Dividend and capital gains tax optimization

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MrCurious
Posts: 32
Joined: Mon Aug 10, 2020 9:42 am
Location: Bosnia / Croatia

Dividend and capital gains tax optimization

Post by MrCurious »

Hi guys!

I am constructing a portfolio for two generations of my family and the plan is to invest a great part of our savings. One of the objectives is to provide 2-3% passive income, especially for older family members.

It seems that the taxes in my country (Bosnia) will have a major effect on tactical allocation.

In my country we have:
  • 10% dividend tax. Please remember that level 1 taxes are automatically withheld. Effectively we have 15% level 1 tax (e.g. US) + 0% level 2 tax (Ireland domiciled ETFs) + 10% level 3 tax (my country), which is roughly 23.5% in total.
  • 13% capital gains tax. Unfortunately, there are no tax exemptions, even if you hold the stocks for many years.
Interest from bonds and bank deposits is not taxed.

It seems that it makes more sense to sell a part of the equity portfolio (accumulating ETFs) every year to produce desired income and pay capital gains tax, rather than to collect dividends.

On the other hand, due to credit risk and low yields, I am hesitant to introduce bonds to the portfolio. One option is to use fixed-term bank deposits for fixed income. Interests rates on deposits in international banks range from 0,1% to 0,5%. The catch is that government insures only up to 25.000 euro.

I have read a bit about tax harvesting strategies, but it appears that they are more applicable in the US than in Europe.

I would be grateful for any tips or thoughts!

PS
I am only interested in legal solutions for tax optimization :)
TedSwippet
Posts: 3638
Joined: Mon Jun 04, 2007 4:19 pm
Location: UK

Re: Dividend and capital gains tax optimization

Post by TedSwippet »

MrCurious wrote: Wed Apr 14, 2021 10:01 am In my country we have:
  • 10% dividend tax. Please remember that level 1 taxes are automatically withheld. Effectively we have 15% level 1 tax (e.g. US) + 0% level 2 tax (Ireland domiciled ETFs) + 10% level 3 tax (my country), which is roughly 23.5% in total.
  • 13% capital gains tax. Unfortunately, there are no tax exemptions, even if you hold the stocks for many years.
To be clear, you lose 15% in US tax at Level 1 only to the extent that the ETF holds US stocks. For an all-world equity ETF, that would be around 60% US stocks, so your US Level 1 loss would be 9%, and after 10% local an effective 18.1%.

Here is the thing, though. Comparing tax drag numbers like this only makes sense when you are deciding between US domiciled and Ireland domiciled ETFs. It doesn't make any sense comparing between two Ireland domiciled ETFs, one accumulating and the other distributing, because both will have the same internal Level 1 taxes inside them. The only difference is how you as an investor receive the generated cash. Accumulating and distributing ETFs that hold the same assets (typically, different classes of the same underlying fund) will generate the same returns for an investor.

Now, to your question. Assuming your country does not tax accumulated but unpaid dividends annually and as if paid anyway (that is, it does not do what the UK does), then superficially, if choosing between an accumulating and a distributing ETF, both domiciled in Ireland, for you it makes sense to pay the 10% dividend tax rather than the 13% capital gains tax. In most countries, capital gains taxes are lower than income taxes, making accumulating ETFs the better choice usually, but your country seems to be the other way around.

The one thing that might pull in the other direction is if you were not planning withdrawals for some time, in which case your uncollected dividends could roll up in the fund without any annual 10% tax; over time, this might overcome the slightly higher capital gains tax rate. From what you wrote, I don't think that's your case.
MrCurious wrote: Wed Apr 14, 2021 10:01 am It seems that it makes more sense to sell a part of the equity portfolio (accumulating ETFs) every year to produce desired income and pay capital gains tax, rather than to collect dividends.
Unless I'm missing something, I think the other way around. Your income tax is lower than your capital gains tax.
MrCurious wrote: Wed Apr 14, 2021 10:01 am On the other hand, due to credit risk and low yields, I am hesitant to introduce bonds to the portfolio. One option is to use fixed-term bank deposits for fixed income. Interests rates on deposits in international banks range from 0,1% to 0,5%. The catch is that government insures only up to 25.000 euro.
This is what I do, in effect creating a 'bond ladder'. I have split my cash into multiple fixed-term accounts, typically one year, though a couple of two year ones (reaching for yield, I'm afraid!) to stay below the protection limits. It is a bit of a nuisance to manage, but I think it beats bond funds.
MrCurious wrote: Wed Apr 14, 2021 10:01 am I have read a bit about tax harvesting strategies, but it appears that they are more applicable in the US than in Europe.
Typically, these are purely tax plays, and as such they rely entirely on exploiting features of a local tax system. These features may or may not apply in different countries; for example, in the UK we have little or no use for 'tax-loss harvesting' so beloved of US investors.
WienerG
Posts: 62
Joined: Thu Feb 06, 2020 6:11 pm

Re: Dividend and capital gains tax optimization

Post by WienerG »

OP,

I know you stated that you are domiciled in Bosnia. However, have you considered (would it even be a consideration?) Setting up your domicile.in Croatia? They have zero dividend & capital gains tax. Might be worth investigation if you were interested.

WienerG
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