Why Property Is a Fundamentally Broken Investment In Ireland

[Greenbook]

Which are exactly what you are calling for.

My points are as follows:

1. The deemed disposal rule means that ETFs are extremely unattractive for ordinary retail investors who want to save outside of a pension scheme. I think that the deemed disposal rule should be abolished and you should be taxed in the normal manner on these investments when you sell.

2. All the regulatory interference in the PRS has made it extremely unattractive and risky for ordinary people. I'm not 'calling' for anything here. That is the trajectory and it is only going to get worse.

 

[TomEdison]

I think that the deemed disposal rule should be abolished and you should be taxed in the normal manner on these investments when you sell.

And my point is that thats' very unlikely to happen as long as the funds themselves can roll up income and gainst tax-free. If you don't have deemed disposal then, as in other countries, your going to have some other mechanism for taxing income and gains as they accrue. Are you calling for deemed disposal to be abolished and not replaced with another mechanism to prevent tax-free rollup? 'Cause I don't think that's going to happen, and I can't see a strong policy reason for arguing that it should happen.

I agree with you about the private rented sector. Quite apart from the political risk to this sector, which is high, I'm also of the view that residential property prices are unfeasibly high, and the scope for further real growth is limited.

 

[stormy]

your going to have some other mechanism for taxing income and gains as they accrue.

Its off thread, but I'm curious - what are the mechanisms in other countries?

The other countries I'm familiar with have the opposite, i.e. its entirely tax free, even up to the point of selling the asset. E.g. the Stocks & Shares ISA in the UK, and the Roth IRA in the US (although US Roth IRA can only withdrawn in retirement). Both can be used to buy assets using after tax income, but the gains on those investments (either via dividends or capital gains) are tax free. These wrappers are both in addition to a pension scheme similar to that in Ireland.

 

[Greenbook]

Are you calling for deemed disposal to be abolished and not replaced with another mechanism to prevent tax-free rollup?

Other countries don't have a deemed disposal rule as far as I know. You pay tax when you sell. Do those other countries tax the ETF on their internal gains?

We have thousands of ETFs based here because, I assume, all the ETFs gains are allowed to roll up. Effectively, we have this huge funds industry based here to avoid tax on rolled up gains.

So my understanding is:

1. If I'm Irish and I buy an Irish ETF, I am subject to the deemed disposal rule because the ETF benefits from the roll up.

2. If I'm not Irish resident and I buy an Irish ETF, I am not subject to the deemed disposal rule because my country doesn't have that rule. The gains in the ETF are still rolled up.

 

[Greenbook]

I agree with you about the private rented sector. Quite apart from the political risk to this sector, which is high, I'm also of the view that residential property prices are unfeasibly high, and the scope for further real growth is limited.

Entirely agree with you on the PRS. You are correct, prices are unfeasibly high and that is yet another risk.

 

[TomEdison]

Other countries don't have a deemed disposal rule as far as I know. You pay tax when you sell. Do those other countries tax the ETF on their internal gains?

The typical rule is that a pooled investment fund is taxed on its earnings unless it distributes its earnings to unitholders each year, in which case the fund pays no tax but the unitholders, of course, do.

A variation on this rule will allow a fund to go untaxed so long as it gives unitholders a statement of the earnings imputed to their units on which, again, the unitholder is taxed.

If I'm not Irish resident and I buy an Irish ETF, I am not subject to the deemed disposal rule because my country doesn't have that rule. The gains in the ETF are still rolled up.

Depends on the law of the country concerned, obviously. Most of them require residents to report the earnings or imputed earnings from overseas investments. There may be a certain amount of tax avoidance going on, with taxpayers failing to report their overseas investments (Ansbacher accounts, anyone?) but for obvious reasons not many countries design their tax system to tax earnings in domestic funds annually, but allow gross roll-up in offshore funds.

We have thousands of ETFs based here because, I assume, all the ETFs gains are allowed to roll up. Effectively, we have this huge funds industry based here to avoid tax on rolled up gains.

Most of the funds domiciled in Ireland are not marketed to retail investors in other countries; other financial institutions invest in them, and their tax arrangements/tax obligations in their countries of establishment may differ.

The Irish-domiciled funds pay no tax in Ireland on their earnings, but many of them either distribute their earning each year, or report earnings to investors in each year, so that the investors can comply with their tax obligations in their countries of residence. Their may be some that don't distribute, marketed to financial institutions (like pension funds) that are allowed gross roll-up.

 

[TomEdison]

Its off thread, but I'm curious - what are the mechanisms in other countries?

The other countries I'm familiar with have the opposite, i.e. its entirely tax free, even up to the point of selling the asset. E.g. the Stocks & Shares ISA in the UK, and the Roth IRA in the US (although US Roth IRA can only withdrawn in retirement). Both can be used to buy assets using after tax income, but the gains on those investments (either via dividends or capital gains) are tax free. These wrappers are both in addition to a pension scheme similar to that in Ireland.

Both in the UK and in the US, mutual funds distribute their earnings ever year and, if they don't, they get taxed.

Both countries permit individual investors to hold their investments in a tax-free wrapper, but these are attended with limits and restrictions. The Roth IRA is a retirement savings arrangement (that's what the 'R' stands for) and we have analogous tax-free wrappers allowing gross roll-up in Ireland - the various PRSAs, pension schemes, retirement annuity contracts, etc. The UK ISA is not retirement-linked, but there are annual limits on what you can put in. As long as you keep within the limits, the ISA does allow tax-free reinvestment of income and gains — not just arising from mutual funds, but from ordinary equities as well.

 

[stormy]

Both in the UK and in the US, mutual funds distribute their earnings ever year and, if they don't they get taxed.

OK, but my point is that within those wrappers that I mentioned, when the earnings are distributed there is no tax within the wrapper or when removed from the wrapper.

we have analogous tax-free wrappers allowing gross roll-up in Ireland - the various PRSAs, pension schemes, retirement annuity contracts, etc.

Are those "analogous" wrappers though - all the ones you mentioned allow investment using pre-tax income right? The ones I mentioned are specifically only investment using post tax income. Both of those countries also have pension schemes allowing one to put in money pre-tax.

I'm aware there are limits on how much can be put in, but those limits seem relatively generous (£20k each year in the case of the ISA). So not only do these countries not have the deemed exit tax, but they have wrappers which allow no tax at all to be paid on gains.

 

[Greenbook]

@TomEdison My ETFs definitely distribute to me every year and I pay income tax on those distributions. But the deemed disposal rule applies as well. Is that correct?

I can invest in Irish domiciled ETF via Davy etc. and have done so. But if I was in Europe, I could not invest in an Irish domiciled ETF unless I was a fund myself. Is that correct?

These rules are even more byzantine than the ones in the PRS!

 

[Greenbook]

@TomEdison Another question if you don't mind please?

I have an ETF that tracks the ISEQ. Let's say 10% of the ETF is in AIB shares because that company comprises 10% of the index. 10% of the ETF is in Bank of Ireland shares because that company comprises another 10% of the index. If AIB's share of the index declines by 2% and Bank of Ireland's increases by 2% due to the share price movements of those shares, the ISEQ will now comprise 8% approx AIB and 12% approx BofI. The ETF will have to sell down AIB shares and buy BofI shares to rebalance its holdings and ensure that it is tracking the ISEQ correctly. It may make a gain or loss due to these changes and will make these adjustments on a daily basis.

That is the tax break/the tax avoidance - the ETF can sell and buy tax free to make sure it tracks the particular index because that is what ETFs do- and that is why the deemed disposal rule exists?

 

[Fortune]

My ETFs definitely distribute to me every year and I pay income tax on those distributions. But the deemed disposal rule applies as well. Is that correct?

No, that's not correct. If you hold an ETF to which distributions are taxed as income, then it falls under CGT rules. If you have one that falls under deemed disposal, then you pay exit tax at 41%/38% on those distributions.

 

[Fortune]

The ETF will have to sell down AIB shares and buy BofI shares to rebalance its holdings and ensure that it is tracking the ISEQ correctly. It may make a gain or loss due to these changes and will make these adjustments on a daily basis.

That is the tax break/the tax avoidance - the ETF can sell and buy tax free to make sure it tracks the particular index because that is what ETFs do- and that is why the deemed disposal rule exists?

No. The value of the shares held on the ETF will have already led to the proportion of the fund made up by BoI being 12% and AIB being 8%. The buying and selling happens when the index itself is updated for companies being removed and added to the index (and likely for other circumstances when the ETF doesn't directly hold shares on companies that make up the index).

Deemed disposal is mainly there to capture tax that would otherwise have been deducted on dividends/income from the fund.

 

[Greenbook]

No. The value of the shares held on the ETF will have already led to the proportion of the fund made up by BoI being 12% and AIB being 8%.

If that is the case, and I stand corrected, then the ETF just buys these shares Day 1 and holds on to them forever. It never sells any of its shares so it does not make any capital gains and has no CGT liability itself. It would be just like me buying AIB and BOI shares and not selling them. Why impose a deemed disposal so. There is no CGT at the ETF level, so what avoided tax is the deemed disposal catching.

Deemed disposal is mainly there to capture tax that would otherwise have been deducted on dividends/income from the fund.

I receive distributions from my EFTs and pay income tax on them at my marginal rate. I return them via my tax return and pay tax. Why is the deemed disposal necessary to capture a tax that I am already paying?

I am unfortunately utterly confused at this stage.

 

[Fortune]

It would be just like me buying AIB and BOI shares and not selling them. Why impose a deemed disposal so. There is no CGT at the ETF level, so what avoided tax is the deemed disposal catching.

Income tax on the dividends has been avoided.

I receive distributions from my EFTs and pay income tax on them at my marginal rate. I return them via my tax return and pay tax. Why is the deemed disposal necessary to capture a tax that I am already paying?

You should be paying exit tax on those dividends, and not income tax. The cynical answer to your question is that the government just took the life assurance exit tax rules and slapped them onto ETFs. They have deemed disposal because the funds are non-distrubiting and so dividends aren't being taxed. Then there's also the "infinite roll-up" argument.

 

[jpd]

No, that's not correct. If you hold an ETF to which distributions are taxed as income, then it falls under CGT rules. If you have one that falls under deemed disposal, then you pay exit tax at 41%/38% on those distributions

Generally, the ETFs available to retail investors in Ireland are subject to exit tax on any dividends they distribute AND are also subject to Exit tax on deemed disposals

There are ETFs in the US, for example, which are subject in income tax on dividends and CGT on disposal but these are not generally availbalt to retail investors

 

[Greenbook]

You should be paying exit tax on those dividends, and not income tax. The cynical answer to your question is that the government just took the life assurance exit tax rules and slapped them onto ETFs. They have deemed disposal because the funds are non-distrubiting and so dividends aren't being taxed. Then there's also the "infinite roll-up" argument.

I think that is what they did, just slapped the life assurance rules on to ETFs which are something quite different.

I also think we are going around in circles on this, but based on what you are saying, and you know more about this than I do:

1. ETFs don't make any internal capital gains because they just passively track the index. They just buy the basket of shares that comprises the ISEQ or whatever and hold on to them - why have a deemed disposal rule so. There is no rolled up CGT - I could replicate the index myself by buying the shares directly. If I didn't sell them I would pay no tax.

2. I definitely get distributions from my ETF - presumably these are my share of the dividends which the ETF gets from holding the shares. I pay tax on them - I'd be astounded if they were tax free in my hands. Why have a deemed disposal when my share of the income is distributed to me every six months or whatever and I pay income tax on that distribution in the same way as I would a dividend paid directly to me by AIB

Perhaps it is confusion at Revenue level, as you indicate, as to how an investment or life assurance fund works and an ETF

 

[Firefly]

Is there any chance someone could start a thread on ETFs in the appropriate forum?

 

[TomEdison]

ETFs don't make any internal capital gains because they just passively track the index. They just buy the basket of shares that comprises the ISEQ or whatever and hold on to them - why have a deemed disposal rule so. There is no rolled up CGT - I could replicate the index myself by buying the shares directly. If I didn't sell them I would pay no tax.

Two points about this:

As I understand it, ETFs that track the index mostly don't do that by buying the exact share, in the exact proportions, that make up the index. They use derivitive instruments, options, puts, calls and the like to replicate the return on the index with a high degree of accuracy. This would result — if they were taxable, which they generally are not — in tax consequences different from the tax consequences that woudl result from actually mirroring the index in shareholdings.

The other point to bear in mind is that we keep talking here about deemed disposal for ETFs. The deemed disposal regime applies to pretty well all pooled investment vehicles; ETFS are a small fraction of the investment vehicle that are covered, and index-tracking ETFs are a smaller fraction still.

I definitely get distributions from my ETF - presumably these are my share of the dividends which the ETF gets from holding the shares. I pay tax on them - I'd be astounded if they were tax free in my hands. Why have a deemed disposal when my share of the income is distributed to me every six months or whatever and I pay income tax on that distribution in the same way as I would a dividend paid directly to me by AIB

In so far as the fund distributes it earnings, your unit values grow less fast than they would if earnings were retained in the fund and reinvested (obviously). The deemed disposal only taxes the earnings that are retained within the fund. So, there's no double taxation there; the earnings that are distributed are taxed on distribution, and the earnings that are not distributed are in due course taxed via the deemed disposal regime.

 

[Fortune]

There are ETFs in the US, for example, which are subject in income tax on dividends and CGT on disposal but these are not generally availbalt to retail investors

Well, we suspect this to be the case, but Revenue have deleted their advice on this matter....

 

[TomEdison]

Are those "analogous" wrappers though - all the ones you mentioned allow investment using pre-tax income right? The ones I mentioned are specifically only investment using post tax income. Both of those countries also have pension schemes allowing one to put in money pre-tax.

I'm aware there are limits on how much can be put in, but those limits seem relatively generous (£20k each year in the case of the ISA). So not only do these countries not have the deemed exit tax, but they have wrappers which allow no tax at all to be paid on gains.

Whether Ireland should have tax-free investment wrappers analogous to the ISA is a different question from whether we should have a deemed disposal regime. You could, in principle, have tax-free investment wrappers, while also taxing fund earnings as they arise in relation to units held outside the tax-free wrapper. This is in fact more or less what the UK has; there is no tax-free roll-up within UK managed funds.

There's another dimension to this which should be born in mind in the Irish context. A constant (and justified) compaint on this Board, and more generally, is that Ireland collects an excessive share of tax through income tax on earnings from employment/trade. But a scheme which exempts investment earnings from income tax shifts the balance even further in the wrong direction. Could I suggest that in the Irish context what we need is not an UK-type ISA which exempts investment earnings from tax; it's a tax-favoured investment account that you get a tax deduction or tax credig for investing, but investment earnings are taxed as they arise?