# Do the tax advantages favour directly buying shares over ETFs?



## Brendan Burgess (14 Feb 2013)

*The tax treatment of buying shares directly is fairly clear and is flexible *

If I make a loss on one share, I can set that loss against the capital gain on another share.  

So, let's say, I have a portfolio of 10 shares which I buy for €10,000 each. 

If I need cash, I can sell a share which has a loss and I can carry that loss forward against gains in another share.  If I sell a share with a gain, I can't use future losses against that gain, unles they are made in the same tax year. 

So with direct shares, I can sell my shares in a tax-efficient manner at any time. 

*The tax treatment of ETFs seems much less clear and appears more restricted 

*When I sell an ETF, I pay exit tax of 36% on the capital gain.  However, if it has made a loss, I cannot set the loss against gains made anywhere else. ( This is not entirely clear and there seems to be no easy to understand summary of ETF tax rules. It appears that some ETFs can be treated as shares, although I don't know how you would identify these)  
Say I invest the €100,000 in an ETF and it falls in value by 20%.

If I sell that ETF, the loss won't be of any use to me against profits elsewhere. So I am better off keeping the ETF until it recovers to the price I paid for it. 

This is the situation I am in myself. I bought the ISEQ ETF and it has fallen in value.  I also have gains in shares which I bought directly but I can't use the ETF losses against them.  Any recovery from here in the ETF  to the initial purchase price is effecively tax-free. So I am stuck with it until it recovers to the price I paid for it. 

*If you already have unused CGT losses on other shares, you should not buy ETFs
*If you already have losses on other shares, you should continue to invest directly in shares. Any gain in the new shares can be used to soak up the losses already made. 

*If you  have unrealised Capital Gains, you should not buy ETFs.
*If you have a portfolio which has overall capital gains, fresh money should be put in shares directly. If these shares fall in value, you can set the losses against your existing gains. 

*If you are an older investor, you should invest directly in shares and not in ETFs. *
Many people die, leaving investment portfolios behind them. If they have direct investments in shares, the gains are free of Capital Gains on death. 
If you have ETFs,


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## Brendan Burgess (14 Feb 2013)

Rory Gillen has written a good piece on the tax treatment of ETFs. 



> Most ETFs, but not all, fall under the good offshore fund rules and  should be taxed under gross roll-up rules, with no tax relief.
> 
> ETCs  (exchange-traded commodities) are securities and taxed as such.
> 
> US ETFs  not constituted under the US Mutual Funds Act are more likely to be bad  offshore funds and taxed as securities. Difficult to determine though.



If you buy a "bad" ETF which is treated as a security, you could use their losses or gains against gains or losses in other shares.  I don't know how  you would identify these and whether "bad" ETFs have some other disadvantages.


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## jaykayphd (14 Feb 2013)

Is the CGT annual exemption allowable against ETF capital gains?


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## Brendan Burgess (14 Feb 2013)

Most "good" ETFs are not subject to CGT so the annual exemption is not available. 

Brendan


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## Scanner (14 Feb 2013)

Hi Brendan,
If you buy a share on the US stock Market which makes a loss, can you sell it at a loss and offset that loss against the profit of a share bought on the ISEQ ?

Scanner


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## Brendan Burgess (14 Feb 2013)

If a gain is subject to Capital Gains, you can set the losses off any other gains.

So if you lose money on a US share, you can set the loss against a gain on the disposal of an investment property in Ireland. 

Brendan


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## 3CC (15 Feb 2013)

Hi Brendan,

I think it is worth noting that when selling an ETF, any losses/gains of the individual underlying shares are effectively offset against one another and this is reflected in the ETF price. So there is a degree of internal 'loss offsetting' within ETF's although there is admittedly more flexibility to actively manage this process with directly held shares.

I suppose if you can commit to investing for the long term where the probability of a nominal loss is low, then ETF's do offer some advantages such as diversification and tax efficiency.

I think that the benefit that the gross roll up regime brings to capitalising ETF's in particular is worth considering. I tried to compare shares vs ETF's vs capitalising ETF's in the thread below.

http://www.askaboutmoney.com/showthread.php?t=175887

I am not sure, but I suspect that every ETF purchase is treated in isolation for tax purposes. If you were to use pound cost averaging to buy your ETF investments, you could end up with a very large number of distinct ETF positions which (I think) are treated separately for tax reasons. 

You have correctly pointed out the disadvantage of having a tax firewall between shares and ETF's across which gains/losses cannot be carried. The situation I describe in the previous paragraph would result in multiple tax firewalls and all the disadvantages that go with that.

One possible solution to this would be to buy into ETF's in big chunks to minimise the number of tax separated positions.

Another solution, would be to sell all separate positions in the same ETF and buy them back en masse as soon as the price rises above your highest purchase price.

A third solution would be to invest for a long term so that the probability of a nominal loss is low.

In summary, I think the advantages that shares have over ETF's in terms of the superior ability to offset losses is diminished over time and eventually outweighed by the advantages of ETF's in terms of diversification and tax efficiency, particularly for capitalising ETF's. ETF's are not for the short term, mind you that is true of most investment.

Regards,

3CC


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## Brendan Burgess (15 Feb 2013)

Hi 3CC

Very interesting points. I suppose that there is some degree of loss offsetting. But during a period of medium term declines in the market as a whole, this will be of little use to you. 

I am a long-term investor, but that doesn't mean that things change unexpectedly and suddenly and I need money so I have to sell some shares. Once you sell or partially sell an ETF, you lose the advantage of any accumulated tax losses.


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## Marc (16 Feb 2013)

Brendan Burgess said:


> Once you sell or partially sell an ETF, you lose the advantage of any accumulated tax losses.



Don't forget that a loss on an ETF or any gross roll up fund is available against itself so in the event of a partial withdrawal you do not lose the advantage of a tax loss per se.

Lets say I put 100k in Anglo Irish bank shares in 2007 and 100k into an MSCI World Index Tracker ETF.

Roll onto the spring of 2009 what is my position?

My Anglo Irish Shares are totally worthless and I have a 100k Capital Gains Tax loss and my ETF is down about 40% worth about 60k. 

Ouch, that hurt. But here's the first point. Whilst the Anglo "investment" is worth nothing at all, at least the more diversified ETF has maintained some value.

So, first point irrespective of taxation, ETFs are better investments than gambling on individual stocks since a well diversified ETF cannot result in zero value.

Let's say I needed to make a partial withdrawal. Well, second point whenever investing long term it is essential to first address short term capital requirements by creating an adequate emergency fund. A prudent investor will therefore always ensure that they have sufficient funds available to meet their short term needs.

But Lets say that we need €30k.

Obviously we can't take it from selling Anglo Shares so we surrender half of our unit holding in the ETF.

Roll the clock onto today and what is the situation?

Well the low price for the I shares MSCI World World ETF was 11.72 and the close on Friday was 22.37 so even if we had sold on the absolute worst possible day in the Spring of 2009 the remaining investment would still have doubled.

We now have an investment with a base cost of 50k (remember we invested 100k and sold half our position) which is worth around 60k after making a partial withdrawal of 30k. 

What is the tax position? Well we had dividends of about €2000pa which were gross roll up so we didn't pay any income tax on these saving around €1000pa depending on our personal rate of income tax.

What is the tax position on realising our investment today?

Well with a base cost of 50k and a value of 60k we would have a gain of about 10k and an exit tax liability of currently €3,600 - roughly in line with the income tax we probably saved on the dividends.

Finally, let's say we inherited 1m today what should we do?

Well, hopefully we have learnt some lessons in the last few years. 

Have a good financial plan and an investment policy statement which sets out where you are and where you are trying to get to. Hopefully, we learnt the difference between gambling, speculating and investing.

We need to have an adequate emergency fund, make a will, ensure you have adequate risk insurance life cover, income protection, other relevant insurance for your circumstances, adequately fund for your retirement, ensure your portfolio is properly diversified across multiple asset classes (stocks, bonds, cash and real estate) ignore the bloke in the pub, a well meaning relative and your man on the telly telling you that this time its different and you need to prepare for the end of the world by loading up on tinned goods and an M16 assult rifle and instead pay for comprehensive financial planning advice which is obtained by paying a fee not commission.

When we have done all those things properly, we will talk about Capital Gains tax loss harvesting strategies and how we can use the 100k CGT loss as part of a prudent financial plan.

But never, ever let the tax tail wag the investment dog.


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## 3CC (16 Feb 2013)

Brendan Burgess said:


> Rory Gillen has written a good piece on the tax treatment of ETFs.
> 
> 
> 
> If you buy a "bad" ETF which is treated as a security, you could use their losses or gains against gains or losses in other shares.  I don't know how  you would identify these and whether "bad" ETFs have some other disadvantages.



Brendan,

Like you, I assumed that bad offshore funds would not be treated as gross roll up and therefore would default back to the 'normal' taxation rules that apply to shares. 

However, there is a brief description of what a bad offshore fund is here, and  it seems to say that bad offshore funds are not treated in the same way as shares. There seems to be third regime which is more onerous again.

[broken link removed]


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## mrbrian (4 Apr 2015)

Hi all,

Has this issue been finally clarified? I had purchased euro domiciled ETF's and don't fully understand the tax implications - can someone clarify current tax on dividends, exit and or. 8 years?

It's a tad confusing to say the least.


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## whytis (10 Apr 2015)

@mrbrian You might be better off posting separately, and/or looking at the related forums here on AAM. If you sell the ETF units at a profit you will be liable to the exit tax (41%?) and will be liable for the "deemed disposal" tax each seven or eight years.


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## mrbrian (16 Apr 2015)

whytis said:


> @mrbrian You might be better off posting separately, and/or looking at the related forums here on AAM. If you sell the ETF units at a profit you will be liable to the exit tax (41%?) and will be liable for the "deemed disposal" tax each seven or eight years.



Thanks for the reply


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## Rory Gillen (23 May 2015)

The issue of how ETFs are taxed has now been settled. In its infinite wisdom, our Department of Finance has ruled that there are two rules:


For EU regulated ETFs, punitive gross roll-up rules apply: No loss relief, gains taxed at 41%, and deemed disposal after eight years. And this is despite the fact that ETFs are clearly not gross roll-up funds.
For non-EU regulated ETFs, they are taxed as shares. CGT on gains, income tax on dividends and loss relief is available. There are a few exceptions that I have ignored for the sake of simplicity.
So, we have the mad situation where if you buy an S&P 500 ETF in London you are subject to the draconian gross roll-up tax rules. If you buy the exact same fund in New York, the tax treatment is the same as shares.

In effect, the Department of Finance has made a mess out of it, and is either too lazy or too inept to bring in a simple, fair and common system for funds taxation. It is my view that funds, all funds, should be taxed as shares. Funds serve a very important purpose: they diversify risk for inexperienced investors. Why does our revenue penalise the industry and investors for that?

*Rory Gillen
GillenMarkets.com*


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## Jim2007 (23 May 2015)

Hi Rory,

Thanks for the update.  Is it possible for you to provide a link for this decision?

Also, it is not clear to me from your statement and example, if the decision only refers to funds that are regulated within the EU or if it also covers funds authorised to be traded on EU markets but regulated else where?


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## Boyd (23 May 2015)

Jim see reply I got directly from revenue here


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## landlord (26 May 2015)

Do the tax advantages favour directly buying shares over ETFs....

This never seems to be mentioned (perhaps because it's relatively insignificant), but shares are charged a 1% stamp duty, where as ETFs are not. 
Certainly for the inexperienced investor like myself, it seems that buying a few well diverse, US domiciled ETFs, will provide a reasonable return, no stamp duty, no complex tax issues (same as shares) and with minimal risk?


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## Sarenco (26 May 2015)

1% stamp duty only applies to shares in Irish companies, 0.5% on shares in UK companies.

In addition to stamp duty, broker commissions and/or fund TERs you will also have currency conversion costs if you invest in non-euro denominated securities.  

You can take your own view as to whether or not investing in US securities (including US domiciled ETFs) entails tax complications but there is certainly no assured return, reasonable or otherwise.


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## landlord (26 May 2015)

I havnt started investing yet so forgive the stupid questions.......
A US domiciled ETF....does that mean the fund has been set up in the US, or all the stocks are from the U.S. or both. 
Can these ETFs be listed on other exchanges other than the U.S. exchanges for example European country's exchanges and would this eliminate the currency conversion fees?


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## Sarenco (26 May 2015)

A US domiciled ETF refers to a fund that has been established in the US and is authorised by the SEC for  sale to the public in the US.

No, US domiciled funds would not be authorised to be offered to the public in the EU and therefore are not listed on European exchanges.  

Currency conversion costs arise where ETF shares (or any other securities) are denominated in a currency other than euros.  However, currency risk/exposure depends on the currency in which the underlying securities/assets of the fund are denominated.


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## landlord (26 May 2015)

....thanks Sarenco

Are there US domiciled ETFs where the underlining assets are European stock to avoid the currency risk exposure?

Or even better are there any US domiciled ETFs where the underlying assets are European stocks and the fund is denominated in Euro to avoid both  the currency risk exposure and the currency conversion fees?


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## Sarenco (26 May 2015)

I'm sure all the big ETF houses in the States (iShares, Vanguard, etc.) have US domiciled ETFs that only invest in equities issued by Eurozone companies but I would be very surprised if any of these ETFs issue share classes denominated in euro (bearing in mind that they are not authorised for sale in the EU).

Incidentally, I am not suggesting that you should avoid exposure to other currencies entirely - bear in mind that currency movements are a two-way street.

I would again advise caution before investing in US domiciled ETFs from a tax perspective - particularly as a US citizen.


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## landlord (26 May 2015)

Thanks that issue has been sorted now as I will be trading in my other half's name only (irish citizen).


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## Sarenco (26 May 2015)

Well that doesn't really resolve all tax issues with investing in US ETFs but I won't repeat my previous comments.

If you are determined to invest in a US domiciled ETF, you might consider something like the Vanguard Total World Stock ETF (VT) and be done with it.

Best of luck.


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## landlord (28 May 2015)

Sarenco said:


> If you are determined to invest in a US domiciled ETF, you might consider something like the Vanguard Total World Stock ETF (VT) and be done with it.



I am still researching the pros and cons of these ETFs as well as other options for example UK Investment companys (trusts), that I believe you previously recommended.

Going back to that U.S. vanguard world ETF, so I can understand it a little better. The fund has an expense ratio of 0.17 (good?).
A risk factor of 4 (on a 5 point scale...seems high?), but what seems like a decent performance after 2009.

I still don't quite understand how currency exposure works.
The underlying assets of the fund are approx 50% U.S. shares and 20% European. 30% others.
However I guess to buy this ETF my online broker will have to convert my money to dollars.
As the dollar is very strong against the Euro now I might not be able to buy as many shares as I could have a few years ago. But my concern is, if I believe that the Euro in 10 years (when I might sell them) will strengthen significantly against the dollar, then my gains will have deteriorated when converted back to Euro. This will be the same issue as buying a sterling based ETF considering the strong pound.
How does the currency of the underlying assets make a difference to my gains over this 10 year period?

Also I can't figure out if this ETF pays dividends or re-invests the capital which I would prefer.


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## Steven Barrett (28 May 2015)

Jim2007 said:


> Hi Rory,
> 
> Thanks for the update.  Is it possible for you to provide a link for this decision?
> 
> Also, it is not clear to me from your statement and example, if the decision only refers to funds that are regulated within the EU or if it also covers funds authorised to be traded on EU markets but regulated else where?



file:///C:/Users/Steven/Downloads/exchange-traded-funds-guidance-note.pdf


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## Sarenco (28 May 2015)

landlord said:


> I am still researching the pros and cons of these ETFs as well as other options for example UK Investment companys (trusts), that I believe you previously recommended.
> 
> Going back to that U.S. vanguard world ETF, so I can understand it a little better. The fund has an expense ratio of 0.17 (good?).
> A risk factor of 4 (on a 5 point scale...seems high?), but what seems like a decent performance after 2009.
> ...


 
All US funds are required to make dividend payments and US withholding tax and Irish income tax are applicable.

A total world index fund/ETF holds (or has exposure to) shares in, effectively, all publicly traded companies across the globe in proportion to their market capitalisation.  This means you would hold a stake in literally thousands of companies and you would take no view as to what country/sector/company will outperform the global equity market - you simply rely on the market to make this judgment for you.  It's really the ultimate form of passive investing.

Yes, currency risk means that if you hold securities (or a fund that holds or is exposed to securities) that are denominated in USD and the USD depreciates in value relative to the Euro, then the value of that those securities fall in Euro-terms.  Of course, the opposite could happen - over the long-term currency exposure is really a zero-sum game.

Incidentally you don't have to use your broker to convert currency - if you do a search on here you will find plenty of posts on the cheapest ways to convert currencies.


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