ETFs offer a low cost way to invest and Ireland’s a huge hub for these funds, but taxes for locals can be punitive

After all, the hub for European-domiciled ETFs sits on their doorstep: almost 70pc of Europe’s ETF market is based in Ireland, thanks – in part – to our favourable tax landscape for ETFs offering exposure to US equities for US clients. By June, the value of assets under management at European ETFs located in Ireland had passed the €1trn milestone for the first time, according to Morningstar data, as a growing majority of providers set up here.

But domestic Gen Z and millennial investors seeking to cash in on this growth typically become frustrated when they realise that not only does Ireland impose a punitive 41pc tax on EU and Irish domiciled funds but also onerous tax filing obligations for investing in them.

For years, Irish tax policy has nudged investors towards either high-risk investments like individual stocks — where a successful gamble will cost them 33pc in capital gains tax (CGT) – or locking away their money until retirement by investing through a pension, with the lure of up to 40pc tax relief. And by leaving their savings on deposit, where interest is meagre and subject to DIRT tax of 33pc, would-be investors risk inflation eroding the value of their nest egg.

Successive governments “have never really wanted to develop an investment culture in Ireland because they were very happy for people to put their money into property and the banks, and the tax system reflected that,” says Ralph Benson, head of financial advice at online pensions and investments firm Moneycube.ie.

“We’re probably half way through the second generation that ever had any meaningful wealth and this (tax) is a bit of a relic. What’s needed is a tax system that reflects the way people earn and invest money in 2023.”

There are, however, grounds for optimism for those legions of ETF investors: earlier this month, Minister for Finance Michael McGrath said during his Budget 2024 speech that his department’s review of the funds sector is “on track” to report to him by next summer and will evaluate the exit tax charged on ETFs and life-wrapped funds sold by life assurance companies.

So is investing in Ireland finally poised to become easier and cheaper?

What are ETFs?

These are collective investment schemes that track asset classes including stocks, bonds and commodities. Shares in an ETF can be actively traded on an exchange and bought and sold through a broker. The most popular ETFs among Irish households are those that track major equity indices such as the S&P 500 and the FTSE 100, though some are industry specific.

ETFs are typically an easier and more cost-effective way for investors to achieve returns from the S&P 500 or the FTSE 100 without having to purchase all the individual stocks or having too much exposure to the performance of a single company or market, advocates say.

Why are they in demand?

Young investors have flocked to ETFs in recent years because they can do so easily through a few clicks on online platforms such as De Giro, Trade Republic, Etoro, Interactive Brokers, and Lightyear.

Index-tracking ETFs typically command very low fees compared to actively managed funds that require a lot of resources to select securities. Because they are mostly passive investments, this can theoretically reduce costs and risks for investors.

“We call it the ‘democratisation of investment’,” says Fergus McNally, a partner at EY Financial Services, where he works at the firm’s asset management practice, and a member of Irish Funds’ members’ council.

“Everyone should have the opportunity to make an investment, make a return, have their money professionally looked after and safeguarded — that’s benefit of an ETF. It’s low cost. These (ETFs) were open to fewer people before the advent of online trading platforms, which are a great leveller.”

How are ETFs currently taxed?

For Irish investors, ETFs are not the no-brainer they appear to be at first glance, because of high taxes and labyrinthine tax reporting requirements.

When an investor buys an individual stock, they pay income tax on any dividend income and then CGT of 33pc if they sell up and make any profit above €1,270. But if you invest in a diversified ETF that tracks global markets, you pay 41pc tax on any profits and dividends. And unlike the CGT on individual shares, if you rack up a loss from one ETF, you cannot use it to offset taxes on gains from another ETF.

McNally says: “If you make a €100 gain and a €25 loss on trading stocks, tax will be levied on the net amount of €75, at 33pc, which amounts to €24.75. But if you make a gain of €100 on one ETF and a loss of €25 on a second ETF, losses cannot be offset, so an Irish investor will pay tax at 41pc of €100, which is €41.”

In addition, under Ireland’s deemed disposal system, an investor is ‘deemed’ to have sold their ETFs every eight years, making them liable for tax on any gains even if they haven’t sold the ETF. By taking a chunk out of your gains every eight years, this deemed disposal rule reduces the power of the compound interest that allows gains to snowball over long holding periods.

“Let’s say you’re tucking away the children’s allowance for their education: you’re paying eight percentage points more in tax and every eight years than if you were investing through the capital gains regime,” Benson says.

This tax is also far higher than it was before austerity budgets: between 2009 and 2013, it was gradually lifted from 23pc to 41pc, yet it only added €233m to our coffers last year.

“If you halved that rate, you’d make a minute difference to the tax take but a huge difference to people who want invest and take financial responsibility for themselves,” Benson says.

How does Revenue collect the tax?

Life-wrapped investment products are allowed to grow tax-free for up to eight years under a gross roll-up regime before life companies deduct the 41pc exit tax at source and pass it on to Revenue. But investors in ETFs need to account for and pay tax owed on a gain themselves.

Most EU- and Irish-domiciled ETFs will have a UCITS, or EU regulated structure, that are liable for the 41pc exit tax. But it’s up to investors themselves to check the prospectus of each fund to determine where it’s domiciled and how it’s regulated. An ETF investor may need to fork out for professional advice to figure all this out and file a tax return.

“If they make a mistake in the tax return, they can open themselves up to a potential Revenue audit, as well as interest and penalties,” says Jonathan Ginnelly, a tax director at Deloitte, which made a submission on the issue to the department of finance last month.

What happens next?

When McGrath’s predecessor, Paschal Donohoe, was delivering his budget speech last year, he said the Government would set up a working group to consider the taxation of funds, life assurance policies, and other investment products, following recommendations made by the Commission on Taxation and Welfare.

McGrath then announced a review of the funds sector in April 2023, and the department of finance launched a public consultation on the matter the following month. The department is due to report back on the issue in summer 2024, once the review is completed.

“Any reassessment of the taxes on these products that might make them more accessible for Irish investors is really positive,” McNally says.