Personal investment accounts: how to receive income without paying taxes and help rebuild the country

What you need to know about the instrument that is just about to be introduced to the market – personal investment accounts

The National Securities and Stock Market Commission (NSSMC), together with LIGA.net, has prepared a series of publications to explain the essence and specifics of financial instruments and mechanisms of their use in a simple and accessible way.

In the previous publication, we reviewed atypical securitization mechanisms used in the United States, the United Kingdom and other Western European countries that can be applied in Ukraine. In this publication, we turn to a new instrument designed to help individuals increase their savings – personal investment accounts.

Prerequisites for their appearance

The goal of any investor is to earn income from their investments. Such income is also called passive income and includes: income received in the form of interest, royalties, dividends, investment gains, insurance payments and reimbursements.

Such income is mainly derived from capital market transactions and is taxed in accordance with the procedure established by law. Taxation is often a decisive factor in the choice of investment instruments.

Almost all passive income is taxed in Ukraine at the rate of 18% (personal income tax) and 1.5% (military duty).

There are also passive incomes taxed at lower rates:

• • Dividend income accrued by residents is taxed at 5% (personal income tax) and 1.5% (military duty);
  • Dividend income accrued by non-residents, collective investment institutions and non-payers of income tax is taxed at the rate of 9% (personal income tax) and 1.5% (military duty).
    And, of course, there are exceptions where there is no taxation at all. For example, income derived from transactions with government securities, which are exempt from these taxes and duties.

Such measures are usually taken when there is a clear need to increase the attractiveness of domestic capital markets, namely, securities transactions.

Most countries are implementing comprehensive programs that provide for the long-term development of the stock market, including the use of different taxation rules. This task is accomplished, among other things, through the introduction of so-called personal investment accounts, which allow for income not only from speculative transactions with securities and dividends and interest, but also the possibility of using a «tax shield» (the use of financial instruments, accumulated losses or a certain capital structure that allow for tax savings).

This tool has been around for years. For several decades, citizens in the United States, Canada, Britain, Japan and other countries have been using personal investment accounts as a means of saving and accumulating their wealth.

Of course, the specifics of using such accounts vary from country to country. This may be manifested in certain restrictions on the objects of investment from such accounts, maturity, the ability to replenish or withdraw funds early, and other aspects.

But common to all countries is the interest in encouraging citizens to form investment baskets on their own, filling the economy with long money. The population receives tax benefits from the state, but at the same time is restricted from early withdrawal.

What legal basis do we have for the functioning of investment accounts?

Currently, such an instrument as personal investment accounts is just being prepared for introduction in Ukraine. A draft law has been prepared that provides for the specifics of using investment accounts. Such accounts will be opened and maintained by investment firms regulated by the NSSMC.

So what exactly will this draft law provide?

A citizen of Ukraine will be able to apply to an investment firm to open a personal investment account: one account with a validity period of at least 1095 days and another account with a validity period of at least 2555 days.

After opening such an account, a citizen has the right to deposit funds into it for the purpose of investing them in investment assets.

Subject to all restrictions on the account’s operation (validity period, not exceeding the amount limit, withdrawal not earlier than the established deadline), the holder is exempt from taxation of income received from transactions on this account.

Key parameters of personal investment accounts

Let’s take a closer look at the key characteristics of the future instrument to better understand its nature.

Validity period. Since it is planned to attract «long money» into the economy through personal investment accounts, the minimum period for which funds must be held on the account will be set accordingly. These are 1095 days for personal medium-term accounts (MTAs) and 2555 days for personal long-term accounts (LTAs). It is important to remember that tax preferences (i.e., no taxation of accumulated funds) will apply if these periods are met.

Annual contribution limit. The maximum annual contribution to an investment account will be set. For individual savings accounts, it will be 300 minimum wages. For individual depositors, the amount will not be limited. Linking the limit to such an indicator as the minimum wage will allow for a dynamic reflection of economic changes.

Assets in which investments can be made. Investors will be able to invest in any securities available on the capital markets. As for the restrictions on the composition of assets that can be purchased with the funds deposited by the investment account holder, they will be determined by decisions of the NSSMC.

Tax preferences. The possibility of being exempt from paying taxes is an incentive and motivation for investors. In this way, a person will have arguments why the funds should «work» in the economy, and not, so to speak, lie at home under the pillow.

Early withdrawal. If the investor decides to withdraw funds from the account before the minimum maturity date, the accumulated amount will be taxed on a general basis (18% + 1.5%). If an investor wants to partially withdraw funds before the account expires, he or she can do so, but the amount should not exceed 10% of the total amount of all contributions made.

The investment firm is the main partner. An investment firm will help a new investor open an account. Of course, any investor may have concerns about long-term cooperation with one investment firm. We can immediately reassure potential users of this tool – at the owner’s decision, the account can be transferred from one investment firm to another, and there will be no risk of losing information or having to start all over again (with a new investment firm).

Conclusions.

The introduction of personal investment accounts will bring Ukraine and domestic capital markets one step closer to the standards and variety of tools that have long been understood and used by our Western partners.

The use of this instrument will have a positive effect on the state, business and investors (account holders). The state will receive «long money» that will help fill the capital markets with liquidity, businesses will receive additional capital for development, and investors will have a reliable and effective tool for investing their savings without paying taxes.

Text prepared by the NSSMC specially for LIGA.net