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How to advise Americans living in the UK
12 August 2010
Tony McLoughlin, investment director at London & Capital, discusses how the investment challenges facing Americans living and working in the UK can be alleviated. With some 182,000 Americans currently living and working in the UK, it is difficult to assess the scale of the issues facing those US citizens who are living in the UK but are non-domiciled: the community we know as US non-doms. However, it is crystal clear that the rules and regulations pertaining to the financial affairs of a US non-dom are now so draconian that many wealth managers and international banks are simply withdrawing from the market. For instance, many Swiss banks refused to service the US non-dom market long ago. For US high-net-worth citizens whose business or personal interests necessitate international residence, this has become a burden, and increasing numbers are seeking professional advice in an effort to identify appropriate solutions, and to mitigate their problems. Rules and regulations Recent legislative activity in America has had some onerous consequences for US citizens living or working abroad. The tax treatment of non-US investment assets can be severe, with the US regulatory authorities imposing greater reporting requirements and higher penalties for non-disclosure. Much of the regulation centres on the US Bank Secrecy Act. Although introduced in 1970, it has been pursued with increasing vigour in the aftermath of the attacks on 11 September 2001, and the notoriety brought about by the publicity surrounding unreported bank accounts held in Switzerland. This Act states that every US citizen or resident must file a report of Foreign Bank and Financial Accounts (FBAR) if they have a financial interest in, or signatory authority over, foreign accounts worth $10,000 or more during any one tax year. More recently, President Obama introduced the Hiring Incentives to Restore Employment Act (HIRE Act). To fund job creation, the Act introduced the Foreign Account Tax Compliance regulations, with the express aim of tackling offshore tax evasion. These regulations have imposed stringent due diligence and reporting requirements on non-US financial institutions in respect of foreign accounts owned by US citizens, residents and entities. As the US Government seeks to resolve its budget deficit, US citizens and residents can expect at the very least more attention around their non-US holdings and, at worst, the regulations may become even more draconian. Key issues for US non-doms The main problems facing US non-doms are: US worldwide income and gains tax Offshore structures Investment ‘tax-traps’ Information reporting obligations. It is essential for advisers to appreciate that Americans are taxed on a worldwide basis, irrespective of where income/gains arise. Coupled with the recent implementation of changes to the domiciliary rules in the UK, this creates an additional set of challenges for US citizens living and working in the UK. US citizens also have to understand that investments will need to be compliant for both tax jurisdictions. The introduction of a ‘stay-related’ threshold (a resident for seven of nine tax years) for automatically attracting UK income tax residency, is another major hurdle for Americans to overcome. In this situation, US citizens deemed domicile for UK income tax purposes can avoid having to include their worldwide income or gains in a UK tax return by electing, on an annual basis, to be treated on the ‘Remittance Basis’ and paying a charge, which is currently £30,000 per annum. Therefore, they will be taxed only on income arising in the UK. Relatively simple savings arrangements such as ISA and SIPP investments will generally lead the US citizen into a ‘tax-trap’. Many Americans have been advised to take advantage of the ISA tax shelter to invest in Unit Trusts and OEICs, blissfully unaware that this will cause them to fall foul of the IRS’s Passive Foreign Investment Company’ (PFIC) rules. They will be taxed aggressively on all gains and may be subject to penalties equal to 100% of the value of the investment. There are just as many problems with SIPPs, which the IRS classifies as a ‘Foreign Trust’, with growth within a SIPP being fully taxable. Many of the professional clients referred to London & Capital have been advised to move their pension pot from a company scheme. But investments that were once fully sheltered from the IRS in a company scheme become fully taxable as a result. So the need for US non-doms to consult with specialist tax and investment advisers is clear and has never been more important. Despite such complications, there are a number of ways which US non-doms can organise investment portfolios and be compliant from both a UK and US tax position. The use of US-compliant insurance wrappers can provide a solution to many of the problems now arising. Furthermore, if a compliant US qualifying insurance policy were owned by a SIPP, for example, the US reporting requirement of the investments is removed, as well as the disadvantageous tax treatment of PFICs. Investment considerations From a US perspective, investment considerations include: Are any investments PFICs for US purposes? Ordinary income tax rates plus compounding interest penalty applies From a UK perspective, investment considerations include: Are any investments subject to the UK accrued income or offshore income gain rules? Are any of the investments hybrid entities that could cause dual taxation if remitted to the UK (for example, US funds structured as LLCs (limited liability companies), rather than partnerships? Does any ‘clean capital’ exist and is it being preserved to allow for tax-free remittances into the UK? The benefits of investing through dual-compliant insurance/annuity products include: Access to PFIC investments Deferral of tax Estate planning opportunities. Finding the right strategy There are a number of key considerations in developing an appropriate investment strategy and to ensure the appropriate organisation of a tax-efficient and compliant investment portfolio; whatever is selected for investment needs to be risk-managed, liquid and tax-compliant. Any experienced investment adviser should also investigate whether there are any tax-efficient or tax-planning opportunities. Examples include using insurance vehicles (such as deferred variable annuities (DVAs), college plans or pension plans. When assessing the investment solutions available it is most important that they are not looked at in isolation. From a tax-compliance perspective, the investment adviser should have a clear understanding of the UK and US tax treatment and the ability to produce UK and US tax information where required. US non-doms looking to invest will have a myriad of solutions available to them. In making those choices they will do well to work with wealth managers specialising in this space and who have the resources to offer appropriate support and guidance. Published by IFAOnline
