A taxing issue for investments
While levies remain an issue with people seeking to make an investment decision, advisers say it should be a secondary consideration, writes FIONA REDDAN
FOR INVESTORS who had their fingers burned on a variety of tax-driven investments such as Section 23 during the boom years, tax and investing no longer go hand-in-hand.
Hindsight, of course, is a wonderful thing, and these days even tax advisers are playing down the importance of their profession when it comes to choosing an investment.
“It [tax] should come into the process because the rate of tax can vary from 55 per cent to 33 per cent, but it’s a secondary consideration as opposed to a primary one,” says Tim O’Rahilly, a partner in the private client practice of PwC.
Similarly, Ronan McGivern, taxation director with Russell Brennan Keane, cautions against making an investment decision purely for tax reasons.
“It must make sense commercially first and foremost,” he says, adding that there is always a risk of a change to tax laws over the period of the investment, pointing to the recent examples of changes to the legacy property incentives and higher earners restrictions.
Nonetheless, if buying a three-bed semi-detached house in the middle of rural Ireland just to shelter your minimal rental profits proved to be a less than wise ploy for many, tax can still have a big impact on the return you get to keep.
As McGivern notes, “to the extent that any gains or profits arising are subject to tax this impacts on the investor’s expected net return from the investment”. But what do you need to bear in mind?
If it’s income-generating . . .
While big-name investors such as bonds guru Templeton’s Michael Hasenstab might be willing to take a punt on Irish Government bonds, they may be less attractive for retail investors. Apart from security concerns, tax is levied on income-generating investments such as bonds at the marginal rate of tax. So, if you’re a higher rate taxpayer you’re likely to end up paying tax of 55 per cent on your coupon or interest. This rate also applies if you’re one of the many Irish investors who have cast their eyes – and their money – to safe havens like Germany.
As O’Rahilly notes, however, “tax is furthest from their mind” when it comes to making such a decision, as it’s based more on maintaining the value of their money rather than maximising it.
Similarly, investors who have put money into deposits in other safe havens outside of the euro zone, for fear of a collapse in the single currency, will pay a higher rate of tax on any interest earned.
If deposits are held within the European Union, then the deposit interest retention tax (Dirt) of 30 per cent applies. However, once the money goes outside the EU, then tax of up to 55 per cent applies. And remember, to be tax compliant, you need to account for these deposits yourself.
“If it’s a non-Irish deposit, it’s up to the individual to pay their own tax,” warns O’Rahilly.
Similarly, if you earn dividends from your share portfolio, tax will be levied on these at your marginal rate of tax.
If it’s a fund . . .
While the tax that’s liable on your fund might be the last thing you think of when you consider investing in emerging market equities or tech stocks, different types of funds are treated differently. For example, for funds that offer regular payments, the rate of tax applied is 30 per cent, rising to 33 per cent to those that accumulate on a gross roll-up basis.
What’s more, the rate of tax also depends on where the fund is domiciled. So, if it’s in Ireland, the EU, US, Switzerland, or an OECD country with which Ireland has a double tax agreement, then the rates outlined above will apply.
However, for funds outside of those jurisdictions, such as the Cayman Islands – which is where many hedge fund structures would be located – then tax on gains is levied at a rate of 55 per cent.
“People who have lived abroad, and invested in certain things while living abroad, when they come back here it’s an entirely different tax treatment and they might not be aware of that,” says O’Rahilly.
Exchange-traded funds (ETFs) are funds that are listed on a stock exchange like a share, but are typically structured like a fund and tax at a rate of 33 per cent applies. Where things might get interesting, however, is where you have an ETF that isn’t structured as a fund and is liable to capital gains tax (CGT). In such cases, you might be able to carry forward any losses you have incurred against gains in the fund – thus diminishing any losses you may have incurred along the way.
If you’re liable to CGT . . .
One of the main tax advantages of investments that are liable to CGT at 30 per cent is that you can carry forward losses made in the past and set them against any gains you may have made. CGT applies when you dispose of an asset such as a share or property.
So, if you’re still smarting from that hit you took on Anglo Irish Bank shares but your stock portfolio is starting to turn around and you’re looking to sell up, you might be able to significantly reduce any tax bill you will incur.
“From a tax perspective, it can make equities more attractive,” notes O’Rahilly.
And there is no timeframe on when you must carry forward your loss – so even if you don’t crystallise a gain on your share portfolio for another 30 years, those Anglo losses will still be put to use.
If you are carrying significant losses in your portfolio, perhaps through an investment in AIB or Bank of Ireland, McGivern notes that if you are about to realise a capital gain, then it might make sense to crystallise your loss on those shares by selling up. This way you can shelter the gain from tax to the proportion of the loss you incurred.
If it’s bricks and mortar . . .
While property investment might be almost gone the way of the dodo, last year’s budget did introduce an incentive for those looking to buy property before the end of 2013. For those that do so, and hold the property seven years, any gain made on the property during that period will be exempt from CGT.
O’Rahilly says that despite the exemption he has seen little interest in property at present.
“Commercially, getting access to bank financing is critical for many investors and is slowing the process. In addition the uncertainty surrounding the property tax is having the effect of further stalling investment decisions,” he says, but adds that in time, the incentive could start to stimulate the market.
Of course whether or not this incentive might be mitigated by the impact of the forthcoming property tax remains to be seen.
“This will be another tax on property ownership. Any additional tax/cost will obviously reduce the net return generated by the investment,” says McGivern.
While the level at which this tax will be levied is still very uncertain, it’s unlikely that this charge will be allowable as a tax deductible expense.
“If an investor was entitled to offset the property tax against their rental income, but a homeowner couldn’t . . . it probably wouldn’t fly in this environment,” says McGivern.