Tax treatment of exchange-traded funds has to change

Minister for Finance Michael McGrath reportedly plans to review the 41 per cent exit tax charged on exchange-traded funds (ETFs). It’s about time: the current system is madness. If you profit from making a speculative bet on a single stock, you pay capital gains tax of 33 per cent. In contrast, if you carefully invest your money in a diversified ETF tracking global markets, you pay 41 per cent tax – even if you are a lower-rate taxpayer.

Worse, Ireland’s deemed disposal system means you must pay 41 per cent tax on ETF gains after eight years, even if you don’t sell the fund.

The magic of compound interest means that gains snowball over long holding periods, but paying tax after eight years undoes this huge benefit. Indeed, it may even cost Revenue, which would ultimately collect more money if the deemed disposal rule was applied after a longer period (say, 16 or 24 years).

Deemed disposal was introduced in 2006, the reasoning being that Revenue didn’t want to wait decades to get its share of investment profits. However, Revenue does collect tax from distributing ETFs that distribute annual dividends, so why are such funds treated identically to accumulating ETFs that reinvest dividends? And unlike with individual stocks, you can’t offset ETF losses against gains.

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The tax treatment of ETFs in Ireland robs investors of an ideal long-term investment option. Some ordinary investors will respond by opting for more speculative options, such as single stocks. Others will just keep their money in the bank, earning almost nothing.

In the UK, investors can make tax-free investments via individual savings accounts (ISAs). Other countries have similar systems. Irish legislators should take note.