domiciled in France, receive dividends from French companies without any deduction of withholding tax, and the same is true for German-domiciled ETFs receiving dividend income from German companies.

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In several European countries, for example, the 30% withholding tax rate on dividend distributions from US companies can be reduced to 15% by applying the double tax treaty between the US and the relevant jurisdiction.

The ability to gain treaty access may be dependent on the fund operator being able to demonstrate to the US authorities that a minimum percentage of investors in the collective investment vehicle is resident in the country concerned (51%, for example, in the case of the US double tax treaty with Ireland). For many Irish-domiciled funds sold to investors from across the region, this percentage of local ownership is unlikely to be reached and so treaty access is not guaranteed.

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Securities lending is often used to “optimise” post-tax dividend rates, particularly within Europe. For example, according to the “Introduction to Securities Lending” published by ISLA, “an offshore lender that would normally receive 75% of a German dividend and incur 25% withholding tax could lend the security to a borrower that, in turn, could sell it to a German investor who was able to obtain a tax credit rather than incur withholding tax. If the offshore lender claimed 95% of the dividend, it would be making a significant pick-up (20% of the dividend yield).”

ETF and index providers may make use of such tax arbitrage “earnings” to improve fund performance, but they are under no contractual obligation to credit any such earnings to their funds if they track an index version that assumes a worse tax outcome.

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