Why do I need to know about PFICs (Passive Foreign Investment Companies)?
There has been an increasing effort by US policymakers, such as the Internal Revenue Service (IRS), to bring US owned assets back onshore where they can monitor them properly. Partly, this has been done by initiatives such as FATCA, but the Passive Foreign Investment Companies (PFICs) regime is an important part of the agenda.
What is a PFIC (Passive Investment Company) ?
Given the complex name, it is easy for unsuspecting expats to believe that the regime only encompasses complex investments – offshore trusts or similar. In fact, almost all investments registered outside the US are caught by the PFIC reporting legislation, including basic mutual funds, insurance products and even tax-incentivised savings products such as ISAs and – in some cases – pensions.
Why were the PFIC rules introduced?
The PFIC rules have been designed to ensure that it is difficult for US expats to invest abroad. As such, assets deemed to be ‘PFICs’ are subject to significantly higher tax rates.
Who is caught by PFIC rules?
The PFIC rules extend to all US citizens, US residents, green card holders and to trusts controlled by US-connected people. The legislation includes those who live outside the US and may have done so for some time and must be filed using Form 8621 for each tax year.
What does PFIC (Passive Investment Companies) mean for investors?
The PFIC tax regime is onerous: Capital gains are taxed at an investor’s high current income tax rate, with no reduction for holding assets over a longer time frame. The IRS also assumes that all gains were made evenly over the course of the investment and then levies interest on the tax ‘deferred’. As a result, tax rates from PFICs (Passive Investment Companies) can hit as high as 100% of the gain. The aim is to make the tax rates so punitive that no counterbalancing investment gains can possibly make it worth investing in these assets.
How can expats be caught by PFIC rules?
It is easy for expats to get caught by the PFIC rules. Many US citizens coming to the UK, without a US specialist investment advisors make the mistake of investing through UK collectives or funds. Non-specialist UK IFA’s and wealth managers will typically recommend this type of investment and may not realise the consequences.
Are there any other issues?
There is a secondary problem for US citizens moving to the UK. Once they become domiciled for UK income tax – this happens automatically if they are resident for 7 out of 9 consecutive tax years in the UK - the UK tax authorities will treat their US mutual funds in much the same way as the US tax authorities treat PFIC’s, through the UK offshore fund rules, with some equally nasty tax treatment.
How does the UK’s offshore fund regime work?
The offshore funds regime in the UK applies to any ‘collective investment scheme’. This includes plain vanilla US Exchange Traded Funds (ETF’s) and mutual funds and in practice, most other collective investment vehicles other than partnerships, whether or not the investment management takes place within the UK. This applies to any collective fund without ‘distributor status’ in the UK.
As with PFICs (Passive Foreign Investment Companies), the tax treatment can be onerous: Any capital gain will be taxed at the highest rate of UK income tax (up to 45% rather than the more generous 20% that applies for capital gains on investment in the UK). Dividend and/or interest payments received will also be treated as income.
It is important, therefore, to establish before any investment in an offshore fund is made whether the fund has distributor status. Where there is a choice between two similar offshore funds, one with distributor status will be significantly more tax efficient from a UK perspective.
Are there any other important considerations?
Many US individuals and families who decide to come to the UK are often not made aware of the UK remittance rules and can find themselves paying their highest rate of UK tax should they wish to bring in funds from their US brokerage accounts.
Many of the most common US domestic broker platforms are unable to separate capital and income. US citizens moving to the UK need to ensure that they hold their investments with a custody platform that can separate capital and income or risk problems bringing money into the UK efficiently.
The right adviser
Negotiating the complexities of the US/UK tax system, finding the right investment management, while staying on top of your long-term plans is no mean feat.
It is key that US/UK families find an investment advisor that can not only put a compliant investment strategy in place, but can also produce the US/UK investment information and manage their US, UK and offshore investments cohesively.