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Robert Paul, Partner in the US Family Office spoke to Pau Morilla-Giner, CIO and Tahir Mahmood, Tax Specialist at London & Capital about the tax implications of an American buying a property in the UK, we have summarised their discussion below.
Building an investment portfolio in the UK isn’t a straightforward process for American expats. Despite the principles of investing being the same in both countries, the different fund structures available and tax rules applied throw up all manner of obstacles. Indeed, the real complication is how the Internal Revenue Service views UK fund structures and tax wrappers such as Individual Savings Accounts.
Under the US tax system, Americans are taxed on worldwide basis regardless of where they live. Even though the UK and US have tax treaties in place to prevent double taxation, matters are rather different when it comes to investment vehicles because many of the products used in the UK are not compatible with American tax rules.
For instance, you may think a unit trust or open-ended investment company (OEIC) is the same as an American mutual fund. But you’d be mistaken. While they achieve the same things, the way British funds are legally structured is what causes the most trouble with the IRS.
In the UK the most common funds structures are OEICs and unit trusts. These can create a tax disadvantage if they are not structured to comply with US tax rules. This is because they are regarded as passive foreign investments companies (PFIC) by the IRS and are taxed in such a punitive manner that the liability can potentially wipe out any gains made.
Conversely, a similar situation can work in reverse. Americans who live in the UK but have investment portfolios in the US can run into trouble. Unless the funds held in the US have reporting status in the UK, they will fall under offshore fund rules and any proceeds will be taxed as income rather than capital gains.
For Americans who hold assets in both the US and UK, it is critical that they are structured so that they are compatible with the tax regimes in both countries. On top of this, it is important to take note of currency movements and an investment time frame, because this can also affect any tax that may be due, especially for those who are longer-term residents in the UK.
While most funds outside of the US do not comply with PFIC rules, all is not lost. There are a few funds that are treated as qualifying funds for US tax purposes, so it is possible to build an investment portfolio comprising open-ended funds in the UK. Similarly, the same is true of UK offshore funds rules. Some US mutual funds and ETFs have UK reporting status, which means they report the necessary information to the UK to ensure they are taxed in the same was standard UK funds.
There is one way around this problem, however, and that is to invest directly into stocks and bonds. They will be taxed under the normal rules in both countries and offer a broad investment selection. Investing this way may be more labour-intensive for some and requires careful active management, but it is an easy way to avoid falling foul of the tax authorities.