Ex-pats gain from change in law

Are Irish and European investment funds taxed unfairly? Do two sets of rules apply for domestic and ex-pat investors in savings and pension plans? Should a level playing pitch be established on which everyone can compete fairly or should the tax break be repealed?

All of these issues have been raised by the arrival on the market of an investment product earlier this year aimed at Irish people working abroad who, prior to the change in the law, were forced to encash any foreign-based investment funds brought back to Ireland.

Sold exclusively by Irish life assurance companies based in the International Financial Services Centre, as a result of amendments to the Finance Act 1997, the product - a savings policy or a retirement benefits policy - allows for investment in a mainly equity-based fund that is entirely free of any internal taxation.

If it is encashed outside the State the return is tax free. If the policy-holder returns to Ireland (you only have to be outside the State for six months to take out the policy) the existing balance is not taxed but tax will be liable on any gains from the date of return. However, you will only have to pay the tax at the standard rate of 26 per cent upon maturity and only on 75 per cent of the gain.

By comparison, an Irish resident who purchases a life assurance savings policy is buying into a fund that is taxed internally, every year at 26 per cent. The fund manager is required to buy and sell to meet that tax bill and this obligation will always influence the deals he makes. The taxes are also payable on the entire fund, not just 75 per cent of it.

The main advantage of a rolling-up, tax exempt fund is that of time on money: the return will inevitably be about 13 per cent better than on a fund where tax must be paid annually on any gains. The ex-pat choosing the retirement benefit option will enjoy a tax-exempt fund. (So will the Irish resident since all pension funds are tax-exempt).

They will not get the tax deduction on contributions and will have to pay 26 per cent tax on 75 per cent of any income and capital gain, but the trade-off is that they will not have to buy an annuity with the matured fund.

Unlike Irish pension fund holders who can only convert 25 per cent of the fund into a lump sum, the entire fund from the ex-pat policy will be paid as a lump sum. On top of that, this fund - regardless of its size - will have no impact on any pension benefits he will receive from his occupational pension.

Investment advisers we spoke to all think this IFSC-based investment is one of the best tax breaks for clients who may find themselves working abroad. "The rationale behind Section 66 and 67 of the Act is to encourage Irish ex-pats to invest their overseas earnings in IFSC companies," explains Mr Aidan McLoughlin of the independent financial advisers FEN.

"From the Government's point of view the provisions of the Act do not represent a substantial concession as such individuals could in any case structure their investments so as to avoid a charge to Irish tax whilst non-resident in Ireland. In addition such individuals could, through proper planning maintain these investments overseas on their return to Ireland and not pay any tax in Ireland." Better they should pay 26 per cent tax, than no tax at all, is the Government's view, says Mr McLoughlin.

But that does not address the other issue raised by this new tax break: the unfairness of Capital Gains liability on returns from life assurance policies. While the life assurance companies were lobbying for this special tax status for expatriate workers in order for them to buy their products while out of the State, the same companies had already successfully lobbied to keep out the life assurance products of foreign life assurers.

Three years ago - and despite the EU Third Life Directive - new taxation laws were passed which meant the proceeds of life assurance investment policies, purchased from overseas companies, would now be subject to a 40 per cent tax on any income or capital gain. The standard CGT tax relief and indexation would not apply. In other words, you could expect to pay at least 14 per cent more tax on your proceeds from a policy purchased from a UK provider than by buying the policy from an Irish one, where the tax is paid internally at 26 per cent. To illustrate the advantageous tax benefits of the IFSC product, let us assume an annual lump sum contribution of £2,000 per annum for 20 years and a growth rate of 10 per cent.

After the 20 years, the mature IFSC policy fund, 75 per cent of which is taxed at 26 per cent, will have grown to £104,057 or a net annual return of about 8.43 per cent. The same policy, taken out by an Irish resident and taxed internally at 26 per cent will pay out £92,000 or a return of 7.4 per cent. Someone taking out an equivalent British policy with the punitive CGT liability would receive £76,750, or a 4.14 per cent annual return. The difference in the cash value between the IFSC policy and the other two is £12,057 and £27,307 respectively.

As a testament to the strength of the insurance lobby here, the new CGT regulations were implemented without much protest. Its only critics are a small band of mainly fee-based independent financial advisers who are not remunerated by life company commissions and who wish to widen their clients' portfolios by including non-Irish based investments.

As it stands, the real winners are life assurance companies and their subsidiaries.