“How To Live Outside The United States In An FBAR And FATCA World” – Part 2 – Taxation and your country of residence

Introduction …

Tax Connections recently reposted a post that I wrote:

“How To Live Outside The United States In An FBAR And FATCA World”. That post was reposted at the Isaac Brock Society, where it has received a number of interesting comments. Additional comments appear at the American Expatriates Facebook group. The comments have made me realize that there are many, many, more dimensions to this problem.

Americans abroad by definition live in other nations and are subject to the tax jurisdiction of other nations. My first post dealt with the life of U.S. citizens abroad from the perspective of U.S. taxation and regulation. What about from the perspective of your country of residence!

A particularly insightful comment at the Isaac Brock Society from Edelweiss reminded me that Americans abroad must be mindful of the tax laws of their country of residence. Edelwiess’s comment which is worth a post (and is being reposted here) is a stark reminder how the laws of all nations can impact your choice of investments anywhere.

In my original post, I listed as my “5th Commandment” (of 10 Commandments):

5. Thou shalt NOT buy non-U.S. mutual funds. If you do, you will have your gains confiscated in the form of an “Excess Distribution” Tax. Buy American. Buy U.S. mutual funds.

This is true from a U.S. tax perspective. Edelweiss reminds us that we must also consider the tax perspective from the country of residence – in this case the U.K. Edelweiss comments:

I have an issue with commandment 5. I totally agree with thou shalt not buy a foreign mutual fund. However, I think the conclusion that one should buy US mutual funds is very location dependent. Maybe Canada has better tax treatment of US mutual funds but the UK, for instance, does not. Depending on where you live, the conclusion might be as severe as “thou shalt not participate in any collective investment vehicle”.

In the same way that the US has punitive treatment for foreign mutual funds, the UK has punitive treatment for HMRC non-reporting funds. In the UK, gains on the sale of an HMRC non-reporting fund are treated as income and not subject to the capital gains regime. This can have dire tax consequences for UK resident taxpayers. For example, a £10,000 capital gain in an HMRC reporting fund wouldn’t be taxed at all in the UK since it would fall within the annual £10,000ish exclusion on capital gains. An HMRC non-reporting fund, would have the capital gain treated as income and subject to taxation at up to 45% (ie up to £4,500). (http://www.buzzacott.co.uk/news/fund-reporting-status-is-your-fund-attractive-to).

Just for the fun of it, I thought I would check to see how many HMRC reporting funds there are and how many of them are US funds. There are (according to https://www.gov.uk/government/publications/offshore-funds-list-of-reporting-funds) about 42,000 HMRC reporting funds. The list of reporting funds doesn’t seem to include UK registered onshore funds who are already under the HMRC reporting regime. Of the 42,000, about 7,000 don’t have an ISIN code (International Securities Identification Number). These look mostly like hedge funds which are generally not available to retail investors. That leaves about 35,000 HMRC reporting funds. If you sort by ISIN code I count about 75 funds that have an ISIN code which begins with US (as opposed to GB or CH or IE or LU). I’m going to assume (this is not an area of expertise for me) that means that there are 75 US registered funds that are also HMRC reporting funds. So, out of the hundreds of thousands of funds available to invest in (including UK onshore funds), it looks like about 75 would attract neither UK non-reporting fund treatment nor US PFIC. So, if you’re a UK resident US citizen you’re screwed if you buy a UK mutual fund (PFIC) and screwed if you buy a US mutual fund (HMRC non-reporting fund status). Your returns are decimated by the one or the other country’s punitive regime.

What I can’t rule out is that some of the HMRC reporting funds have an LU or IE ISIN code but are somehow registered in the US. For instance, one of the largest ETFs in the UK is iShares FTSE 100. The info page (https://www.ishares.com/uk/individual/en/products/251795/ishares-ftse-100-ucits-etf-inc-fund) lists one ISIN for Ireland but says its registered in 16 countries. However, none of those 16 countries is outside of Europe.

I also can’t rule out that more US registered funds would somehow be considered UK compliant despite not being on the list of UK reporting funds. The UK reporting status seems to be most at risk for adverse treatment if it’s an accumulation class fund (where dividends are accrued but not distributed as opposed to income class shares which pays all income to the individual shareholder). I’m pretty sure that the US doesn’t have accumulation class mutual funds so maybe there is a broader variety of funds to choose from.

Polly reinforces Edelweiss’s comment as follows:

@Edelweis
I agree- I think all mutual funds are off limits for expats.

Reading this just makes me sick to my stomach. In fact- I can hardly stomach it anymore. The injustice just screams to the heavens, but nobody in charge is listening. Its like blasphemy, what is being done to expats. The unfairness and exploitation should be named a CRIME, and not what I always hear: “but its the law!”

The following day (September 16) Publius, http://isaacbrocksociety.ca/2015/09/14/how-to-live-outside-the-united-states-in-an-fbar-and-fatca-world/comment-page-2/#comment-6554912 OAP http://isaacbrocksociety.ca/2015/09/14/how-to-live-outside-the-united-states-in-an-fbar-and-fatca-world/comment-page-2/#comment-6555731 and Edelweiss http://isaacbrocksociety.ca/2015/09/14/how-to-live-outside-the-united-states-in-an-fbar-and-fatca-world/comment-page-2/#comment-6556362 added the following comments on the post at the Isaac Brock Society:

Publius:

Brilliant line: “A supporter of “citizenship taxation” is a person who thinks about “citizenship taxation”.” Yes! But also never too hard and never, ever outside the box.

@Fred
I think that is why there was a proposal to get rid of the allowance for children abroad. I got a letter from the IRS saying that I might have been able to take another deduction, but I thought this is crazy. I wouldn’t even qualify for this deduction, which is really meant for much poorer people, if I weren’t so wary of the IRS that all of my financial behaviour has changed.

@Edelweiss
I think that the list may not be quite as limited or quirky as you suggest. Just shows that even intelligent people get confused by all this. If you sort by ISIN and look at the ones that start with US, none of the Vanguard funds shows up, but there are NASDAQ and NYSE listed Vanguard ETFs for sale in the U.K. at mass-market company Hargreaves Lansdown. I just mention this because the ones Vanguard UK sells, rather confusingly, don’t seem to be its US-registered ones, whereas HL sells some Vanguard funds that are U.S.-listed, as well many that aren’t and the names of the funds in the two groups can be dangerously similar. The NYSE and NASDAQ-trade Vanguard funds have North American CUSIP numbers and the prospectuses are written for an American audience. Funds can slip in and out of U.K. reporting status, but the draconian rules only apply if a non-reporting fund is held outside a pension.

@pukekonz
I do wonder how sad a life those people must lead to waste it on such pointless vitriol.

The way I see it, it is all about the money. The U.S. has a massive deficit and is far too dysfunctional to put through new tax legislation, so it is determined to enforce to the hilt whatever bizarre laws it already has on the books.

OAP:

@ Edelweiss, & Publius RE: mutual funds.

I’ll start with a disclaimer. During my 35 years in the UK I’ve never, ever had any funds, stocks, shares, or anything that even obscurely resembles them. I know nothing about them. A large part of my motivation for avoiding them was (and is) the fear of reporting to the IRS, or more correctly, the fear of reporting incorrectly to the IRS (or HMRC) leading to a never ending chain of mail trying to correct the errors. I do my own US and UK tax returns and try to stay within a comfort zone of being (reasonably and hopefully) sure of complying with the filing requirements by limiting types of income. Thank (whatever your choice of Deity, or not) my pensions were of the UK and other EU registered final salary type (treaty). As for reporting UK and EU pensions as a UK resident, there are still known unknowns.

That said, this discussion of mutual funds often arises on the expat sites. The general conclusion is that HL do offer ‘some’ ETFs which meet both UK and US reporting requirements. The restriction is that 95% are Vanguard, and HL seem to be the only firm offering them, so you’re limited as to choice of ETFs and limited to HL as the broker. If you’re unhappy with either, tough luck. The following is one of the better explanations of the whole conundrum:

http://thunfinancial.com/american-expat-pfic-uk-non-reporting-fund-investment-trap-article/

From what I’ve seen, I don’t think Edelweiss is too far out in the number available. I’d guess an estimate of 100 to 150 as being generous.

What I do think is of interest, is the possibility of adding even more commandments to John’s selection above for those in the UK. I’m sure for other countries there are also additional ‘situations’.

11. Don’t take the 25% tax free lump sum amount on a maturing pension. This has always been a debatable question, and the IRS has issued a private letter saying it’s not tax free in the US, irrespective of the treaty or the definition of a lump sum. It’s now even more complicated due to the new UK pension rules allowing partial payments with partial ‘segments’ of 25% being tax free. Even the compliance condors are running for cover on this issue, as no one seems to have a grasp of what this means for a US return. Of course, one may take the tax free amount in the UK and then pay tax on it to the US which defeats the purpose established for those in the UK.

12. Don’t be a pensioner with a yearly gross income between roughly £8,000 and £15,000, if all income falls within employer pensions, State pension, cash ISA interest, and £1,000 of ‘taxable’ UK interest (unearned income, and depending on exchange rates). You may well owe HMRC £0, but you’ll likely owe the IRS.

The new UK rules on tax free amounts are hurting anyone who files a US tax return (yearly large increases on the personal allowance + new, larger ISA allowances + the new tax free amount on normal interest). I’ve had notices from both banks and building societies that all ‘taxable’ interest will be paid gross (no withholding) starting 6 April 2016. If your ‘taxable’ yearly interest is over £1,000, the tax won’t be paid until a self assessment form is filed which can be 18 months in arrears given the offset differing tax years between the US and the UK. For those who have planned for retirement wisely yet avoided the US pitfalls of having normal UK ‘mutual funds’, there may be an initial year or two when US reporting using tax credits from the UK will need to be carefully planned for and calculated.

Edelweiss:

@Publius

I took a closer look at some of the 7,000 funds registered for HMRC reporting status but that didn’t have an ISIN. Vanguard has a series of funds registered by Vanguard Index Funds and Vanguard Scottsdale that are reporting funds without an ISIN (I had previously skimmed these and discounted them as they looked mostly like hedge funds). If you take Vanguard 500 Index, it has no ISIN but has a CUSIP number of 922908363 which when you do an internet search leads you to a NYSE ARCA listed ETF trading under the ticker symbol “VOO” called Vanguard 500 Index Fund ETF Shares. From reading the prospectus it looks like some sort of listed interest in the Vanguard S&P 500 mutual fund that is convertible into mutual fund shares. Somewhat strangely, none of the “summary prospectus”, the “statutory prospectus” nor the “statement of additional information” for this ETF contains any reference to HMRC, reporting, UK or United Kingdom. If you relied on the prospectus, you would be clueless. The Hargreaves Lansdown website unhelpfully lists the reporting status of this fund as “n/a”.

So it does look like there may be additional candidates for non-PFIC funds with HMRC reporting status amongst the 7,000 with no ISIN over and above the 75 with a US ISIN identifier.

@OAP

You raise an interesting point about the new interest income allowance. I wonder if this impacts the UK’s status under HTKO (due to interest income withholding). Thankfully, I don’t have to worry about it anymore. But if I were still a US person, I would be worried about being put into basket FTC, split tax year, amended US return hell.

You might want to consider adding “don’t be made redundant” to your list of commandments. I doubt the UK’s £30,000 tax-free allowance would be tax free to the US.

@ Don

Unfortunately, it appears the only entity in the UK that doesn’t have to abide by the Equality Act is the government itself. This is what I was told by the government’s discrimination hotline in a conversation a few years ago. So, you can’t sue the UK government on the grounds of discrimination. There may be grounds other than discrimination to sue the UK government but I think a European Court of Justice effort would prove to be more fertile ground.

 

This is very important reminder:

Anything you do for U.S. tax purposes will have an impact on your tax situation in your country of residence! Don’t forget that basic fact.

Your choice of tax preparer and his or her country of residence …

The fact that U.S. persons abroad are subject to the tax jurisdiction of BOTH the United States and the country of residence implies that one needs a tax adviser who is “literate” in the tax systems of both countries. In practical terms this means that you should use a tax adviser in your country of residence. How many U.S. tax advisers in the United States are literate in both:

– the U.S. tax system and the __________________ tax system.

I suspect very few.

Obvious conclusion ….

Living as a “tax compliant” U.S. citizen abroad is somewhere between difficult and impossible. There are many non-compliant Americans abroad who are coming into U.S. tax compliance for the sole purpose of renouncing U.S. citizenship and NOT being a “covered expatriate and therefore subject to the U.S. Exit Tax rules.

John Richardson

 

 

 

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