It was Winston Churchill who first coined the term ‘special relationship’ to refer to the close ties between Britain and America. The term was used in Mr Churchill’s’ “Iron Curtain Speech” given in March 1946 to a crowd in Fulton, Missouri. In the 70 plus years since the former UK prime minister made his speech, the ‘special relationship’ has blossomed. Today, the US and the UK are each other’s largest investor country; America is Britain’s top export destination and the US’s second-largest trading partner.
In 2016, the US State Department estimated that there are nine million US citizens living abroad and Britain has often been cited as the number one destination for US expats living outside their homeland, followed by France and Germany. The Office for National Statistics estimates that there are around 140,000 Americans living in the UK (2017). Despite the looming prospect of Britain outside the European Union, the UK is still seen as a favoured destination for Americans.
Yet for those US citizens currently living in the UK, or those in the process of moving, there are several important considerations when it comes to managing their wealth and financial affairs.
Various pieces of legislation, including the Hire Act, the Foreign Account Tax Compliance Act (or Fatca) and the Alternative Investment Fund Managers Directive (AIFMD), to name but a few, mean that any American living outside the US must contend with an alphabet soup of red tape and reporting requirements.
With this comes understandable confusion about where they can and can’t invest. For Americans living in the UK, the areas to consider can be broken down into four main categories:
- Underlying investments
- Investment products
In the UK, the most common form of investment used is funds or collective investments that are usually either structured as OEICs or unit trusts.
These types of investments, however, if not structured in a US-friendly manner, are extremely tax disadvantageous for Americans as they are regarded as PFICs (Passive Foreign Investment Companies) by the Internal Revenue Service, or IRS and, as such, are taxed in a much more punitive manner than they would be for a non-US tax reporter.
In much the same way as in the UK, the US investment industry is dominated by mutual funds, index funds and more recently exchange-traded funds (ETFs). Unless these have ‘reporting status’ in the UK, they fall under the UK offshore fund rules which results in any proceeds being taxed at UK income tax as opposed to potentially more favourable capital gains or dividend tax.
Another option is to invest in individual stocks and bonds. These individual assets are taxed under the normal regimes in both jurisdictions and give broader investment selection. There is also the potential to buy individual stocks that qualify for advantageous tax treatments on their dividends.
Much like investments there are some very common products used in the UK that Americans must handle with care. ISAs (Individuals Savings Accounts) for UK savers are very popular for tax-efficient investing. The government will allow an individual over 18 to invest £20,000, in the 2017 to 2018 tax year, of after-tax money into an ISA. This money will grow free of all tax while it is invested and – on top of this – the proceeds can be withdrawn at any point, also without being taxed.
The IRS, on the other hand, does not recognise these products. This means that they are viewed for tax purposes in the US like any other general investment account. There is a common misunderstanding that because the IRS does not recognise the ISA wrapper, they “do not work” for Americans.
This is not the case. An American living in the UK should take advantage of the ISA allowance before investing in a standard general investment account. The different treatment of these products by the UK and US is a common cause of mistakes. The investments within the wrapper are not subject to the higher UK tax rates but, instead, to the more favourable US tax rates.
Although the difference in the tax rates may be small it still makes sense to take advantage of this difference while it is around.
Once this is understood it is just a case of ensuring that the actual investments within the wrapper are not tax disadvantageous. This is achieved by ensuring the ISA wrapper selected allows for investments such as those discussed earlier. At this point, I recommend speaking to your wealth adviser to establish which option best suits your personal requirements.
In brief, the US and the UK have a pension treaty that means that any employer-sponsored pensions are considered by both jurisdictions in the manner they are treated in their home country. This means that any investments within them are immune from any of the negative tax treatment discussed previously. However, the water has been muddied since the dawn of private pensions and more specifically SIPPs (self-invested personal pensions), as there is no specific reference made to these in the US/UK pension treaty.
SIPPs are commonly set up as trusts and so could potentially fall under the ‘Foreign Grantor Trust’ rules in the US. This means they will need to file additional reporting information and to be transparent from an IRS perspective. This transparency would mean the underlying investment again must be reviewed, because, much like the ISA, the most common investment available within these products would fall foul of the PFIC rules.
What could you do?
Given the ambiguity in this area from a tax perspective it is difficult to provide a hard and fast ‘solution’. We like to find the path of ‘least regret’.
Should the IRS decide that SIPPs are in fact foreign grantor trusts, then ensuring the money is not invested in assets that are taxed punitively is key. This prudent approach ensures that whichever the IRS decides, there will not be a negative tax surprise further down the line.
This may not be the most commonly reviewed area but where the investments are and how they are structured can be just as important as where they are invested. For Americans who come to the UK, they often arrive on the premise of staying for a few years and then returning to the US without ever needing or wanting to bring money from the US into the UK. Should this be the case and they do not trigger the seven out of nine-year residency rules in the UK, then their US investments are safe from the eyes of HM Revenue and Customs.
However, like many things in life the initial plan does not always stay the same. For those who end up deciding to stay in the UK for longer periods of time, or want to invest money in the UK, the structure of their offshore assets becomes extremely important. If a US individual wants to bring money into the UK from abroad and there has not been a clear separation of the original clean (tax paid) capital from the rest, the UK will view the monies as ‘mixed’. This mixed capital can be subject to income tax on remittance to the UK and thereby causing potential double taxation.
This is the most commonly overlooked issue but has the potential to cause enormous headaches.
Given that it is difficult to plan for events that may or may not happen, finding an approach that maintains the most flexibility is often the best answer. The solution to this problem may sound simple enough, but it is easier said than done. Assets that are offshore from a UK perspective should be set up in such a way that ‘capital’ is separated from ‘income’. This means that any income/interest/dividend that gets distributed from the assets needs to be ‘swept’ (within 24 hours) to a separate account.
What could you do?
Quite often the mechanism for doing this is more difficult than it sounds, as many of the investments do not allow for this or custodians are not geared up to do it. Ensuring that the investment manager and the custodian bank are able to execute this is fundamental.
Although this does require re-organising offshore assets, like all these things, this should be done as soon as possible after becoming resident in the UK.
Take action now and get in contact with me or another member of the US Family Office at London & Capital on 020 7396 3388 or email us on firstname.lastname@example.org. We’d love to be able to help.
We have been providing specialist wealth management services to Americans living overseas since 1989. We understand the complexities involved with being an American living outside the US and this helps us provide all clients with holistic wealth planning, long-term investment advice and consolidated reporting.
This article was first published on FTAdviser.com.