PERSONAL FINANCE:Your queries answered

Q

Almost 10 years ago, I purchased units in a managed fund. There is no associated policy with any benefits or mortgage cover.

The value of the holding is now higher than the purchase price. The managers now tell me that the 2006 Finance Act introduced the concept of “deemed disposal” under which tax at 30 per cent is payable on the increase in the value over its purchase price. This tax is, they say, payable each eight years after the holding has been acquired, even though it has not been encashed.

This would be a tax on a notional capital gain but apparently capital gains tax law is irrelevant. So actual capital losses cannot offset the notional gain, and there is no gains threshold. This position seems so bizarre that I wonder whether my understanding is incorrect?- Mr RC, Dublin

A

The fund managers are correct both on “deemed disposal” and the irrelevance of capital gains tax law.

This relates to exit tax. Since 2001, new funds are taxed on the basis of “gross roll up” – ie, annual gains are rolled over within the fund and tax is levied only when you exit. This tax was originally set at the standard rate of income tax plus three percentage points to compensate Revenue for forgoing annual taxation on the fund. The current rate of exit tax is 30 per cent.

For the purposes of calculation, depending on when your fund passed the eight-year mark, the tax was 28 per cent in 2010 and 26 per cent in 2009.

There is no capital gain in funds. Any growth is treated as investment income (like deposit interest income with DIRT) and that is why CGT does not apply.

The 2006 Finance Act introduced a measure to tax increases in fund value every eight years if the fund had not been encashed. That was to stop people rolling over funds ad infinitum for the purposes of tax avoidance.

Following a subsequent amendment in the 2008 Finance Act – designed to placate fund managers rather than customers – investors in some funds are now required to return this tax themselves.

Other amendments in that Act enabled assessment of tax liability to be based on fund value at either June 30th or December 31st closest to the eight-year term of investment. There are provisions in place to ensure that your gain is not double-taxed.

Say you have a fund investment of €100,000 made in March 2002. At the end of December 2009 – the closest fund value review date to your eight-year anniversary – it is worth, say, €150,000 and you have made no partial encashment in that time.

The €50,000 gain under “deemed disposal” is taxed at the then applicable rate of 28 per cent, giving a tax liability of €14,000. This is paid to Revenue and your fund is now worth €136,000 (€150,000 minus €14,000).

Now assume that this year you decide to cash your investment. It is now worth €145,000.

Before calculating your tax liability, you must “gross up” the fund by adding back the amount paid over to the Revenue, the €14,000. This gives you a new maturity value of €159,000 – or a gain of €59,000 on your original investment.

The tax rate in 2011 is now 30 per cent and this is the rate levied on your investment gain –30 per cent of €59,000 is €17,700.

As you, or the fund managers, have already paid Revenue €14,000, you are now liable for a further €3,700.

If the fund has fallen in value in the interim and you have paid more tax than you would ultimately have been liable for, you or the fund manager claims a refund from Revenue.

This column is a reader service and is not intended to replace professional advice. No personal correspondence will be entered into. Please send your queries to Dominic Coyle, Q&A, The Irish Times, 24-28 Tara Street, Dublin 2. E-mail: dcoyle@ irishtimes.com