As we begin to approach this year’s tax filing and payment deadlines, the difficult market conditions in the first half of 2022, coupled with increasing inflation, will likely lead to tax consequences for clients. With investors opting for more complex investment vehicles, now is a good time to recap on important tax rules that relate mainly to Irish and foreign fund investments.
In recent years, it is fair to say that the range of investments available to investors has moved away from traditional equity and bond portfolios in favour of fund investments.
On receiving annual tax packs from an investment adviser, tax advisers may wonder why there is such a focus on fund investments in portfolios. The change is generally to reflect diversification, wider access to products and lower costs. While this may benefit the client from an investment perspective, the complex rules for applying the correct tax treatment are sometimes not fully appreciated.
Investment undertakings tax
For example, the holdings of many Irish fund investments that are subject to investment undertakings tax ('fund exit tax') are held in a recognised clearing system, where the obligation to pay tax on the return rests with the investor. Some important points to remember are:
- The return is taxed as investment income for the individual and corporate investor (one not trading in financial assets).
- No loss relief – capital gains tax (CGT) – is available on the disposal of the investment. Losses on such an investment cannot be offset against CGT gains.
- In general, an exchange of units by an investor between sub-funds of an umbrella fund where no payment is made is not liable to tax. Similar rules apply on switching between different classes of units of a fund.
- Where the view is that the eighth-year deemed disposal rule applies (ie there is a deemed disposal of the investment on the occurrence of every eight-year anniversary following the acquisition), tax will be due on any gain arising. Tax advisers will need to track when this event will arise.
Most Irish investment managers do not wish to provide an outcome that results in punitive tax rates
Investment definitions
Exchange-traded fund (ETF)
Investment fund that aims to track an index of securities (eg stock market index), sector, commodity or other asset. Can be purchased or sold on a stock exchange in the same way as a regular share.
Offshore fund
Generally, offshore funds are similar in design and nature to an Irish collective investment, so rather than having a direct investment in, for example, an equity or property, an investment is made in a pooled investment fund.
Source: Goodbody
Offshore funds
For foreign funds (referred to as offshore funds in the TCA 1997), a degree of analysis is required to determine whether the fund will be subject to offshore fund rules and, if so, whether the investor holds a material interest in the fund.
If the answer to both these questions is yes, the next question is fund location and whether this is in a 'good' or 'bad' region.
Here, 'good' means located in the EU, EEA or an OECD double tax agreement country, and if the fund is similar to certain Irish regulated investments this will generally result in the funds tax rate applying (41% for an individual or 25% for a corporate). The rules in relation to losses, exchanges and the eighth-year deemed disposal rule also apply.
Most Irish investment managers generally do not wish to provide an outcome for clients that results in punitive tax rates or a lack of clarity, and so it is rare that 'bad' funds will feature in an investment portfolio.
US-based holdings
Because they feature in many investment portfolios, it is important to remember that prior Revenue guidance indicated that US-domiciled exchange-traded funds (ETFs) were treated like an equity investment for tax purposes. This guidance no longer applies to such investments with effect from 1 January 2022.
The removal of this guidance means that it is important to analyse a US ETF under the offshore fund rules to determine the Irish tax treatment.
Where the previous guidance had been relied on for an ETF but the offshore fund rules now apply, for the eighth-year deemed disposal rule, the eight years should be counted from 2022, so the earliest deemed disposal will occur in 2030. In this situation, the ETF's acquisition cost remains the same.
The inability to use fund losses in the calculation of taxable gains may shift the focus to succession plans and lifetime gifting
Succession plans
The inability to use Irish and offshore fund losses in the calculation of taxable gains may shift the focus to succession plans and lifetime gifting. On death, these fund investments are not like CGT investments: death generally gives rise to a tax charge.
Therefore, there may be merit in transferring fund investments to children while they are loss-making. While no relief for the losses arises on transfer, depending on whether the capital acquisitions tax threshold of €335,000 has been used, either no or a reduced gift tax charge may arise.
