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Friday, 14th August 2020
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Ever changing savings market Back  
The Minister’s for Finance’s latest incentivised savings product has met with popular approval. The range of incentives and penalties in the area of savings regimes can now be quite confusing.
The consequences of a decision to save can vary from paying tax at 42 per cent on the resulting income, to receiving a 25 per cent subsidy from the Government. In between lie a bewildering variety of tax charges and exemptions.

From time to time the cry goes up ‘Let us have a level playing field.’ The current hilly playing field is more suited to fox hunting than croquet.

The promised new scheme
Every adult will be able to select a savings product in which he may invest up to £200 per month over a five year period. The State will top up the investment return provided by the markets, with a subsidy of 25 per cent of the sum invested.

The form of the investment can range from bank deposit accounts to dot com quoted shares, whether held directly, through collective investment undertakings, or through life assurance products.

The accumulated income and capital gains (but not the government subsidy) will be taxed on encashment at 23 per cent, provided encashment does not occur until the end of the five year period from the creation of the investment account.

It is proposed that a savage penalty, a 23 per cent tax on the total encashment sum including capital saved by the taxpayer, will apply if the product is encashed before the five year deadline has expired. This penalty seems completely over the top.

I confess that my first reaction to the proposal was that if the Minister indeed has surplus cash in his hands which he does not wish to use to pay down the national debt, it would be more appropriate for him to return it to the taxpayers from whom he took it. On reflection, that however is most likely what he is doing. Those who can afford to save £200 a month are those who are most likely to be substantial taxpayers. It is an ingenious method of returning to the taxpayer, moneys already taken from him. It is more debatable as to whether it will cause those taxpayers to increase their savings, as opposed to diversify the form of their savings.

Gross roll up fund
Typically this is a unit trust or life assurance based product. The money which is invested in these products goes into a fund. That fund is free of tax on the income it earns and capital gains it crystallises. Any sum taken out by the investor in excess of what he invested is taxed at 3 per cent over the standard rate of tax ie currently 23 per cent. If the fund is Irish, this will operate as a withholding tax. If the fund is based in another EU state, the tax will be collected by assessment.

This tax treatment was introduced in last year’s Finance Act for funds in Ireland, and will be extended by the forthcoming Finance Bill to other EU funds.

The fund manager is able to actively manage the investments within the fund, disposing of investments as he thinks best, without having to consider Irish tax consequences of a disposal. The investor is able to defer payment of tax until they require cash out of the investment.

Alternative retirement fund (ARF)
This product is available only to a person on reaching retirement. It is available currently only to a self-employed person, or a person in non-pensionable employment, a proprietary director or a person in pensionable employment in respect of their AVC contributions only.

An ARF is free of Irish tax on its income and on its capital gains. The ARF owner is liable to tax at his marginal income tax rate on all sums which he withdraws from the ARF. This is operated by withholding at source, a form of PAYE.

For many people payment of tax at the marginal income tax rate will result in a higher liability than payment of a 23 per cent exit tax on a gross fund as described above. Furthermore the tax on the ARF is on the totality of the withdrawal, whereas in the gross fund it is only on the surplus over the sum originally invested.

However for the most part the ARF holder will have obtained income tax relief at his marginal income tax rate for his contributions to the pension arrangements which created the fund, whereas the investor in a gross fund has received no tax relief on the sums invested.

Non-EU fund
An investor in a non-EU fund (eg a unit trust or insurance based product) will suffer tax at either a 40 per cent CGT rate, or marginal income tax rate, depending on the type of fund. The tax arises on encashment. This contrasts sharply with the 23 per cent rate applicable on encashment to an EU based fund.

Justification for this discriminatory treatment (apart from the fact that we can get away with it under EU law) is probably that the Revenue Commissioners have means of obtaining information about EU investments but are less well equipped to obtain information in relation to investments made outside the EU and they are therefore more open to tax evasion. It is not clear however why those who don’t evade tax should be penalised in the name of those who might do so.

Equities
A person may chose to invest in equities directly rather than through a fund. In such a case they will pay 20 per cent CGT on gains arising on disposal of investments (after allowance for inflation). They are taxed on their dividend income as it arises at their marginal rate of income tax.

The overall tax treatment is broadly comparable in terms of rates with that applying to an Irish or an EU based gross fund. There is one big difference and that is that if the individual investor wishes to sell out of one company, and invest in another company, he may have to pay capital gains tax on the share he disposes of. In contrast, the fund manager can go in and out of shares, crystallising gains as he goes, without paying any tax. The fund manager has greater flexibility to make investments without regard to the tax consequences.

Deposit accounts
An individual investor in a bank or building society deposit account will pay tax under the DIRT system at the standard rate of income tax, currently 20 per cent. He has no further income tax liability in relation to the return. This compares unfavourably with a gross fund in that DIRT is payable as soon as the interest is credited, whereas an investor in a gross fund will pay tax (at a rate which is not very different to the DIRT rate) only when he cashes in his investment.

Government stocks
Income from a government stock (the interest) is taxed at the taxpayer’s marginal rate of tax. However the capital gain on disposal of the stocks is free of tax in most situations.

The value of government stocks can fluctuate due to changes in prevailing interest rates. These fluctuations can throw up significant gains or losses.

Obviously this exemption does not apply to a person who holds government stocks in the course of a trade, something which would be unusual for an individual as opposed to a company.

Other State savings products
There are several savings products provided by the State or its institutions, which are entirely exempt from Irish tax. These include prize bonds, savings certificates, post office savings bank products etc. Tax exemption in the case of savings certs and some of the other products is subject to an upper limit on the total sum which an individual may invest in that fashion.

The return on some of these products could be fairly said to be ‘not exciting.’ Of course that wouldn’t be true if you won a prize bond draw!

It would be foolish to make major investment decisions without considering the range of taxation treatments available on different products.

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