Dividends and tax avoidance. Singapore investors love them.
Just recently I came across an article talking about the most tax efficient ETFs for Singapore investors.
If you are a non-US tax resident and have invested in US stocks, you may be aware that there is a 30% tax on all dividends received. This is dreaded dividend withholding tax known to all dividend investors.
The purpose of this article is not to talk about dividend withholding tax. So either check out the article by investment moats or the one by financial horse.
But if you need my explanation, here it goes: tax is complicated.
To conclude his piece, the author recommended Irish Domiciled UCITS ETFs because the withholding taxes on dividends paid to non US investors are half (15%) compared to a US Domiciled ETF (30%).
Sounds Good, But Is There a Catch?
So it got me thinking. Would those UK listed Irish domiciled ETFs be affected by Brexit? Surely not?
So, I did my research and wandered down the rabbit hole.
EEA, UCITS and Passporting
UCITS stands for the Undertakings for Collective Investments in Transferable Securities Directive. It is a legal act that allows collective investment schemes to operate freely throughout the EU on the basis of a single authorization from one member state.
It is quite a mouthful. UCITS basically allows EU-domiciled funds to be traded in other EU countries with less hassle.
If a certain firm is authorized to sell certain investment products by one regulator in an EU member state, it can ‘passport‘ and sell to other EU retail investors without requiring another separate authorization.
So this typically reduces the cost of listed an ETF in EU. It is cheaper to list a fund in Ireland and passport to London.
EEA stands for European Economic Area. This is the single market that consists of all EU member states.
London is currently in the EEA so UCITS applies.
Brexit Withdrawal Agreement
UK has officially left the EU on 31 Jan 2020. Everything seems to be normal. So all is well right?
This is because currently UK is in a transition period and all rules of the withdrawal agreement apply.
The UK is still part of the customs union and the single market. UK is still aligned with EU regulation and hence everything is still operating as normal.
However, there is still one point of concern, that is the transition period ends on 31 December 2020. All trade agreements between the UK and EU are subjected to negotiations that are yet to come.
If negotiations are not reached by the deadline, a no-deal Brexit ensues. The UK parliament has put into law forbidding any deadline extension.
Given that it took three years for the UK parliament to come up with a withdrawal agreement for the temporary transition period, it is unlikely that the UK can negotiate a more permanent comprehensive trade deal within just a year.
Also, there are reasons to believe that the UK prime minister may be planning for a no-deal or at least moving in that direction.
No-Deal Effect on Irish Domiciled ETFs listed in UK
An analysis by Mason Hayes & Curran suggests that it might get harder to market Irish Domiciled funds in UK and it will be subjected to UK regulation.
This is due to the UCITS and passporting rules. Irish domiciled funds might have to go through an independent registration and listing process similar to the case with Switzerland now.
What this means is higher cost and more barriers to entry for new EU domiciled funds. It might mean there might be fewer listings in London in the future.
Also note that last year, Switzerland lost access to EU market within just 30 days notice. Something similar could happen to UK in the future.
The UK also wants to seek permanent equivalence arrangements with the EU which is quite unlikely as reported in the news recently. You may want to read more if you want to find out about equivalence arrangements.
Temporary Permission Regime
The Financial Conduct Authority (FCA), is the financial regulator in the UK. In order to ensure minimal disruption, the FCA has introduced a temporary permissions regime (TPR).
The temporary permissions regime (TPR) will enable relevant firms and funds which passport into the UK to continue operating in the UK when the passporting regime falls away at the end of the implementation period.fca.org.uk
What a relief! So, ETFs (like IWDA which I am holding) will still continue to sell in the UK in a no-deal scenario under the TPR.
However, it seems that eventually the passporting will stop and these funds will still have to seek authorization in the UK.
We expect the regime will be in place for a maximum of 3 years within which time firms and investment funds will be required to obtain authorisation or recognition in the UK, if required.fca.org.uk
An Inconclusive Conclusion
Without a doubt, the UK investment industry and EU investment companies will continuously try to adapt and put measures in place to reduce needless friction to their investors.
In a best case scenario, we investors can still access the same low cost and tax efficient ETFs from UK.
In a worst case scenario, the higher costs and administrative burdens might increase the ETF fees, the London Stock Exchange might have fewer listings and ETFs might choose to list in other EU markets.
So in the short term, I think we can still enjoy access to the low cost and tax efficient ETFs listed in London.
In the long term, there is still a lot of uncertainty and depends entirely on whether the UK manages to get a new trade deal with the EU.
Which probably will not happen.