In our last blog, on non-US investments, we looked at US taxpayers investing in non-US collective funds.
For example, EU-registered mutual funds and ETFs. These can lead to significant challenges – both reporting and taxation – for the US person.
This blog is introducing a similar problem. It addresses UK residents who want to invest in and/or maintain investments in the US.
For example, a person who grew a brokerage account in the US while living and working there. What happens when they return to the UK? Do they need to make any adjustments?
It depends on how the brokerage account is invested.
Frequently, brokerage accounts contain US-based collective investments, i.e. mutual funds and ETFs, that are registered and regulated in the US.
By default, if a UK resident owns US-based collective investments, they must report their capital gains as ‘offshore income gains’ and are subject to UK income tax, at rates of up to 45%, rather than capital gains tax rates at up to 20%.
This is to prevent investors from accumulating income free of tax in an offshore fund and then claiming preferential capital gains tax treatment on disposal of the units.
About Reporting Funds
A UK taxpayer can avoid the punitive taxation mentioned above if they are invested in UK reporting funds.
Reporting funds are a subset of “offshore”* collective investments where the fund has applied to HMRC for “reporting fund” status (all US funds & ETFs are by definition offshore funds to HMRC). Once this status is granted, the fund is required to report to the investor and HMRC details of the income that has arisen within the fund, and whether or not the income has been distributed to the investor.
A UK resident invested in a reporting fund must declare the income (whether or not distributed) on their UK tax return for the year and pay tax on that income at their marginal rate of income tax (up to 45%, or up to 38.1% for dividends). Gains arising on the disposal of units are subject to capital gains tax (CGT) at a top rate of 20%.
About Non-reporting Funds
If an offshore fund has not been granted reporting fund status, then it is a non-reporting fund.
Non-reporting funds do not report any accumulated income to HMRC. Therefore, the investor is liable for UK tax only on income that has been distributed – i.e. the fund distributes some income and/or the investor sells some/all of their holding in the fund.
As a result, the investor will not suffer any tax on an un-distributed income, but all distributions, whether they be income or capital gains are subject to income tax of up to 45%. This is a much higher tax burden compared to reporting funds.
Therefore, there is a clear advantage for most UK resident taxpayers to invest in reporting funds in their US investment accounts. Although they have to pay income tax on income the fund earns annually, even if they don’t actually receive it personally (e.g. it is used to buy more investments within the fund and/or it is distributed in subsequent years), their capital gains will be taxed at a maximum of 20% upon disposal.
Luckily, HMRC make this relatively easy by maintaining a public list, including a very large number of Vanguard ETFs.
So far, we have assumed that the reader is a UK resident and has UK domicile as most returning British expats are likely to be and have. Americans who have moved to the UK are more likely to be considered non-UK domiciled, at least initially.
Such taxpayers may have the option of being taxed on an arising basis (where offshore income/gains are UK taxable as they arise) or on a remittance basis (where only offshore income/gains that are remitted to the UK are taxable).
Reporting funds may not be tax efficient for non-UK domiciled persons claiming the remittance basis.
If this applies to you, please do more research (see the links below) and please liaise with a UK tax specialist familiar with this.
If you are claiming the remittance basis and paying the annual UK remittance basis charge, you should already be receiving advice that takes these matters into account.
For most UK residents investing in US-based funds, reporting funds are to be preferred. For anyone planning on moving to the UK, ideally you want to address this before you become UK resident.
For someone who is both a US citizen and a UK resident, investing can become particularly challenging. If you invest in GBP then you are strongly advised to avoid PFICs [LINK TO BLOG 4], which excludes the vast majority of mainstream collective investments.
If you want to invest in USD, you face the same challenge. Most non-US USD funds/ETFs are PFICs, so you turn to US funds/ETFs. Your field is narrowed to those that have reporting status (luckily for you there are many good options).
Unfortunately, this just is what it is. The best you can do is to work within the system. The trouble starts when investors are unaware of these issues and, worst case scenario, the US citizen and UK resident ends up with GBP PFICs and US / USD non-reporting funds. That is likely to be expensive to resolve.
* To quote HMRC from the www.gov.uk website: “An “offshore fund” is defined in UK tax legislation. Broadly such a fund is an investment scheme of which the trustees or operators are not resident in the UK”
Plan First Wealth LLC is a Registered Investment Adviser. Information presented is for educational purposes only and does not intend to make an offer or solicitation for the sale or purchase of any specific securities, investments, or investment strategies. Investments involve risk and unless otherwise stated, are not guaranteed. Be sure to first consult with a qualified financial adviser and/or tax professional before implementing any strategy discussed herein. Plan First Wealth does not provide any tax and/or legal advice and strongly recommends that Clients seek their own advice in these areas.