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Non-US Funds and “Stocks and Shares” ISAs


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f you have ever sought advice from a UK independent fi nancial advisor it is likely that they will have advised you to invest in non-US funds (due to the returns that can be achieved) or a stocks and shares ISA (due to benefi - cial UK tax treatment). Unfortunately for US citizens or green card holders the IRS might then regard you as having invested in a Passive Foreign Investment Company (PFIC) and when non-US funds are sold they can be subject to onerous tax charges. This is attributable to the fact that


the IRS does not want people invest- ing in non-US funds and accumulat- ing the income within the fund and then, when the fund is sold, for it to be treated as a capital gain. A PFIC is defi ned as any foreign


corporation which meets one of the following tests: i. 75% or more of the gross


income of such corporation for the taxable year is passive income, or ii. The average percentage of assets held by such corporation dur- ing the taxable year which produces passive income or which are held for the production of passive income is 50% or more. In broad terms, passive income means non-trading or investment income such as rents, interest or divi- dends. Therefore an investment in a non-US fund (be that held in a stocks and shares ISA or independently) would fulfi ll either one or both of these tests.


18 The American Under PFIC rules, where a US


shareholder is invested in a PFIC, at any time during the holding period of the shares, (a) any gain recog- nized by the US shareholder on the disposition of stock in the PFIC, will be subject to tax at ordinary income rates (rather than long-term capital gains rates), and (b) any such gain is then also subject to a penalty interest charge that is designed to put the US shareholder in essentially the same position they would have been in had they earned the income person- ally over the holding period. There- fore in summary, the UK tax benefi ts of investing in an ISA for example, are simply canceled out by the US income tax and interest charge.


Reporting Requirements PFICs are reported on an annual basis by fi ling a separate Form 8621 “Infor- mation Return by a Shareholder of a Passive Foreign Investment Com- pany or Qualifi ed Electing Fund” for each PFIC investment (i.e. each non- US fund), which is attached to and fi led with the tax return by the due date (inc. extensions). Taxpayers owning PFICs treated under the Mark-To-Market or Quali- fi ed Electing Fund rules are required to fi le a Form 8621 on an annual basis to report the annual income from the PFIC. Individual taxpayers owning a PFIC treated under the excess distribution (default method) must fi le a Form 8621 to:


by Phil Hawkins


i. Report an election (i.e. QEF or


MTM), distribution from the PFIC or a disposition of an interest in the PFIC; or ii. Report certain non-income


information in the event the tax- payer’s ownership in the PFIC invest- ments exceed specifi c valuation thresholds.


Excess Distribution Method (Default method) Unless you make a formal election you will be taxed on this basis and an “excess distribu- tion” is tied to the relative frequency that the PFIC earns and distributes income as a measure of the defer- ral of US taxation and the amount of such distributions. The amount of an “excess distri-


bution” is calculated with reference to 125% of the average amount received during the three preceding taxable years (or shorter if the hold- ing period is). On receiving a distribution or sell- ing a non-US fund, all of the income and gains held within the fund are taxed at the highest income tax rate (currently 39.6%). In addition to this, the income and gains are considered as being earned ratably over the term of your investment, and inter- est is payable on income and gains which are considered earned in ear- lier years. The interest is currently 3% and compounded annually. Also, it is worth noting that losses can be disallowed.


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