Taxation on investments: What changes might be on the way?

While tax is always a consideration when investing, it shouldn’t be the first thing one thinks of. In Ireland, however, it is often the case that the “tax tail wags the investment dog” rather than the other way around. It’s an issue that has perplexed investors for some time, and has made investing in exchange-traded funds (ETFs) among other products trickier than in other jurisdictions.

Change may be on the way. Last year, Minister for Finance, Michael McGrath, set out the terms of reference for a review of the taxation of investment products, and then, in June 2023, he commenced a consultation process, “Funds Sector 2030: A Framework for Open, Resilient & Developing Markets”.

While the review covers a broad range of issues, including those specifically related to Ireland’s asset-management and fund-servicing industry, it is the element related to the tax treatment of retail investments that will be of most interest to Irish investors.

And there appears to be appetite for change in official circles: as the report notes, the “current treatment of financial products is confusing and may potentially distort the neutrality of the tax system in this area”.

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Since the launch of the consultation, almost 200 submissions have been received, 53 from industry participants and 140 from individuals responding in a private capacity. And according to the Department of Finance, “a considerable number of these were concerned exclusively with taxation”, and more specifically, the tax regime for ETFs.

A summary report of responses found that the general perception is that taxation “is a major barrier to increasing retail investor participation in Ireland”.

If change comes, it could be on the way as early as this year; the review team is set to report to Mr McGrath over the summer, after which he will consider its findings with a view to implementing any changes in the Finance Bill.

“I do think tax has a role to play and I would anticipate making some changes,” he said last week.

But what has been called for?

Harmonising tax rates

Many of the responses to the consultation focused on the need to simplify and harmonise the taxation of investment funds.

That is no surprise, perhaps, given the differences in how retail investments and savings products are currently taxed in Ireland. As our table shows, it differs substantially.

In its submission, KPMG said: “Overall, the approach to taxing investments is far too complex, with too many different regimes applying which make it almost impossible for an individual without a tax qualification to understand the tax regime that applies in each case.”

The Big Four firm argues there is now “no reason” why there should be any differentiation between the tax treatment of investments in fund and insurance products.

Some investments are liable to tax at the life assurance exit tax rate of 41 per cent, others at capital gains tax (CGT) of 33 per cent. Deposits are liable to Dirt at 33 per cent; and yet others incur income tax, PRSI and USC.

One area that has been a bugbear for some time is the difference between Dirt, or the tax on basic deposits, and exit tax on life assurance products, which were levied at the same rate, of 41 per cent, until 2016

The discrepancy is also highlighted by the Irish Tax Institute in its submission. As it notes, if you buy a property outright, you’ll pay capital gains tax (CGT) at a rate of 33 per cent on any profit you might make but if you were to put your money into a property fund, you will face tax at a rate of 41 per cent.

It argues that “different forms of investment and savings income and gains should be subject to an equal level of taxation”. It argues that a single rate of tax of 33 per cent (equal to current rates of CGT/Dirt) should apply for investment income and gains.

Deloitte has suggested a simpler approach, where a 41 per cent exit tax would be applied on a self-assessment basis for income and gains from all investment fund and life assurance products.

One area that has been a bugbear for some time is the difference between Dirt, or the tax on basic deposits, and exit tax on life assurance products, which were levied at the same rate, of 41 per cent, until 2016. Now, however, Dirt has dropped to 33 per cent.

Last year, some €45 million in Dirt tax was raised – a sharp increase on the €14 million raised in 2022, according to latest figures from Revenue. This contrasts with the €231 million raised from exit tax in 2023, and the €233 million in 2022.

Back in 2022, the Commission of Taxation and Welfare recommended that deposit interest should be liable to the marginal rate of tax, plus PRSI and USC; however, as Deloitte points out, moving to self-assessment “may result in significant cost and resources”. It suggests a flat rate of 40 per cent on deposits, deducted at source, with standard-rate taxpayers entitled to claim a partial refund.

Deemed disposal

A key feature of the Irish investment funds regime is that after being invested in a fund for eight years, the investor must pay tax, typically at a rate of 41 per cent, on any gains made to date. This tax arises regardless of whether or not the investor is exiting their position by selling the fund or ETF.

Known as deemed disposal, it was introduced in the Finance Act 2006 to address perceived tax avoidance, and means that you must settle up, as it were, with the tax authorities every eight years.

It followed the introduction of a “gross roll-up” regime for fund profits. Previously, Revenue had taxed investors’ profits on such investments every year.

When it comes to a life wrapped fund, the life companies automatically deduct the tax and hand it over to Revenue; if you invested via a broker or online fund platform, you must calculate the tax and pay it yourself via a tax return.

But is it time to say goodbye to this approach? Interrupting a fund to pay tax on it even though you’re not cashing it in will impact the overall performance of the fund. And for investors allocating money to a non-life wrapped fund on a monthly/ad hoc basis, it makes calculating the tax owed particularly tricky.

The Irish Tax Institute notes that investors may be forced to liquidate their investments in order to discharge the tax liability ‘which can be problematic where the investment is in a long-term investment product’

In its submission, Chartered Accountants Ireland said that it should be abolished, arguing that “it is difficult to operate in practice and it is problematic for funds with a long-term strategy”.

Referring to the current reform of the European Long-Term Investment Fund regime, the industry association said it would appear to be “counterintuitive” for Ireland to operate a tax regime which discourages investors from making long-term investments or simply holding investments for longer than eight years.

The Irish Tax Institute notes that investors may be forced to liquidate their investments in order to discharge the tax liability “which can be problematic where the investment is in a long-term investment product”.

Deloitte agrees, arguing “it would be preferable for investors in Irish funds to be taxed on a self-assessed basis with no deemed disposal events”.

What about loss relief?

Another issue for investors relates to so-called loss relief, where investors in shares for example, can offset any losses incurred against future gains in order to reduce their tax liability. This advantage does not currently apply to investors in funds.

Many of the submissions suggest it should be extended to them.

In its submission, Deloitte argues that investors should be taxable on their net overall investment gains, and thus loss relief should be available.

KPMG says the lack of it can even give rise to “irrational investment decisions”, with investors holding on to underperforming investments in the hope that they will recover “because the tax cost of shifting is too high”.

It also means that investors can gravitate towards products that offer CGT treatment. But many of these are US products and, as pointed out by KPMG, these impose “US inheritance/estate tax on the value of these products where an individual dies with only minimal exemptions” – a further complication and a loss of tax revenue for Irish exchequer.

Taxation of ETFs

Investment in ETFs has exploded in recent years, and is set to grow even further. In its submission, BlackRock, the world’s largest asset manager, estimates that ETF assets in Europe will reach €2.5 trillion by 2027.

However, due to issues with the Irish tax regime, they are not as attractive as they should be – despite being considerably cheaper than other options. You’ll pay just 0.07 per cent to invest in the Vanguard S&P 500 UCITS ETF, for example, but you’ll pay north of 1 per cent a year to invest in a similar fund with an Irish life company.

One issue is that ETFs with a European domicile are subject to deemed disposal – including that aforementioned Vanguard fund which has an Irish domicile. But US and Canadian ETFs are taxed under the CGT regime and so deemed disposal does not apply. But regulatory changes at European Union level have made investing in offshore funds more difficult.

In its submission, Matheson says the tax treatment of ETFs is a subject of “continuing uncertainty” for many Irish taxpayers.

“This uncertainty illustrates the broader concern regarding the complexity, and lack of clear black-line tests, in ascertaining the tax treatment of non-Irish funds,” it says, arguing that such uncertainty should be clarified by legislation or more detailed guidance from Revenue.

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