The Roadmap for Deemed Disposal

[Wolframius]

They are objectively better for the overwhelming majority of individuals than expensive life policies or undiversified individual share portfolios.

I agree but is difficult to go from a objective disincentive to an incentive, a return to a neutral situation would be probably more achievable.
The SIA could have been a good opportunity, but it muddled things rather than introducing simplification.

 

[TomEdison]

I did not ask for tax breaks, there is nothing wrong with the exit tax, the problem, as noted multiple time, is the deemed disposal. People should not have an incentive to invest in ETF, but they should not have a disincentive to invest in them, like it is now.

The aim, broadly, is neutrality between direct investment in securities and indirect (via an ETF or other pooled fund) investment in securities.

If you invest directly in securities, then income (dividends, interest) gets taxed as it is received, and gain on the disposal of securitie are taxed as they are realised.

If you invest indirectly, via a managed fund, then there are a few diffeerent approaches available.

1. Don't tax the fund. Let it accumulate income and gains gross. Tax the individual if and when they dispose of their interest in the fund.

This isn't neutral. It favours indirect investment via a managed fund by deferring the levying of tax and allowing accumulation in the meantime; by taxing the entire investment return, including accumulated income, at the CGT rate rather than at marginal income tax rates; and by enabling investors who hold until death to avoid tax altogether.

2. Tax the fund on income and gains as they acrue. Do not tax the individual on disposing of their interest.

This is closer to neutral, but still isn't neutral, because the rate at which the fund pays income tax and CGT may not be the same as the rate at which the invidual investor would pay them. Different investors will be at different marginal income tax rates. Also investors lose the benefit of the small gains exemption.

3. Require the fund to distribute all income and gains to investors as they accrue, and then tax investors on those distributions (income tax or CGT as appropriate).

This is fairly neutral and, internationally, it's quite a common approach.

4. Require the fund to report all income and gains as they accrue, and then tax investors on their share of the income and gains, whether or not it is distributed to them.

This also neutral, and also common. Funds can distribute income and gains or not, as they choose, or they can offer both distributing and non-distributing units, allowing the investor to choose whichever suits their needs best.

Ireland takes none of these approaches. Essentially what we have is a variation on approach no. 2. The fund is not taxed on income and gains as they accrue; it is allowed to accumulate them gross for up to 8 years and then it gets taxed. In principle this is a bit better for investors than the straightforward version of approach no 2, since there is some element of accumulation before taxation.

DD is not popular, and clearly there is an appetite for change, though we don't yet know how or when it will be changed, and the transition could be technically challenging and quite messy. But its very unlikely to be a transition to option no. 1, which is the least neutral of all the options, and so the one that amounts to the greatest tax incentive to pursue investment in securities via managed funds rather than directly.

 

[TomEdison]

We regularly use taxation to nudge behaviour in the direction of things that are deemed mutually beneficially for individuals and the state.
Sugar tax, minimum alcohol pricing, EV subsidies etc.

I don't think this analogy holds up. By discouraging the consumption of sugar or alcohol we (hope to) realise a benefit to the state/the community in the form of lower health costs, a reduction in alcohol-related social harms, etc. By discouraging the use of fossil fuels there is likewise a benefit that accrues to the community at large, not just to the individual driver. That's why we offer tax incentives for these things.

But the benefit resulting from the diversification and low costs associated with low-cost pooled investment vehicles accrues entirely to the individual investor in the form of a higher return on his investment; there is no incidental benefit flowing directly to the rest of us analogous to the benefits of carbon reduction, or lower health costs, or being the victims of drunken violence slightly less often. If he doesn't have the wit to choose this investment for his own benefit, I don't see any argument for why other taxpayers should pay him to do so.

 

[ClubMan]

They are objectively better for the overwhelming majority of individuals than expensive life policies or undiversified individual share portfolios.

Not necessarily. There are some crazy ETFs out there. E.g. crypto etc.

Here’s a selection of weird and wonderful ETFs

We take a look at some of the more interesting ETFs found on interactive investor.

www.ii.co.uk

But the well diversified ones tracking respected indexes or markets are indeed probably more suitable for many investors than having them try to create and manage their own personal diversified basket of shares.

 

[Setforlife]

But the benefit resulting from the diversification and low costs associated with low-cost pooled investment vehicles accrues entirely to the individual investor in the form of a higher return on his investment; there is no incidental benefit flowing directly to the rest of us analogous to the benefits of carbon reduction, or lower health costs, or being the victims of drunken violence slightly less often. If he doesn't have the wit to choose this investment for his own benefit, I don't see any argument for why other taxpayers should pay him to do so.

Well the argument is that the benefit is more money is made and compounded than would be gained in taxes, which comes back into the economy via spending on goods and services, increasing gdp, vat etc from those A zero sum game probably individually but if 100s of thousands of people did the same it could (in theory) be noticeable.

 

[TomEdison]

Well the argument is that the benefit is more money is made and compounded than would be gained in taxes, which comes back into the economy via spending on goods and services

Well, I'd like to see the workings. I'm sceptical.

It's basically trickle-down economics, isn't it? Give a tax break to investors to encourage them to make investments that are already in their best financial interests only they're too dim to see it, in the hope that the resulting financial benefit to them will translate into a benefit to the rest of us when they receive their investment return and spend it.

I can't help feeling that if the justification is the benefit to the rest of us, the money would be more effectively spent providing a benefit directly to the rest of us.

The real-world problem we face in terms of suboptimal investment decisions is not investors choosing high-cost pooled investment vehicles rather than low-cost pooled investment vehicles; it's investors choosing bank deposits rather than pooled investment vehicles. You can create an incentive to address that by just jacking up the DIRT rate, or lowering the DD rate, or both. That would be a much more transparent incentive, and therefore likely more effective (though, admittedly, we are targetting a group of people who are by definition not chasing the highest return and/or are not very perceptive). Plus, in so far as it involves raising the DIRT rate, it's revenue-positive, not negative.

 

[Zion2022]

It's basically trickle-down economics, isn't it? Give a tax break to investors to encourage them to make investments that are already in their best financial interests only they're too dim to see it, in the hope that the resulting financial benefit to them will translate into a benefit to the rest of us when they receive their investment return and spend it.

I’d have thought it was a natural conclusion that individuals in a country getting wealthier through investments was a clear win for the state either through future ‘trickle down’ or reduced support requirements.
Quantum would be hard to estimate but it certainly seems positive to me.

Any even finances aside, the state should want its people to prosper when there is no significant direct cost to them (I.e. other tax payers)

You can create an incentive to address that by just jacking up the DIRT rate, or lowering the DD rate, or both

Agreed, but that is just getting to the same outcome I was proposing. Make the ‘best investment’ the most relatively advantageous through taxation. Currently it is the least which is madness.

There are some crazy ETFs out there. E.g. crypto etc.

Yes fair, I was referring to ETFs in the passive global sense. There’s a limit to which you can protect everyone from themselves. Suspect these are fair niche products as most people who want crypto will just buy crypto.

 

[boomshine]

Well, I'd like to see the workings. I'm sceptical.

The better argument of ETFs vs Investment Trusts is that deemed disposal regime reduces tax gained for the government i.e. the group not the individual suffers, plus it also comes with worse results for the individual after 2-3 disposal events far more than the other touted options of either investment trusts or single stock picking (i.e. gambling/actively trading).

Figures via gemini - a simplified leave 100k windfall in there for 30 years and assuming the person is a high earner and reinvesting the dividends back into the trust:

30-Year Performance & Tax Comparison​

Metric	Accumulating ETF (38% DD)	UK Investment Trust (33% CGT)
Initial Capital Invested	€100,000	€100,000 (€99,500 net after stamp duty)
Gross Portfolio Value (Yr 30)	€1,006,266 (un-taxed) / €565,655 (post-DDs)	€796,344
Cumulative Cost Basis	€356,456 (stepped up via DD)	€147,926 (initial + net reinvested dividends)
Taxable Gain at Final Exit	€209,195	€648,417
Capital Gains / Exit Tax Paid	€236,679 (across 4 DD events)	€213,978 (33% CGT at Yr 30 exit)
Total Dividend Income Tax Paid (53%)	€0 (reinvested inside fund)	€54,883 (paid annually over 30 years)
Total UK Stamp Duty Paid (0.5%)	€0	€743 (€500 upfront + €243 on reinvestments)
Total Lifetime Taxes & Duties Paid	€236,679	€269,604
Net Final Value (Yr 30)	€486,160	€582,366
Net Effective Annualized Return (CAGR)	5.41%	6.04%

It also ironically gives the UK almost 1k euro in taxes instead of our country due to UK stamp duty fees.
Plus as trusts are actively managed by UK based traders, the total fees on the trusts, will help to pay salaries for UK folks while nothing is gained here.

If the argument is just pick your own stocks, good luck getting average person to succeed at that.

Government loses 33-34k euro over 30 years doing the 'smart' IT approach, while the individual loses almost 100k euro.

 

[Duke of Marmalade]

But its very unlikely to be a transition to option no. 1, which is the least neutral

The Life companies would certainly howl on the neutrality issue. The authorities would be more concerned by the tax avoidance aspect. That phrase "tax avoidance" is almost a de rigueur genuflection every time the policymakers mention DD.

 

[TomEdison]

I’d have thought it was a natural conclusion that individuals in a country getting wealthier through investments was a clear win for the state either through future ‘trickle down’ or reduced support requirements.
Quantum would be hard to estimate but it certainly seems positive to me.

If the argument is “better investment returns = clear win for state; therefor tax incentive = good”, that’s woefully incomplete. If you take it seriously, then the logical conclusion is zero taxation of investment returns; even a tax subsidy for investment returns. But that would obviously be nonsense. And one of the reasons it’s nonsense is that you ignore the cost of the tax incentive.

You have to quantify the cost of the tax incentive you propose, and you have to quantify the societal benefit you expect to result, and then compare the two. Otherwise you’re just engaged in a kind of self-interested wishful thinking, assuming that a tax incentive for behaviour which, by an astonishing coincidence, you yourself wish to engage in will benefit the wider community.

The other factor we have to think hard about here is one I've pointed to earlier - if investing in the passively-managed index-tracker give the best return, given a neutral tax regime, why aren't people doing it already? The investment recommends itself, without any tax incentive. The barrier that prevents them from doing it is clearly not a tax barrier, and whatever is driving their investment decision, they are clearly not chasing the best return. So a tax incentive not only costs money, but likely won't solve the problem, because it's not addressing the cause of the problem, so it's money that's likely to be wasted.

Booomshine, your comparison is interesting and I would have some questions about some of the detail, but it's not the comparison that I'm making. My argument is for tax neutrality as between direct investment in securities, versus indirect investment via a pooled fund.

 

[Duke of Marmalade]

The better argument of ETFs vs Investment Trusts is that deemed disposal regime reduces tax gained for the government

This is an illusion which I have been through with @AJAM before.
If the government invested its taxes either explicitly in one of these vehicles or implicitly in say infrastructure and earned the same return we have a zero sum game. The government and the punter together finish up with the exact same pile.

 

[Zion2022]

better investment returns = clear win for state; therefor tax incentive = good”, that’s woefully incomplete. If you take it seriously, then the logical conclusion is zero taxation of investment returns;

There was obviously no suggestion of zero tax, not sure where that came from. Just that the best investment be made at a minimum as attractive and ideally slightly more than the alternatives. The level of incentive clearly can be very minor.

Given much of the current funds are in cash investments earnings 1-2% and being taxed at 33%, the amount of tax at risk is fairly negligible. It’s very difficult to envisage a world where more money being funnelled into global ETFs doesn’t increase tax take for the state in the long term (along with growing individual wealth)

 

[nest egg]

The other factor we have to think hard about here is one I've pointed to earlier - if investing in the passively-managed index-tracker give the best return, given a neutral tax regime, why aren't people doing it already? The investment recommends itself, without any tax incentive. The barrier that prevents them from doing it is clearly not a tax barrier, and whatever is driving their investment decision, they are clearly not chasing the best return.

What do you think is the reason people aren't chasing the best return?

 

[Greenbook]

What do you think is the reason people aren't chasing the best return?

Yes, they are wildly popular in the US for example. I gather than there is huge investment there by retail investors.

As I understand it, in the US, the passive tracker must distribute its dividends and any gains it has (there won't be too many of those it is tracking, not actively trading). The investor is taxed on what he receives. After that he benefits from the compounding increase in share values. The tax treatment is the same as holding owning shares except the clueless retail guy doesn't have to pick and he also benefits from a low cost fund. Trackers are cheap to run, no trading in and out, no research as to what is the next big thing, no expensive experts working out the direction of the market. It is buy and hold with adjustments as companies at the bottom of the index get replaced (and that could be at a loss as well as a gain).

Why we can't have a similar system here is beyond me. Even taxing deemed but undistributed income and gains would make more sense.