Taxation issues to be considered when making investments
The environment for investing has changed significantly over the last number of years. In addition the application of tax to income and gains on such investments has also varied, in particular in the context of the rate of tax applicable. The manner in which people use funds to make investments will depend on factors such as the type of investment to be made, the length of time the funds are to be invested, the future plans of the individual and the tax history of the individual (if they have significant levels of personal losses carried forward from prior years that they might use to offset future gains on investments).
Given that the return on cash deposits is currently so low, it might be viewed that it is uneconomical to leave savings sit in a deposit account. In addition, the DIRT rate is now 41% and for individuals, interest income is also subject to PRSI at 4% which brings the effective tax rate to 45% on deposit interest. The high level of tax rates now applicable to a lower return has resulted in some investors looking to alternative investment options.
The more conventional investment alternatives are shares/securities, real property and funds. Determining the suitability of the investment asset will depend on factors such as whether the individual is seeking a long term investment (property) and whether they are prepared to also invest time in managing the investment (e.g. share portfolios – although this can be minimised if investment is made through a stockbroker firm).
Another issue to consider is whether the investment should be made by the individual directly, or whether they might consider setting up an investment company to make the investments. For individual investors the investment income will be subject to a maximum rate of income tax of 55%, compared with a corporate entity that will pay corporation tax on investment income at 25% plus potentially close company surcharge which will bring the effective rate of tax to 40%. For Irish dividend income, the corporate entity would be exempt from corporation tax so that the only exposure to tax would be the close company surcharge at 20%.
The increased income tax rate is largely due to the introduction of the Universal Social Charge (“USC”). The increase in personal tax rates means that the rate of return on the investment must be substantially higher in order to achieve a similar level of return to that of a number of years ago when tax rates were lower. Thus a greater degree of risk in the investment assets chosen would be required to earn the desired level of income or gains. Therefore investing through a corporate entity may be an attractive alternative for some investors.
CGT seven year exemption
For property acquired before 31 December 2014, there is an exemption from CGT when that property is subsequently sold, if it has been held for a period of 7 years.
Since the introduction of this measure in 2012, individuals who hold residential (non-principal private residence) or commercial property may have considered selling this property in to a company. Assuming the current market value of the property is less than or equal to the acquisition cost of the property then the sale of the property into the company will not be subject to CGT for the individual. If the company holds the property for at least 7 years from the date of acquisition (and assuming the property market continues to recover) then any gain on the disposal of the property will be relieved from CGT for those 7 years (note if the property is held for a period of longer than 7 years then the exempt gain will be pro-rated depending on the total period of ownership).
It is important to note that there must be a commercial rationale for the sale of the property to a connected company in order for the relief to apply. As outlined above, this exemption will no longer be available for property acquisitions after 31 December 2014. Therefore, in order to qualify forthis relief, an unconditional contract for sale must be signed by the end of 2014. The company must pay the market value of the property in order to avail of the relief (this might be left outstanding as a director’s loan).
As part of their inheritance/wealth planning, parents could consider selling property assets to children for 75% of the current value. Any increase in value will arise in the children’s hands free from gift/inheritance tax, and the gain on the sale of the property by the children will be relieved for the 7 year period from the date of acquisition by the child. Again this needs to be carried out before the end of 2014.
Stamp duty will be payable on the acquisition of the property and will be applicable to the market value price.
Taxation issues associated with investment companies
Withdrawal of assets from company
If investments are made through a company, consideration needs to be given to how the assets or funds are withdrawn from the company. If the cash/assets in the company are distributed out, other than on a liquidation, then any such distribution will likely be subject to income tax. Such a distribution might take the form of a salary or dividend. In trading companies a salary might be paid as this is deductible for corporation tax purposes, unlike a dividend which is not deductible. However, in the case of an investment company there would be a limited deduction available for the company (Revenue guidance sets a maximum deductible salary at 10% of the company’s gross income). Thus if distributions are made by the company other than on liquation a double tax charge will arise, i.e. corporation tax of 25% payable by the company and up to 55% income tax in the hands of the shareholders. On this basis, if there is a requirement to have access to the investment income in the short term an investment company might not a suitable option.
If assets are distributed on a liquidation of the company then CGT treatment should apply. For those who currently have significant capital losses then they might simply liquidate the company after a specified period and use their losses to shelter the gain arising on the liquidation.
Alternatively, in certain cases it might be worthwhile considering moving tax residence and utilising Ireland’s extensive double taxation treaty network to shelter the gains from tax. The point at which the funds are extracted might be when it is more favourable to hold the funds personally (e.g. when the rates of personal taxation are reduced) but at the moment, given the high rates of personal taxation, for some people, the use of a company to hold your investments might be a more efficient and desirable option. If however, the individual requires immediate access to the investment income then the use of a company may not be practical.
In some cases, a non-Irish resident company might be suitable. The application of the double taxation treaty network could be utilised to minimise the taxation exposure. The taxation of the income in the country of residence would need to be considered in detail before any action is taken. Another key benefit of using a non-Irish resident company is that it will not be subject to the 20% close company surcharge.
The choice of country of residence will also depend on the objectives of the individual, e.g. if the focus is on the taxation of income or on the ultimate CGT position on the disposal of investment assets then the most suitable jurisdiction may differ.
Advice should be sought before any decision to use a non-Irish resident company as an investment vehicle to ensure it is a tax efficient option, that it can benefit from any relevant double taxation treaty and/or that the taxation position in the country of residence will not be prohibitive.
Investment structures, such as those mentioned above, might also be utilised as part of an individual’s overall wealth planning. In the case of an investment company, either Irish or non-Irish, the individual might make a gift of shares in the company to his children after the initial capital contribution has been made. The disposal of the shares will be subject to CGT for the parent, and gift tax for the child. However, as both tax charges arise on the same event the CGT paid by the parent can be taken as a credit by the child against his/her gift tax. In such a case any increase in the value of the company then arises free of gift tax in the child’s hands. The parent could retain the voting rights in the company so that the child does not get immediate access to the company assets and thus preserves the capital value for when the child is older.
In general investments in life policies and funds are taxed on a gross roll up basis, i.e. the income and gains are allowed to build up tax free in the funds and are taxed on exit. However, there is a deemed exit every 8 years and tax is paid at this point. The tax paid on the 8 year deemed exit will be available as a credit against the tax due on the ultimate exit. The taxation regime applicable to funds differs from the conventional taxation applicable to shares, real property etc. For example Irish domestic life policies are taxed at 41% in the hands of an individual but at 25% in a company. However, where the investment decisions are influenced by the policy holder (i.e. a personal portfolio life policy) then a rate of 60% applies to both individuals and companies. The suitability of a company over direct personal investment would need to be considered carefully in the case of life policies or funds. In addition the application of the close company surcharge will depend on the nature of the life policy or funds so this should also be considered carefully before any investment decision is made.
As tax is a significant consideration when deciding what to invest in and how to make the investment one should take care to assess what suits the individual’s needs and objectives in making the investments. Deloitte has significant experience in assisting individuals in determining what investment options are most suitable, and which investment vehicle is most appropriate. If you wish to discuss possible investment options, and the taxation considerations of same then please contact one of Deloitte’s Private Clients team.
Author: Jonathan Ginnelly, Manager, Tax and Legal, T +353 1 417 2531