The cumulative effect of the 8 year rule

[3CC]

I will be investing in some shares and ETF's in the new year. I have been aware for a a while now that ETF's are treated like a investment fund rather than a share for tax purposes and therefore are subject to the 8 year deemed disposal rule.

So I decided to run some numbers to see the exact effect.

Assumptions:
- CGT is 33% throughout
- your investment doubles every 8 years (if you are going to make a wild assumption, it may as well be a simple one).
- ETF units are sold to pay for the CGT as it falls due

So below is a summary of the outcome (ignoring dividends)

For shares:
Year 0 Invest €100k in shares
Year 8 Value = €200k
Year 16 Value = €400k
Year 24 Value = €800k
All shares are disposed of in year 24, the gain realised is €700k, the CGT is €231k.
The remainder is €569k or 7.5% pa

For an ETF
Year 0 Invest €100k in ETF
Year 8 Value = €200k
Deemed disposal for year 8 (gain = €100k, CGT due is €33k, need to sell €49,253 therefore remaining amount invested is €150,746
Year 16 Value = €301.492
Deemed disposal for year 16 leaves the remaining amount invested at €227,224
Year 24 Value = €454,488
Deemed disposal for year 24 leaves the remaining amount invested at €342,562 OR 5.2% pa

I will be investing in both shares and ETF's but on the basis of the above, I am inclined to lean more heavily to shares.

I am just posting this in case it is of use to others. All comments welcome.

 

[Marc]

You have ignored dividends to simplify the calculation but in practice this is critical for the analysis.

Let's assume that all your assumptions hold but that the investment return is made up of 50% dividends and 50% capital gains.

Under these conditions your return for shares would be

€100k invested
Annual dividend at 4.525% (assuming a total return of 9.05%pa to double capital in 8 years)
Dividend €4525
Tax at 55%
Tax €2488.75
Net dividend €2036.25 x 8 years
€16,290

Capital gain element
€100,000 x 4.525 for 8years
€142,482

Total return € 158,742

So, the impact of income tax on dividends is significant enough (depending on the dividends actually paid) to bring the year 8 total return close to that of the year 8 fund value net of exit tax .

Note that I have simplified the analysis slightly and ignored the return on the net dividend which could be reinvested back into the stock or left on deposit etc.

 

[jpd]

What have I missed - why do you need to sell € 49,253 in year 8 - surely you only need to sell € 33,000 worth ?

 

[3CC]

What have I missed - why do you need to sell € 49,253 in year 8 - surely you only need to sell € 33,000 worth ?

Hi JPD,

My assumption is that in year 8, the CGT liability will be €33,000 and that this will be paid by selling part of the fund. In order to net €33,000 from a sale after CGT, you will need to sell €49,253 gross.

You could pay the CGT related to the deemed disposal from your own savings but for the sake of comparing to the share scenario where you do not need to come up with money for the CGT every 8 years, I have assumed that the CGT is paid by selling part of the fund.

3CC

 

[3CC]

Hi Marc,

I accept your point that ignoring the dividends is an oversimplification.

I'll redo the exercise taking the dividends into account. I was going to do it based on a capital appreciation of 5% pa and a dividend rate of 4% pa.

I'll revert when I have it done.

 

[dub_nerd]

Hi JPD,

My assumption is that in year 8, the CGT liability will be €33,000 and that this will be paid by selling part of the fund. In order to net €33,000 from a sale after CGT, you will need to sell €49,253 gross.

You could pay the CGT related to the deemed disposal from your own savings but for the sake of comparing to the share scenario where you do not need to come up with money for the CGT every 8 years, I have assumed that the CGT is paid by selling part of the fund.

3CC

I still don't get it. The 33k that you are trying to raise is the 33% CGT on the entire 100k gain. But then you are saying that you are liable for CGT again on the sale that you make to raise it. How can that be -- are you not paying CGT twice on the same money?

 

[3CC]

Hi dub_nerd,

I think you are right. Given that the entire fund is deemed disposed, actually selling the units does not create any additional CGT liability and therefore I would just need to dispose of €33k of the fund and pay the CGT liability from the deemed disposal.

I have just redone the calcs taking this and the other comments from Marc into account.

Does anyone know how I could post the results which are on an Excel sheet.

Thanks,

3CC