In 2022, Ireland’s Commission on Taxation and Welfare published a pivotal report titled “Foundations of the Future,” which aimed to examine the effectiveness and sustainability of the country’s taxation and welfare systems. Among the numerous areas of analysis, the Commission focused on how investments are taxed in Ireland and made recommendations for improvements that could better align the system with the needs of investors and the country’s fiscal goals.
This article looks at some of the key issues raised in the Commission’s report and discusses potential ways to make Ireland’s investment taxation landscape more efficient and fairer for investors.
Exchange-Traded Funds (ETFs): A Case in Point
An Exchange-Traded Fund (ETF) is an investment fund that trades on a stock exchange, allowing individuals to invest in a wide range of assets such as stocks, bonds, or commodities.
How ETFs Are Taxed in Ireland
For Irish tax residents, the taxation of ETFs can be seen as inconsistent and unfair when compared to other investment types. Investors are taxed at a rate of 41% on both capital gains and income earned from ETFs. To put this into perspective, for every €100 in gains from an ETF, €41 goes to the Exchequer. In comparison, for gains from individual stocks, the tax rate is only 33%, resulting in a 24% higher tax burden on ETF investments.
Interestingly, the taxation of dividend income from ETFs is more favorable for higher-rate taxpayers. While dividends from ETFs are taxed at a flat 41%, the same dividends from stocks are subject to marginal tax rates, which can push the total tax burden on stock dividends to as high as 52%. For standard-rate taxpayers, however, the opposite is true. ETFs’ flat 41% tax rate can lead to significantly higher tax payments compared to dividends from company stocks.
But one of the most debated and controversial aspects of ETF taxation in Ireland is the deemed disposal rule. After eight years of holding an ETF investment, and every eight years thereafter, the investor is deemed to have sold and repurchased their shares, triggering a 41% tax on any unrealized gains. This rule is unique and diverges from the global principle that unrealized gains should not be taxed. It was introduced to prevent long-term investors from holding accumulating funds and avoiding tax altogether. Despite its original intent, it remains a contentious issue for many retail investors.
Moreover, losses from ETF investments cannot be used to offset gains from other investments, unlike losses from stocks. This “ringfencing” of ETF losses adds another layer of complexity and unfairness to the system.
The Path Forward: A Push for Reform
The Commission on Taxation and Welfare has recommended several reforms that could address these issues. One of the key recommendations is to simplify the taxation of investment products, reducing complexity and ensuring that taxes are applied in a fair and neutral manner, regardless of the type of investment. A working group has been established to explore these ideas further, and its findings could lead to significant changes in the coming years.
One of the most important aspects of the Commission’s proposal is the elimination of tax inequalities between Irish and foreign investors. Currently, foreign investors in Irish-domiciled ETFs do not face the same deemed disposal tax liabilities as Irish investors. This disparity creates a significant disadvantage for domestic investors and discourages long-term investment in ETFs.
Suggested Changes to ETF Taxation:
- Eliminating the Deemed Disposal Tax: The current system, which taxes unrealized gains on ETFs every eight years, is seen as punitive and discourages long-term investing. By removing this rule, Ireland would align its tax treatment of ETFs with global standards, fostering greater investment activity.
- Introducing Capital Gains Tax (CGT) and Income Tax on ETF Returns: The Commission has recommended that ETF gains be subject to the standard 33% CGT, with income from ETFs taxed as regular investment income. This would simplify the tax structure and offer a clearer, more predictable tax regime for investors.
- Allowing ETF Losses to Offset Other Gains: Allowing investors to offset losses from ETF investments against gains from other investments would provide greater flexibility and fairness, ensuring that investors are not penalized for poor performance in their ETF holdings.
Pension Contributions: Simplifying the System
The Commission has also suggested changes to the pension contribution system. Currently, pension contributions in Ireland are subject to age-related limits, which means the amount a person can contribute depends on their age. These limits also apply to a person’s annual earnings. The Commission proposes removing the age-related contribution rates and introducing a single annual contribution rate applicable to all investors, while keeping lifetime contribution limits in place. This change would streamline the system and encourage higher pension contributions.
The current system is particularly restrictive, as it limits the amount a person can contribute to their pension based on their age and earnings. This creates inequities, especially for individuals who may not have had the opportunity to contribute to a pension early in their careers. A single contribution rate and the ability to carry forward unused contributions would allow for more flexible and equitable pension saving.
Addressing Capital Gains Tax
The Commission has also called for an increase in the overall tax yield from wealth and capital taxes, including CGT, property taxes, and capital acquisitions taxes. While this recommendation could lead to higher taxes on capital gains in the future, it highlights the importance of maintaining a balanced and sustainable tax system. Given the reliance on corporation tax and income tax from high earners, the Commission’s focus on capital taxes suggests that the government will need to carefully consider how to increase revenue without stifling investment activity.
Conclusion
Ireland’s investment taxation system is far from perfect, and the recent Commission on Taxation and Welfare report highlights several areas in need of reform. By simplifying the tax treatment of investment products, eliminating the deemed disposal tax on ETFs, and allowing for more flexibility in pension contributions, Ireland can create a more equitable and sustainable tax system that encourages long-term investment and wealth creation.
At a time when the Irish State Pension faces significant challenges, it is crucial that the government fosters an environment where citizens are incentivized to invest for their future. Improving financial literacy and awareness about the importance of investing is also a key component of this reform. The changes recommended by the Commission are an important first step toward building a more robust and fair investment taxation system in Ireland.