Deemed Disposal at 38% vs CGT at 33% - a stochastic analysis

[Duke of Marmalade]

Below is a summary of some doodles I have been doing following the drop in Exit Tax to 38%.
I have assumed the alternative "CGT" approach would be along the Swiss lines as alluded to by @nest egg, viz. dividend income taxed annually.
It is based on 1,000 stochastic simulations. Stochastic is preferable because of the asymmetric approach to capital losses.
Assumed an overall return of 7% p.a. including 2.5% dividends and annual volatility of 14%.
The investor is assumed to be subject to a charge of 52% on dividends as they arise annually.

Observations
On average there is not much to chose between the two approaches, with Exit Tax slightly better in the mid durations. There are two influences. First the longer the period the more deferral of CGT has a benefit. OTOH the Exit Tax regime is more beneficial on the treatment of dividends.

The surprise to me came from the poor performing 10 percentile. I have made the fairly optimistic assumption that losses in the CGT case get immediate 33% relief and expected this to dominate. It does so in the early years but in later years even the 10 %ile shows some gains and so the allowance for capital losses is irrelevant. In contrast the Exit Tax regime benefits from capital gains effectively sheltering dividends.

At the upper end the CGT regime comes out more clearly as the winner as the prolonged gross roll-up has most beneficial effect in these scenarios.

Conclusion
Contrary to my earlier intuition, I don't see much scope for further reduction in the Exit Tax rate. Indeed (especially if a left wing government emerges) increases in the CGT rate seem more likely than increases in the Exit Tax rate.
The non allowance of capital losses in the Exit Tax regime is not such a deficit as some seem to think - to lobby for their allowance would be a Pyrrhic victory.

I have attached a copy of the spreadsheet.

 

[Corola]

How sensitive are the results to change in assumption of dividend yield, for example at 1%?

The people on AAM who invest in CGT assets tend towards low dividend stocks like BRK.B or Investment Trusts like JAM or FCIT.

 

[ClubMan]

low dividend stocks like BRK.B

Just to be clear, BH has never paid dividends and doesn't do so as a matter of policy.

 

[Zebedee]

Investment trusts have (mostly) higher AMCs and potential underperformance risks. The discount to NAV may move up and down. They have to dividend out 85pc of income.

 

[Duke of Marmalade]

How sensitive are the results to change in assumption of dividend yield, for example at 1%?

Quite sensitive. Below are the results at 1% dividend. Note that I am not requiring that the instrument actually pays dividends. I am assuming that one way or another (eg the Swiss way) the tax man gets their share of the underlying income earnings. I presume, for example, that BH has underlying income earnings.

 

[CharlieMac]

If anyone who can understand this feels like making a plain and simple layman's English explanation of what all this means that would be much appreciated.

 

[Corola]

Contrary to my earlier intuition, I don't see much scope for further reduction in the Exit Tax rate.

So you conclude that an index fund (SP500 or MSCI World?) taxed at 38% under gross-roll up is equivalent to being taxed at 33% under CGT.

I suppose my question is slightly different: what level would the 38% have to drop to to persuade someone already investing in BRK.B (purely for the tax efficiency, ignoring other considerations) to switch to a gross-roll up fund?

 

[Zenith63]

If anyone who can understand this feels like making a plain and simple layman's English explanation of what all this means that would be much appreciated.

As Corola just replied, the analysis shows that since the reduction of Exit Tax to 38%, whether you buy an ETF in say an All World Index or try to roll-your-own by buying a basket of shares in that index (to benefit from the lower CGT rate) you're going to end up with about the same amount of money in your pocket after all taxes are paid.

Duke's point is that this is probably not a coincidence; the government likely did similar analysis to come up with the 38% rate and it is unlikely they will reduce it further (all other things being left equal) because Exit Tax would then have a significant advantage over the CGT taxation model.

The interesting angle for me is that for the average person looking to put away some savings, they no longer need to worry that they're losing out if they go the ETF route. The difference is negligible before you even start to consider your time spent rebalancing a roll-your-own index, early CGT payments when you need to rebalance, hassle buying shares and dealing with dividends for the India/China/USA/Korea companies you need to buy to track the index properly, index tracking errors, stress, risk of emotional decision making etc.

 

[Duke of Marmalade]

So you conclude that an index fund (SP500 or MSCI World?) taxed at 38% under gross-roll up is equivalent to being taxed at 33% under CGT.

Well, I am assuming that if index funds where moved from Exit Tax to CGT there would be a mechanism for annually taxing the internal income generation.

I suppose my question is slightly different: what level would the 38% have to drop to to persuade someone already investing in BRK.B (purely for the tax efficiency, ignoring other considerations) to switch to a gross-roll up fund.

I am not totally familiar with BRK.B but I assume it manages to be only subject to CGT with no tax on income. The spreadsheet attached to OP would reflect this situation by setting the dividend rate to 0. Below is the picture with an Exit Tax rate of 27%.

 

[joe sod]

Conclusion
Contrary to my earlier intuition, I don't see much scope for further reduction in the Exit Tax rate. Indeed (especially if a left wing government emerges) increases in the CGT rate seem more likely than increases in the Exit Tax rate.
The non allowance of capital losses in the Exit Tax regime is not such a deficit as some seem to think - to lobby for their allowance would be a Pyrrhic victory.

ireland already has among the highest CGT and investment taxes in Europe as it is and Europe is moving in the opposite direction trying to get an investment and stock market regime more like the US since Europe is falling behind in having large innovative tech companies. Is it really credible that a future Irish government could just thumb their noses at all these developments and continue to insist on punitive investment taxes.

Also politically the FF/FG government is very left wing as it is and is to the left of the Labour government in UK with alot of its policies. Look at the most recent budget, they gave more welfare increases but more taxes effectively on the working population that need to drive to work everyday. The gap in the irish political scene is that their is no proper right wing philosophy pushing back against all these leftist tendancies, the large spoiled vote in the presidential election is a partial reflection of this.

 

[Duke of Marmalade]

ireland already has among the highest CGT and investment taxes in Europe as it is and Europe

My comment that I don't see much scope for further drops in Exit Tax was in the context of the current landscape and in particular with reference to current CGT and DIRT. As @Zenith63 put it, I was assuming "all other things being left equal". But of course if there is a change in broad tax philosophy that moves the goalposts.
It is not immediately obvious that increased investment by Irish folk is good for the Irish economy as it would be mostly into foreign assets.

 

[joe sod]

It is not immediately obvious that increased investment by Irish folk is good for the Irish economy as it would be mostly into foreign assets

yes, but ireland is an EU country for 50 years now, that is very small minded and frankly outdated thinking but yes that is still how the current irish establishment thinks, but they are wrong, its just that they have been spoiled by huge multinational revenue flows that they haven't had to reform their oudated mindsets.

 

[CharlieMac]

Taking the most recent post by @Duke of Marmalade, in the rightmost green column does...

1.52% mean that being invested in an EFT would give you 1.52% greater returns than an investment subject to CGT, after Year 1?

Likewise in that same column does...

-0.78% mean that being invested in an EFT would give you 0.78% lower returns than an investment subject to CGT, after Year 40?

 

[Fortune]

that need to drive to work everyday

That choose to drive to work every day

 

[Duke of Marmalade]

Taking the most recent post by @Duke of Marmalade, in the rightmost green column does...

1.52% mean that being invested in an EFT would give you 1.52% greater returns than an investment subject to CGT, after Year 1?

Yes, you are interpreting the figures correctly. But this particular post is very artificial. I was asked for the Exit Tax that would equate to CGT for BH. I am not familiar with BH but I assume it is a share which rolls over all its income and therefore, in theory any way, is only subject to CGT and no annual income tax. I modelled this as a share earning 7% p.a., all capital. I then by trial and error found that if Exit Tax was 27% every 8 years that would "equate" to CGT of 33% throughout. I was looking for a result which would equate the two left column figures. Exit Tax at 27% should beat CGT at 33% in the early years with the position reversed in the later years as the gross roll-up of the CGT catches up.
The figure of -0.35% for DD8 - CGT in Year 1 looks out of kilter but that is because not getting relief for losses is dragging down the Exit Tax regime.

 

[Zenith63]

-0.78% mean that being invested in an EFT would give you 0.78% lower returns than an investment subject to CGT, after Year 40?

Just to be clear, it is 0.78% lower average return per annum. Your total return after 40 years would be something like 18% lower.

 

[CharlieMac]

Your total return after 40 years would be something like 18% lower.

Well doesn't this shine a different light on things so? Maybe the data needs another column with a cumulative percentage which would clearly show the magnitude of the advantage of a CGT investment over the long term.

Duke's point is that this is probably not a coincidence; the government likely did similar analysis to come up with the 38% rate and it is unlikely they will reduce it further (all other things being left equal) because Exit Tax would then have a significant advantage over the CGT taxation model.

If Duke's calculations suggest Exit and Deemed Disposal (DD) tax @ 27% would be comparable to CGT @ 33% then you could argue it would make some sense for Government to keep the deemed disposal tax but reduce it and Exit tax to 27% to incentivise ETF investing because at least then they are guaranteed to collect tax every 8-years. CGT based investments could be held for decades with the investor selling little or none of them.

Obviously I would prefer DD went away but there are ways the Government could give investors a carrot while also increasing the tax take from ETFs.

 

[Duke of Marmalade]

If Duke's calculations suggest Exit and Deemed Disposal (DD) tax @ 27% would be comparable to CGT @ 33%

Just for clarity this was in an instance where all growth comes in the form of capital. If income is taxed annually, possibly on a look through basis, it fundamentally affects the calculus. OP was meant to indicate that 38% DD Exit Tax is similar in the round to CGT + annual income tax on a typical income earning index/share.

 

[Protocol]

Can somebody explain the reference to the 10th and 90th percentile?

 

[Zenith63]

Well doesn't this shine a different light on things so? Maybe the data needs another column with a cumulative percentage which would clearly show the magnitude of the advantage of a CGT investment over the long term.

The figure you referred to was for the 90th percentile result of a side calculation of something unusual, if we go back to the original post where it’s looking at something similar to the FTSE All World index (total return of 7%, 2.5% dividends) the difference between the deemed disposal and CGT models is virtually zero over a 20/30/40 investment.