Key Irish tax considerations for individual investors in foreign funds

Article published in the Chartered Accountants Ireland journal Tax.point - February 2021

With historically low interest rates, many investors are now considering other investment opportunities outside of deposits.  Funds have become more popular, allowing investors access to a diversified portfolio of shares and debt in a single holding. 

Funds also tend to offer gross roll up i.e. the fund itself is exempt from tax, profits “roll up” within the fund and tax applies at the level of the investor.  For the Irish investor, a special tax regime can apply to such investments - for foreign products, known as the “Offshore Fund” regime.  This is where matters can get complicated; firstly, in determining whether this special regime applies and then, understanding the tax implications associated with it.

This article concentrates on foreign funds as this is where the main complexity lies for investors. 

For most Irish funds, tax compliance is the responsibility of the fund and generally, the individual Irish investor should have no additional tax obligations here.  The Irish tax headline analysis on Irish funds should also be clear at the outset but is not necessarily the case for foreign products.  The Irish tax treatment will depend on where the foreign fund is located, with one set of Offshore Fund rules applying for funds resident in an EU, EEA or an OECD country with which Ireland has a Double Tax Treaty (EU/DTA) and another for all other countries.   

If the fund is regulated as a UCITS in its home jurisdiction, then it will be regarded as an equivalent fund.  There is more uncertainty for other funds such as collective investments, particularly as the test requires them to be “similar in all material respects” to the relevant Irish fund.  To determine this, consideration will need to be given to the legal and regulatory treatment of the foreign fund in its home jurisdiction. 

Revenue has provided commentary on the popular Exchange Traded Funds (ETF’s) and confirmed their view that ETFs domiciled in the EU should be regarded as equivalent.  Clearly, it is always open to an investor to take a different view here – this will depend on the facts and circumstances of each case.  Revenue is also “prepared to accept” that investments made in ETF funds outside the EU (but within an EEA/treaty jurisdiction, apart from the USA) are not equivalent to Irish funds and therefore fall outside the regime*.  Per Revenue guidance, the treatment of ETFs domiciled in the USA should follow the same approach, but such ETFs are not commonly available now for Irish investors.  

*Post Brexit, it would be welcome if Revenue update their guidance here.

In addition to the equivalence test, in all cases a “material interest” test will need to be satisfied to be within the Offshore Fund regime.  Broadly, there is a material interest if at the time of acquisition, it would be reasonable to consider that at some point during the next seven years the investor would be able to realize their investment. 

The tax consequences of investing in EU/DTA Offshore Funds 

For individuals, there are three headline tax impacts for investments within the scope of the Offshore Fund regime: 

• A blanket tax rate of 41 percent applies on gains and distributions.  USC and PRSI should not apply. 

• A disposal is deemed to occur on each eight-year anniversary of the acquisition and 41 percent income tax is payable on the uplift in value at that point. 

• Gains on these funds cannot be sheltered with tax losses.  Furthermore, tax losses arising on these investments cannot shelter other profits.  In practice, a fund structured as an umbrella fund consisting of various sub-funds may facilitate loss relief at levels within the fund itself.

There are other tax consequences which can significantly impact an investor.   

The death of an investor triggers an exit tax charge at the 41 percent rate.  The exit tax payable on the death of an individual is allowed as a credit against Capital Acquisition Tax (CAT) payable by the beneficiary.  For this reason, it may not be particularly tax efficient for such funds to pass to a surviving spouse as the benefit of the exit tax credit in that scenario is lost.

Non-Irish domiciled individuals resident in Ireland are taxable on the remittance basis which broadly means that foreign investment income and gains are only subject to Irish tax when remitted to Ireland.  However, because gains on these funds are classified as foreign income under Schedule D, Case IV, the remittance basis does not apply and thus these profits are automatically within the scope of Irish tax.  

On acquisition of an interest in an Offshore Fund, an individual is automatically regarded as a chargeable person; they need to file an income tax return and provide acquisition information relating to such funds in their return.  A point sometimes overlooked is that this obligation also extends to investments in non-equivalent offshore funds; even though these are subject to ordinary tax rules.  

It is also worth noting that in the past, a higher income tax rate applied if Offshore Fund profits were not correctly included in the investor’s tax return, but this is no longer the case (apart from on PPIUs). 

Tax treatment where fund fails equivalence and/or material interest test

Where the foreign investment is not equivalent to an Irish fund, or not a material interest, the investor is taxed under the ordinary rules for foreign income and capital gains.  There are no special restrictions on capital losses and this benefit combined with the lower tax on capital gains (33 percent compared to 41 percent) can make such investments more attractive to some Irish investors.

Investment in other countries (including Singapore, Cayman, China)

The tax rules here are significantly different to investments in EU/DTA jurisdictions. 

A key point to note is that the equivalency requirements set out earlier in the discussion on EU/DTA funds do not apply to investments in these other countries.  If the investment in the foreign vehicle is regarded as a material interest, then the Offshore Fund regime applies but the equivalence to an Irish fund is irrelevant.

The analysis to determine the tax treatment then hinges on whether there is a ‘material interest’ and this can be a difficult to ascertain.  If this ‘material interest’ test is not met, then ordinary Irish tax rules should apply to the investment.  Generally, an investment in an open-ended fund with liquid assets (such as shares, commodities, currency) is likely to be treated as a material interest as the value of a unit in the fund tracks the value of the assets.  Guidance may also be garnered from the fact that Revenue regard an ETF to generally represent “a material interest”. 

Helpfully, and as already noted, if an Irish intermediary is involved, they should be able to able to advise an investor whether the material interest test is met.

The tax consequences of investments in “Other Offshore Funds”

Offshore Fund investments in these countries give rise to the following key Irish impacts:

• For individuals, marginal rate income tax applies to distributions and gains; these are also subject to PRSI and USC.

• If there is a loss realized on disposal of the fund, it can shelter other investments (as a CGT loss forward), however it is not possible to shelter the offshore fund gain with losses.

• There is no eight-year deemed disposal event. 

Furthermore, for non-Irish domiciled individuals, a gain on disposal of units can qualify for the Irish remittance regime.

There are also special Revenue approved “distributing” Offshore Funds, which are rare in practice but easy to identify as they are on a list published by Revenue.  Such funds may suit investors who require a stream of income, as such funds are required to distribute at least 85 percent of their annual income.  Different tax rules apply; gains on such funds are subject to the rather unusual 40 percent rate of Capital Gains Tax and the marginal rate of income tax applies to dividends.  

In conclusion

In addition to the complexities highlighted in this article, it is also worth noting that the consequences for non-compliance associated with foreign investments can be significant.  It is no longer possible to obtain the benefit of a Qualifying Disclosure for Irish tax liabilities arising from foreign investments and transactions.  This means that individuals who get the tax wrong on their foreign investment are (at minimum ) potentially liable to higher penalties.  No penalties however should arise due to minor errors i.e. where the aggregate tax is less than €6,000 and the default is not deliberate.

This all needs to be considered when evaluating foreign funds for investment.  As with any investment decision, the tax costs will need to be balanced with commercial objectives and the investor’s long-term plan.  However, to do this, the investor needs to understand the tax and associated obligations, including the cost of compliance. 

For foreign funds, especially those outside the realm of ETFs and UCITS, this can often be a challenge, as can be seen from the commentary above.  

Maura Ginty is owner of Gintax (gintax.ie)

Publication date February 2021, Tax.Point Irish tax journal