What is the issue with the 8 year deemed disposal?

[resjudicata]

@war_eagle

If you invest for 40 months and after that period you sell and pay your taxes its the same as paying those taxes every 8 months.

This is just mathematically wrong. Taxing during compounding is not the same as taxing after compounding for your gains.

 

[war_eagle]

@resjudicata If you dont sell your holdings every 8 years, it will result in the same thing. Show me your calculations.

 

[resjudicata]

@war_eagle 100 euro invested for 16 years. 33% capital gains tax. Let's say 33% deemed disposal after 8 years (i believes it's actually 41%), so you keep 67% of the gains

Let's assume compound gain at 5%.

Scenario 2: No deemed disposal

Total gain after tax on final sale: 100 * (1.05[sup]16[/sup] - 1)*0.67 = 79.25

Scenario 2: Deemed disposal, breaks up the compounding with a tax event:

Total gain after 2 tax events: (100 + (100 *(1.05[sup]8[/sup] - 1) * 0.67)) * (1.05[sup]8[/sup] - 1) = 63

Could be a typo in their somewhere but that's the gist.

 

[eviolite]

@resjudicata I was just looking at your calculations and I was wondering. You are assuming that the taxed money is being paid by money invested in the fund, making the fund pool smaller every 8 years.

What if after 8 years you pay your taxes with money from outside the actual fund, without selling said fund, wouldn't the compounding interest not be affected? You would even end up paying the same amount of tax as if the deemed disposal didn't exist

 

[resjudicata]

@eviolite

What if after 8 years you pay your taxes with money from outside the actual fund

Then that money on the side has to be part of your analysis.
That's money you aren't investing that you could.

 

[eviolite]

@resjudicata Well, I wouldn't invest 100% of my savings, so if I have something on the side and that would prevent me from resetting the compounding interest every 8 years, why wouldn't that make sense?

16 years down the line, the total amount of tax I would've paid would be the exact same as if 8 years deemed disposal didn't exist, right?

Don't you think this would be a viable strategy?

 

[resjudicata]

@eviolite

Well, I wouldn't invest 100% of my savings, so if I have something on the side and that would prevent me from resetting the compounding interest every 8 years, why wouldn't that make sense?

It has to be part of your analysis. You aren't avoiding resetting anything

16 years down the line, the total amount of tax I would've paid would be the exact same as if 8 years deemed disposal didn't exist, right?

Nope. Because the tax you paid early from cash on the side could have been invested until the final disposal instead of paying tax.

 

[eviolite]

@resjudicata If I have $1000 invested over 16 yrs and I pay the taxes with cash that I have set aside every 8 years, in the end of the 16 yrs the compounding interest will be the same and the taxes I would've paid in total would be the same as if the 8 yr deemed disposal didn't exist.

Care to prove me wrong with a calculation? The money I have set aside won't pay any taxes if it is invested elsewhere or even on a savings account.

 

[resjudicata]

@eviolite

If I have $1000 invested over 16 yrs and I pay the taxes with cash that I have set aside every 8 years, in the end of the 16 yrs the compounding interest will be the same and the taxes I would've paid in total would be the same

The cash involved is higher though so the total return is lower

In the deemed disposal scenario I outlined with 100 euro invested the tax due after 8 years would be 15.75. That means if you want to pay with uninvested cash you need 15.75 extra cash sitting aside that you don't require in the non-deemed disposal scenario.

No extra cash required in the regular case because you can stay fully invested with all available cash until the investment is finally sold and then pay your tax

 

[eviolite]

@resjudicata I understand your point. But if you do have that cash sitting aside the total outcome is exactly the same. You pay the same total tax and expect do get the same return.

I'm not suggesting that 8 yr deemed disposal is a good law or that it makes sense. I'm just saying that it can be mitigated in case you don't lock up 100% of your savings on a non-retrievable investment and you have some decent investments you can quickly liquidate (which you totally should anyway) to pay those taxes every 8 years.

 

[pablo283]

@war_eagle If yu have shares for forty years you'll have paid tax on them 5 times instead of just when selling. Also if you need to sell shares to afford to pay the tax this will have a very significant effect on your compound interest at the end.

 

[steveh]

@war_eagle

If you invest for 40 months and after that period you sell and pay your taxes its the same as paying those taxes every 8 months.

Wrong. Whenever you pay tax you are withdrawing money to pay it that could be used to earn further interest, thus you earn less interest over the lifetime of the investment. With 41% DIRT this actually comes out to a serious loss in investment earnings over a 40 year period.

 

[steviepugh]

@war_eagle Its the compound interest killer and is simply laughed at by every other first world country.

 

[cathyhlikesflowers]

@war_eagle Not quite the same. I'm just learning the ropes on this stuff, as I'm a little fed up of where my savings are getting me, but the general gist goes as follows. More knowledgeable people, correct me where I'm wrong.

If you have money invested, and you make a gain, rather than take the gain out as a dividend or otherwise (and pay tax on it), many investors will choose to reinvest the gain, so that it makes further gains. There's something of a snowball effect, as each gain is reinvested and generates further gains, increasing your initial investment.

If you must pay tax on these gains before they are realised (cashed out, so to speak), you have less money to reinvest and thus, less money to make future gains from. The gains don't have the same opportunity to "roll up" as they might in other jurisdictions which do not have deemed disposal laws. While at the end, you still have a tax bill to pay, you've also had an opportunity to make a greater pre-tax profit, due to the ability to reinvest any gains made.

In Ireland, the "roll up" can take place in periods of 8 years. In 2006, the government enacted legislation that forces investors to artificially realise their gains and pay the due tax on them, rather than allowing further "roll ups" to take place. [I am unsure how this is administrated in practice, and someone might enlighten me here - do you file your return after the 8 years and Revenue bills you, or does your broker take the tax? The former seems more likely.]

The policy rationale is as follows, per a parliamentary question answered in 2018: "A deemed disposal occurs 8 years following inception of a policy of life assurance or acquisition of a fund and then every 8 years thereafter. The deemed disposal rules also apply to equivalent offshore funds. Any gain on the investment which arises from the date of inception or the date of acquisition to the date of the deemed disposal is subject to tax. This ensures that income isn’t being rolled up in life assurance policies or funds without being taxed."

Essentially, Irish tax law allows a certain amount of rolling up to take place, but forces a tax liability on the gains of an investment after 8 years. I couldn't find anything in the Explanatory Memo for Finance Act 2006 providing concrete rationale for why it was introduced.

Deemed disposal is one thing, but the tax charged at the deemed disposal time (exit tax of 41%...!) doesn't get as much airtime as it should. Particularly when you look at where DIRT (33%), CGT (33%) and even the marginal income tax rate (40%) are at.

 

[scripturewinds]

@war_eagle You can invest in UK based Investment Trusts.

These are actively managed and linked to indexes but do not directly track them. They have higher charges than ETFs, the ones I'm in are typically 0.3 -0.9%. The ones I'm in do not pay dividends, but many do.

They are closed ended companies meaning no more shares will be issued and they are treated as shares, so no deemed disposal, taxed at 33% CTG.
Annual CTG exemption of €1270.
Losses can be carried and written off against other investments.

Examples are:
Edinburgh Worldwide Investment Trust
Monks Investment Trust
Allianz Technology Trust
Scottish Mortgage Investment Trust
BMO have a bunch of funds

Trustnet have a list of them all.

Also Berkshire Hathaway and Markel are worth looking both are treated as shares.

 

[latashadavis]

@scripturewinds Which trusts are you invested in?

 

[scripturewinds]

@latashadavis Mostly the Ballie and Gifford funds, so Edinburgh Worldwide, Monks, Scottish Mortgage. B&G have a proven track record of picking stocks and they diversify all over the developed world and some emerging markets. I also have units of the Allianz Technology Trust.

I've been looking at the US insurance funds, Allegheny, Berkshire Hathaway and Markel. These would be very US focused, mainly blue chip and value stocks and a bit of tech. I think these are currently undervalued because they have a lot of value stocks, which have sound fundamentals but are not benefiting from the current tech-gasam

 

[anro25]

@scripturewinds Thanks for the information. My question is, aren’t you concerned about investing in GBP (or pence)? There is exchange fee and possible loss due of Sterling Pound’s value against Euro? Of course I assume your main currency is Euro.

 

[scripturewinds]

@anro25 Good Question, and the answer is a little longer than I first anticipated when I started typing.

First, of course I'd prefer to invest in a fund that has a base currency of euros, it makes the transaction easier, and avoids the small added cost of converting between currencies.

As for worrying about exposure to GBP, the exposure isn't to the base currency of the fund, it is to the currencies of the underlying constituents of that fund, same as a S&P 500 ETF, whether the base currency is Euros or GBP, the exposure is to USD. If the USD rises against the EUR, but the S&P stays flat, then the EUR S&P 500 ETF rises, and vice versa.

As I write the the top 10 holdings of SMT are :

1 Tesla Inc USD

2 Amazon.com USD

3 Illumina USD

4 Tencent CNY

5 Alibaba CNY

6 Meituan Dianping CNY

7 ASML EUR

8 Delivery Hero EUR

9 Netflix USD

10 Spotify USD (it is listed on the NYSE)

The currency exposure of this fund is mostly in USD. The regional exposure is :

1 North American Equities 55.30

2 Chinese Equities 19.00

3 Eurozone Equity 17.30

4 Developed European Equity 3.70

5 Money Market 2.00

6 UK Equities 1.30

7 Indian Equities 1.10

8 Global Fixed Interest 0.30

This is a quite diversified fund with a very small exposure to UK Equities and thus a small exposure to the GBP.

Now, when it comes to price, things get a little more nuanced where ITs are concerned.

If you go onto the trustnet site for SMT: https://www.trustnet.com/factsheets/t/be08/scottish-mortgage-investment-trust-plc

You will see that the SMT is currently running at a discount Vs the underlying holdings, it yo-yos a little, but this fund was running at a premium, this sudden change may be due to currency changes, or maybe a large sell off. Many will see this a a buying opportunity. Buying something at a discount, i.e. for less than its NAV, makes sense right? And buying at a premium is the opposite.

While this may seem concerning, from a tax/revenue perspective, it highlights the key difference between Investment Trusts and ETFs or other Open Ended funds. When you buy an ETF, or an OEIC, the fund issuer can just create more units for you. You do not necessarily buy them from someone else in the market. Your transaction does not affect the price of the ETF because the price is a direct reflection of the NAV of the constituents, not the demand for the units in the ETF*.

The demand for shares of an IT, and some currency fluctuation cause the discount/premium that you see quoted with all ITs. Ultimately where the NAV goes the share price will follow, however it may take a little longer than the immediate reflection you see with an ETF. The price will always regress towards centrality vs the premium/discount, so buy at a discount if you can, it could be free gains.



*If there is a massive inflow to a particular S&P 500 ETF, the issuer buys the underlying constituents, that raises the price of the constitutes and thus of the ETF. The point is, the price of an S&P 500 ETF is a reflection of the S&P500 price, not the demand for that ETF. If, at the exact same moment, everybody sold their iShare S&P500 ETF and bought the Vanguard S&P500 ETF, in theory, it would not affect the price of the Vanguard ETF, they would just issue more units and the net amount of money in the S&P 500 has not changed, so that would remain the same too.

 

[latashadavis]

@war_eagle So you'd rather pay tax every 8 years, then another tax when you sell for your retirement. Rather than just paying tax once when you retire.