Revenue's Treatment of Investment Funds, Far from a Joke
- Starlight Adviser
- Jun 9, 2024
- 4 min read
Updated: Jun 10, 2024
Model Portfolios: 'A Panacea for Revenue Treatment of Investment Funds'
by Starlight Wealth, as featured in the Sunday Times, 9th June 2024 (edited)
A client says to his Investment Adviser “On my last statement my investment value seems to have collapsed – is this right?”
“Well – I have some bad news and some good news"
”What’s the good news?”
"We’ve created enough tax losses to last you several lifetimes!”
Perhaps it's for a very particular audience, and I don’t have that Hal Roache delivery. What’s decidedly unfunny however is the peculiar situation that exists in Ireland around the treatment of gains and losses on fund investments.
Exit Tax...oh and Losses are for Life
Exit Tax is charged on all investment fund profits at a rate of 41%. There is also a deemed disposal rule where, after the eight year of holding the investment, the tax is payable regardless of whether you sell. On shares and bonds held directly, capital gains tax (CGT) is charged at 33%, and then only on sale. To add insult to injury, you cannot offset losses on fund investments against gains on other funds or indeed any other capital gain. Although the industry has lobbied for change – and the government is not entirely unsympathetic – I’m not sure the investment industry will get all it desires. Is it a vote winner? No. Will it reduce tax take? Probably. Revenue also has some valid retorts, particularly concerning dividends and coupons: accumulating funds roll these up within the fund, but if you received them when holding the investment directly you would be liable for tax at your marginal rate - and PRSI and USC.
Why invest in a Fund to start with?
Yet not being able to offset losses does seem particularly egregious. Take an exchange-traded fund tracking the so-called Magnificent Seven tech giants. An ETF is a legal construct that lets individuals pool their money to invest in a selection of underlying shares, in this case, Alphabet, Amazon, Apple, Meta, Microsoft, Nvidia and Tesla.
So it’s the same as owning a portfolio of the individual shares, except you are doing it by owning one item, the ETF, rather than seven. If investors owned the underlying shares directly, they would have all the benefits of CGT treatment and could offset losses.
In the case of passive funds such as ETFs, there is no added manager skill. The benefit is purely convenience and being able to mutualise the cost of investing. With our ETF example, an investor can buy this one security relatively cheaply. To buy the underlying shares used to be time-consuming and costly. Happily, this is no longer the case. Equity investing has become commoditised and, for those familiar with the platforms, practically free. For most investors who use these platforms, it’s more of a hobby where they take small holdings in a handful of shares, mostly household names. It’s like a day out in Leopardstown: a nice way to spend a few hours and some cash, but not serious investing.
Model Portfolios - A Panacea for Diversified Investing
How can investors put off by the tax situation with funds take advantage of the new low-cost trading possibilities?: Model Portfolios.
Model Portfolios constructed by a third party are designed to mimic the traits of an index or market sector. Investors buy the constituents of the fund and bypass the manager. The Magnificent Seven is a simple example - but model portfolios can be as varied as your or the model provider's imagination allows. Some follow an underlying index, and others will have greater ambitions of picking the hottest shares in AI, for example. For Irish investors, these are now an obvious alternative to buying a fund.
Most significantly, model portfolios let investors hold individual shares and securities that are subject to standard CGT treatment charged at 33% and standard CGT offset eligibility. The arm-wrestle between the industry, Government and Revenue is but a sideshow.
When is a Capital Loss an Asset?
Back in 2008 and the tough years that followed, many investors had significant paper losses on investments in funds, and of course property. Technically it’s a loss only when you sell. However, many investors were forced to sell, and in some instances, funds closed. These are losses that can never be used to offset gains. If those investors had instead invested in Model Portfolios, any such investment losses could be carried forward as a 'financial asset' on their personal balance sheets, thereby reducing their taxable capital gains down the road.
As a cohort, retail investors buy most often at market highs and sell most often at the lows. That is human nature, and probably cannot be changed. What can be changed is your tax situation. Investors should start to consider Model Portfolios – then they might find my joke at least a little amusing.
Alex McKnight has nearly 30 years’ experience in institutional investment management gained predominantly in London and New York, is a former Chief Investment Officer, and is a co-founder of Starlight Wealth, a wealth management firm that draws on the founding teams’ diverse knowledge and international experience to offer insightful financial advice and innovative and relevant investment products to the Irish market.
Starlight Wealth's 'Starlight Smart Invest' provides access to the Starlight Smart Invest Portfolios, a range of tax-efficient Model Portfolios, professionally curated by the team at Starlight, all designed to meet clients' specific long-term investment goals.
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