# The Deemed Disposal Provisions (Finance Act 2006)



## darag (7 Aug 2007)

I'm finding it hard to find a clear explanation of the mechanics of the above.  As an exercise I did up a simple spreadsheat to figure out the effect of this measure on investment returns.

My assumptions are as follows:
A deemed disposal event occurs on the year 8 anniversary of the policy.  The effect of this event is the same as if you had cashed in your policy and immediately bought back in.  Thus on year 8, the value of the exit tax which would have applied had you disposed of your policy is deducted from your policy and handed over to revenue.
Subsequent to the deemed disposal, the taxable gain will be based on the value of the fund just after the deemed disposal event.
In addition, Quinn-life informs me that


> Where there is an actual disposal subsequent to the deemed disposal, an adjustment is made so that the total tax paid does not exceed that which would have been payable had the deemed disposal not occurred.



The effects of this change are tricky to understand because of the permutations and combinations.  For example, if your investment is underwater at the 8 year point, the deemed disposal event will have no effect as the exit tax would have been 0.  If your fund is up (as you'd hope) at the 8 year point, and subsequently you cash in (before the next deemed disposal event), then there are two situations to consider.

If the fund has gained since the deemed disposal event, then there won't be any adjustment according to the information above supplied by Quinn.  However, the 23% deducted at the 8 year point will damage your overall returns.  The more your fund gains subsequent to the deemed disposal, the more you are disadvantaged by this deduction.  There are a number of parameters but for reasonable initial growth (5-10% per/annum), the equivalent rate of exit tax (had the new rule not been introduced) ranges from around 26% if your fund subsequently gains 20%, to 30% if your fund subsequently gains 90%.  These are approximate as they vary according to the growth during the initial 8 year period.

If the fund loses value subsequent to the deemed disposal, then things become more interesting.  In this case, you will be due a refund from revenue if my understanding of Quinn's statement is correct.  The worse the fund does, the bigger the refund.  For example if the fund tanks (again assuming 10% growth for the first 8 years) by 40% subsequent to the deemed disposal, then the refund will mean you will actually have more money than you would have even if the exit tax was 0% under the previous regime.  However this will be only a small consolation given your investment has tanked.

However, the really interesting question is the effect on long terms savings.  The news here is not good at all.  For example, if you invest for 20 years and the fund grows on average 10% a year, the effective exit tax under the new rules is 34%.

Before I get carried away with indignation, are my assumptions correct here?

If they are, then this is a serious change in general taxation policy which up to now has encouraged saving and investing (low CGT and related taxes) at the expense of consumption (high VAT).  Now I recognise the attraction for the government in sneaking in incomprehensible taxes but surely this is indefensible.  Given that ETFs or UCITS, for example, seem to fall under the same regulations, the effect will be to force savers to put their money into more expensive (in terms of trading costs and paperwork) and riskier less diversified individual shares in order to avoid these punitive taxes.  For long term savers (20 years), except for the top 3% earners in the country, a 34% exit tax is more punishing than income tax.  This means saving using life company funds or UCITS is effectively waste of time.

Until the removal of inflation indexation for CTG calculations (which effectively doubled the rate of CTG for typical returns and periods), it made sense to put your money into shares.  After that change, you were generally better off buying units in life company funds.  Now it looks like you're better off shifting your money into shares again.  These changes make life difficult and expensive for savers.  Could we not expect some sort of rationality in the approach to taxing savings?  Is there anything which can be done to challenge the capricious nature of these changes?

To make things worse, this change is retrospective and affects any savings going back to 2001.  How are people supposed to rationally make decisions regarding savings with the background fear that retrospective taxes can be whimsically introduced by the government at any stage?  This new regulation establishes a terrible precedent in this regard by creating uncertainty. 

Finally, how should savers respond to this change?  My instinct is to move my long term savings out of Quinn, Rabo and Irish Life funds and buy non-UCIT shares through an offshore broker.  However, some of my savings are in the likes of with-profits funds which cannot be cashed in without suffering punative penalities.  Also, I'll be facing a lot of paperwork and calculations each year to declare my savings to revenue.  Personally, I'm not taking about huge sums here; it's about two years of after-tax income and given that I don't own my own home, I need a rainy day fund.


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## LDFerguson (7 Aug 2007)

Hi darag, 

My understanding is that the exit tax collected at year eight is used as a tax credit against exit tax due on subsequent encashment.  

Let's say the investment has grown by the eighth year.  The exit tax is deducted.  There's a smaller residual fund growing in subsequent years.  

But before this change, there was a larger fund growing which resulted in a larger maturity value and a larger final exit tax bill.


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## capall (7 Aug 2007)

darag said:


> If the fund has gained since the deemed disposal event, then there won't be any adjustment according to the information above supplied by Quinn. However, the 23% deducted at the 8 year point will damage your overall returns. The more your fund gains subsequent to the deemed disposal, the more you are disadvantaged by this deduction. There are a number of parameters but for reasonable initial growth (5-10% per/annum), the equivalent rate of exit tax (had the new rule not been introduced) ranges from around 26% if your fund subsequently gains 20%, to 30% if your fund subsequently gains 90%. These are approximate as they vary according to the growth during the initial 8 year period.
> 
> If the fund loses value subsequent to the deemed disposal, then things become more interesting. In this case, you will be due a refund from revenue if my understanding of Quinn's statement is correct. The worse the fund does, the bigger the refund. For example if the fund tanks (again assuming 10% growth for the first 8 years) by 40% subsequent to the deemed disposal, then the refund will mean you will actually have more money than you would have even if the exit tax was 0% under the previous regime. However this will be only a small consolation given your investment has tanked.
> 
> However, the really interesting question is the effect on long terms savings. The news here is not good at all. For example, if you invest for 20 years and the fund grows on average 10% a year, the effective exit tax under the new rules is 34%.


 

Your calculations and assumptions are a bit off the wall.

Firstly I don't see this as a new extra tax. Before 2001 all such savings products had tax at the standard rate deducted from all gains made.
We then switched to the gross calculation basis where you pay standard rate + 3% on exit only .
Then the government introduced this measure to collect tax after 8 or 12years(if premiumns < 3000/year),in order to prevent the tax on investment gains being deferred indefinitely.   

The deemed tax provisions is designed to collect the tax due earlier rather than increasing the overall tax take.
If you pay the deemed tax and then cash in 2 years later and the fund has risen in value ,you will pay more tax,calculated based on the overall gain and the tax paid to date

If you cash in and the fund has dropped then you will get a refund but you can be assured the revenue won't be refunding more tax than it originally collected


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## darag (7 Aug 2007)

Hi Liam.


			
				LDFerguson said:
			
		

> Let's say the investment has grown by the eighth year. The exit tax is deducted. There's a smaller residual fund growing in subsequent years.
> 
> But before this change, there was a larger fund growing which resulted in a larger maturity value and a larger final exit tax bill.


Yes, this accords with my understanding of the system.  There are a couple of ways of looking at it but the "larger final exit tax bill" is possible but unlikely from what I can see.  The problem is that while the nominal value of the tax take will be more or less the same, the _present value_ of the take increases considerably which damages your returns and the longer the investment period the more the damage.

Hi capall.


			
				capall said:
			
		

> Your calculations and assumptions are a bit off the wall.


Is "off the wall" the same as wrong or incorrect?  If so which of the three stated assumptions are incorrect?

If one or more of them is incorrect, then of course my calculations will be wrong.  However, I'm pretty confident in my abilities to translate assumptions like the above into Excel models.  And I'm pretty confident that the figures I gave above are correct given these assumptions.

To be honest, the history of our tax system is of marginal interest.  Like most savers, my interest is in maximising my returns given the current tax rules.  I want to ensure my assumptions are correct so I can make rational choices, hence my interest in your "off the wall" judgement.


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## F. Kruger (8 Aug 2007)

I received an updated Quotations Disc from one of the Life Companies this morning which 'reflect these legistlative changes' i.e. deemed disposal.

I compared, on a like for like basis, an investment of €100K on the old and new quotation software.

Projected values at 6% after payment of tax for years 1 and 5 are identical.

At year 10 there is a difference in values of €752 in favour of the old regime  and at year 20 the difference is €7,541.

Remember, this is just one companies software. When I receive other discs I will do a similar comparison.

It looks like a B&B every 8 years may be in order.


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## jpd (8 Aug 2007)

The following example shows how the tax is calculated and the effect on a subsequent encashment

Investment €10,000 on 01/01/2002
No encashments before 01/01/2010 (8th anniversary)

Policy value at 01/01/20010 € 18,000
Deemed enchashment with gain of € 8,000
Tax due at 23% = €1,840 is deducted from fund and paid to revenue.

Full encashment of fund on 01/01/2012
Fund value €22,000

First fund value is increased by previous tax deducted = €23,840
Gain = €13,840
Tax at 23%= €3,183
less tax already paid -€1,840
gives tax due on full encashment = €1,343

As you can see this is going to be quite complicated, especially where there are purchases and sales in the period prior to the 8 years !!!


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## capall (8 Aug 2007)

DARAG

Apologies,your analysis isn't off the wall ,I just disagree with the emphasis you are putting on this.

The tax rate is what it is 23% , you can't say the exit tax is 30% based on notional reinvestment of tax paid at a notional return rate of 10%.

This change in the 2006 Act doesn't seem to have raised much of a hue and cry with investors , the main objectors seem to be the fund companies who have had an extra administrative burden  imposed on them.

Also consider that the old net funds are still rolling on and most people haven't switched from these to the new gross funds. 

Possibly the reason is that for most long term investors  their fund investments are mainly in pensions which are exempt from tax.

I agree with you that the change in the 2006 act is disadvantageous to long term fund investors but you still get the opportunity to roll over gains for 8 years which is 8 times better than the pre 2001 scenario ?
I wouldn't call this taxation regime punative.

You can't really compare investing directly in shares and in funds ,they are 2 totally different ways of investing. Most people who know enough about shares to invest directly,trade a bit,they don't just buy shares and hold the same shares for 20 years. By trading they obviously crystalise their capital gains tax charge.

I don't know why you would choose non Ucits for better tax treatment.
Alot of non ucits are subject to 40% capital gains tax, it is the EU that has forced the tax treatment of funds within EU to be on a par,so that individual memebers cannot have a softer tax regime for their own funds

FD Kruger
B&B would make no sense in this situation


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## tolkarovers (9 Aug 2007)

Quick question - as a buy and hold investor should I be looking to move my money out of funds that are now affected by this?


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## capall (9 Aug 2007)

If you're investing for 8+ years and the fund is doing well you would be better off in the gross fund. But you would need to look at the costs of transferring from a net to a gross fund


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## Dave Vanian (9 Aug 2007)

Let's say I'm investing in a fund that doubles your money every four years, in a linear fashion.  

*Old method*
Invest €10,000
Worth €20,000 after 4 years
Worth €40,000 after 8 years
Worth €80,000 after 12 years

Cash in after 12 years.  
Exit tax = 23% x €70,000 gain = €16,100
Net value €63,900


*New Method*
Invest €10,000
Worth €20,000 after 4 years
Worth €40,000 after 8 years
Exit tax = 23% x €30,000 gain = €6,900
Remaining value = €33,100
Value after 12 years = €66,200

Cash in after 12 years
Exit tax = 23% x €56,200 gain = €12,926 LESS €6,900 already paid = €6,026

Final value €60,174

Freddie Kruger's suggestion of a B&B after eight years won't work because the exit tax will get deducted if you cash in after eight years to do a B&B.  Which will happen automatically under the new regime. 

Have I got my method above right?


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## PubMan (10 Aug 2007)

Another scenario is if you plan to move away before you cash in (ie retire in a foreign country). You get really hit in this case and I see no way around it.\?


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## Dave Vanian (10 Aug 2007)

F. Kruger's idea of a B&B would work if the fund falls back to it's starting value or lower.  It would at least reset the clock on the eight years but you might have to incur costs for the B&B transaction, unless you're in a low-charge fund.


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## capall (10 Aug 2007)

The calculation looks ok,but really it is irrelevant now comparing old and new as there is no option now except to be in the new regime

What is more relevant is comparing the old net funds and the gross funds under the new method. Anybody with savings in a fund pre 2001 is in a net fund,where gains are taxed at 20% each year


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## darag (11 Aug 2007)

> Quick question - as a buy and hold investor should I be looking to move my money out of funds that are now affected by this?


This is what I'm trying to figure out.  What I'm unsure about is the whole question of UCITs; my understanding is that UCITs (which include most European ETFs?) are supposed to be treated like Irish unit funds by revenue.  Is this correct?

Going back to your question and assuming I'm correct about the tax treatement of UCITs.  For long term buy and hold then you're looking at equities.  The options for equity exposure for long term savings that I know of are:

Irish unit funds
UCITs
Ordinary shares/non-UCIT ETFs
If my assumption about UCITs above is correct then the Deemed Disposal Provisions apply to them also. However how this will work in practice is beyond me (will Revenue require you to quote the price of the shares when you bought and the price on the anniversary?  When will the tax be due?  Will it be like CGT or will it be like income tax where you effectively pay a year later.  Somehow I doubt revenue even know themselves.).

The problem with non-UCIT ETFs is that you get crucified by the taxman on any dividend income.  The lack of Deemed Disposal and the lower "exit tax" (i.e. CGT) of 20% and the abilities to use B&B or at least balance gains against losses and the annual CGT allowance are attractions or at least give you some tools to minimise losses to the taxman.

The problem with all shares whether UCIT or not is the extra paperwork and the overheads (trading costs) which make relatively small (under 3k?) regular investments unfeasible.

Ideally I'd like to find ETFs (can't afford to buy enough shares to achieve diversification) which offer good diversification and pay NO dividend and which don't qualify as UCITs (meaning they fall under CGT).


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## tolkarovers (5 Feb 2013)

*ETF tax*

Hi Drag,
Did you ever manage to find the below?

Ideally I'd like to find ETFs (can't afford to buy enough shares to achieve diversification) which offer good diversification and pay NO dividend and which don't qualify as UCITs (meaning they fall under CGT).


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## Monksfield (5 Feb 2013)

As I understand the tax position the most commonly-used exchange-traded products which fall under CGT are those which cover commodities - they are Exchange-Traded Products rather than ETFs per se.

There is a range of Exchange-Traded Notes which give exposure to equities,bonds etc the structure of which also brings them under CGT . Drawbacks of ETNs are that these are generally less liquid than mainstream ETFs and they represent a straight counterparty risk to the issuer (the likes of RBS). As non-UCITS the protections afforded investors in relation to diversification and counterparty risk do not apply to ETPs or ETNs.


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