Living in a foreign country is not a new concept and as such the question over which country has the right to tax a person has been disputed for many years. As a result, a complex system of bilateral tax treaties has developed in attempt to deal with the issue. So, while not every jurisdiction has double taxation protection in every country, many expatriates have an element of protection from double taxation if rules are followed.
However, despite a long-standing tax treaty in place between the USA and the UK, which should minimise the chance of double taxation for individuals who find themselves taxable in both jurisdictions, there remain plenty of pitfalls if the rules are not understood. Due to our international experience, we are able to offer a rare combination of independent investment advice and financial planning for dual UK and US tax payers. The following is a guide to remind us of the pitfalls to be mindful of but also offer some options to efficiently invest, without negative tax consequences.
What are the pitfalls?
As highlighted in our guide “US – UK Investment and Financial Planning” a US Citizen or taxpayer resident in the UK needs to navigate two tax jurisdictions that often don’t align. As well as complying with reporting requirements in both locations, including forms like the FBAR and Form 8938, investors need to be aware that sensible tax efficient investing in one jurisdiction could have the opposite result in the other.
In our introductory guide we also explored the need to avoid investing in Passive Foreign Investment Companies (PFIC) from a US perspective and non-reporting offshore funds from a UK perspective. Either of which as a minimum trigger higher reporting requirements and taxation but could also trigger penalties that could wipe out potential profits.
A particular issue is that the combination of the reporting requirements and tax considerations means that the majority of mainstream investment solutions, funds, and custodians become unsuitable for a US taxpayer that is also tax resident in the UK. However, there are suitable alternatives that allow US tax payers resident in the UK to invest.
What are the solutions?
The first hurdle is to identify a financial services provider that will accept a client with these requirements. Since the implementation of FATCA (Foreign Account Tax Compliance Act) in the US, which brought the reporting and taxation issues into sharp relief, many providers will no longer accept US tax payers as clients. However, some do remain, albeit not with a full range of investment solutions available.
Partners Wealth Management has identified a number of suitable companies that do have the required understanding and capabilities to offer a compliant service. These companies also provide account reporting to aid clients in meeting their obligation to report to both the HMRC in the UK and IRS in the USA, meaning that as a US tax payer resident in the UK, you can start investing.
The second hurdle is to then invest in a suitably diversified investment portfolio that not only meets your objectives and fits with your financial plans, but also avoids the previously mentioned pitfalls.
Fortunately, there are a couple of options to achieve this:
1. Invest only in individual securities
By avoiding collective investments or investment structuring and only buying individual shares or bonds, you will not be buying a PFIC from a US perspective and will not hold an offshore fund from a UK perspective.
The clear benefit of this is that income, dividend, and capital gains are correctly taxed in each jurisdiction, without penalty and without losing tax free allowances or lower rate tax bands.
However, the drawback is that investors typically end up with a more concentrated portfolio of companies, which, therefore, reduces diversification and increases company specific risks. Without personal expertise in company analysis and portfolio management, it is not advisable to attempt this alone and so requires oversight from a professional investment manager.
2. Identify and invest only in US funds that have achieved reporting status with HMRC
A domestic US Mutual Fund or ETF is by definition not a PFIC, however, it will be an offshore fund from a UK perspective. Therefore, unless the funds have specifically requested and achieved reporting stats in the UK with HMRC, any profits will be taxed as income which is typically at a much higher rate than capital gains.
There are fortunately a number of US funds (mainly ETFs) that do have this status, but it is limited as rules in the US and UK do not enable the marketing of such funds to non-US residents. Additionally, most European brokers or custodians do not offer access to non-UCITS funds, as they would not comply with recent EU legislation which the UK follows.
However, some custodians and portfolio managers have worked together to offer portfolios constructed with US ETFs that will allow foreign investors and have applied for reporting status. Therefore, this is the second route available to invest for those that want more diversification.
Exceptions to the rule
As always, there is an exception to the rule and in this case, it relates to retirement accounts. The US/UK double taxation treaty provides mutual recognition of each other’s tax deferred retirement accounts meaning that pension savings from employment are not negatively affected by holdings PFICs or non-reporting funds being taxed adversely.
Care still needs to be taken when making additional personal contributions and tax advice should be taken to consider how best to use and report pensions. However, this exception does enable the potential for investors to include pensions in their holistic investment planning and add more investment options and diversity into their holistic strategy.
Whilst both the pitfalls and solutions require careful thought and oversight, proper financial planning and diversified investment management is both possible and advisable for US tax payers living in the UK, as much as any other individual.
Partners Wealth Management’s pure independence and unique combination of expertise and access to investment solutions is available to anyone seeking advice on this subject. We work collaboratively with tax advisors, legal professionals and investment managers to ensure all aspects of your personal circumstances are considered in a unified manner.
The contents of the article have been prepared solely for information purposes. The article contains information on financial products and services and such information is designed for and addressed solely to individuals seeking generic industry information.