Stepping Stones: Tax on investments for Americans in the UK

Case study: Minimising tax on investments

Ian and his family planned on moving from the US to the UK for five years. This could become more permanent in the future but the initial intention is a five year period. He already held an extensive investment portfolio located in the US and was concerned on how the move may affect his tax position. His portfolio totalled $750,000 and included a variety of investments including stocks, bonds, mutual funds and exchange-traded funds. Ian wanted to maintain his investments tax-efficiently, while also bring over some of his US income and gains to purchase a UK property and invest in the UK. He therefore contacted our experts for specialist advice.

Pre-arrival planning

A key aspect for any American looking to move to the UK, is to plan ahead. It was important for Ian to get in touch in advance of moving to the UK so that he was aware of all the relevant tax implications and make tax efficient changes before crossing the pond.

Arising basis versus remittance basis 

We firstly explained to Ian that there were different ways in which he could be taxed in the UK. Although Ian would become UK tax resident, he would not be considered UK domiciled. Domicile essentially means ‘place of permanent belonging’ and because Ian only planned to stay in the UK for five years, he would not be regarded as UK domiciled.

As Ian is non-domiciled, he has a choice of how he is taxed in the UK; arising basis or remittance basis. Arising basis means that Ian would be taxed on his worldwide income and gains in the UK, whereas remittance basis means that he would be taxed on only his UK sourced income and gains, plus any overseas income and gains that is remitted (brought in) to the UK. 

The remittance basis can be a tax efficient route as it avoids some of the pitfalls of the UK tax system on investments. However, there are intricacies and limitations to this option which means that it may not be the best choice for everyone. We advised Ian to file on the arising basis because he wished to bring his overseas income and gains to the UK. 

UK tax implications of US investments

Non-UK funds

The UK tax rates on the disposal non-UK funds can either be at the preferential Capital Gains Tax rates, or at the higher Income Tax rates. This is dependent on whether each fund is considered to be a reporting fund or a non-reporting fund. Any gains on disposals of non-reporting funds while UK tax resident are known as offshore income gains (OIGs) and are taxed at the higher Income Tax rates. 

Ahead of Ian’s move to the UK, we reviewed his holdings in mutual funds and exchange-traded funds. We were able to advise which of these would be considered non-reporting funds and that he should consider selling them prior to becoming UK tax resident. The gain on the disposal of these non-reporting funds totalled £120,000 and the sale prior to the move to the UK saved him £25,000 in tax, compared to if he had sold these once he had become UK tax resident. 

Capital gains on shares

We also advised Ian that the the way in which capital gains are calculated on the sale of shares differs between the US and the UK, which can cause complexities. In general, the US uses a first in first out (FIFO) methodology. This means that if a disposal of shares is made that has various different purchase dates, the earliest purchases are deemed to be sold first. Conversely, the UK uses an averaging method of all purchases of the shares to determine the cost basis. This difference in treatment between the US and the UK can cause a mismatch in the capital gain calculated in each jurisdiction.

Exchange rates

Additionally, we explained to Ian that there will also be the movement in the GBP/USD exchange rates to consider. This is because from a UK tax perspective, the capital gain has to be calculated in GBP. This is done by converting the cost basis and proceeds at the respective GBP/USD spot rates as on the purchase and sale dates. This means that the movement in exchange rates can have an impact on the level of gain or loss that is taxable in the other jurisdiction. It can even be possible to be in a loss from a US perspective, but be in a gain position in the UK.

One of the issues would be that it's time consuming to convert the US disposals into GBP using the correct methodology and exchange rates, and so, this therefore can be costly from a compliance perspective. We advised Ian that he may wish to consider selling any holdings with multiple purchase dates ahead of his move to the UK to avoid those large future compliance costs. We also performed some calculations for Ian and advised that due to the movement in the GBP/USD exchange rate, some of his investments that had grown very little in USD, resulted in gain of £20,000 from a UK point of view. He therefore may wish to sell these prior to the UK and this a UK tax liability of £9,000.

US tax implications of UK investments

As well as using the money brought to the UK to purchase property, Ian also wanted to start investing in the UK in a tax-efficient way from both the UK side and the US side.

Passive Foreign Investment Companies (PFICs)

Like the UK, the US has rules that relate to investments located outside of its jurisdiction. A PFIC is any non-US company or non-US investment trust where the majority of its income is generated from passive sources (e.g. interest, dividends, gains etc.) or the majority of the assets held are passive in nature (e.g. investments). Investing in these products may result in punitive taxation. 

As well as the punitive taxes on PFICs, there are also significant annual US compliance requirements when it comes to these types of investments. PFICs are required to be reported on Form 8621 as part of a taxpayer’s US tax return. A separate form is required for each individual PFIC held during the year, even if no distributions or gains were received from the investment. 

Without seeking professional advice, Ian could have unknowingly invested in PFICs. However, with our advice, Ian was able to avoid these products which ensured his investments stayed tax efficient in the US and avoided significant annual filing requirements and compliance costs.

Individual Savings Accounts (ISAs)

Ian was aware of UK ISAs and told us that he was wanted to invest within these accounts to avoid tax. However, although these accounts are tax free in the UK, they would still be taxable in the US, and so the tax treatment of PFICs would still apply.

We discussed the PFIC issues with Ian, and our Expatriate Tax team worked collaboratively with our Financial Planning team to provide Ian with joined up financial and investment advice, which considered both the UK tax and US tax issues. Ian then had a comprehensive financial plan to follow, which enabled him to invest tax efficiently from both a US and UK tax perspective. 

Tax planning opportunities 

Year-end planning 

We advised Ian that annual year-end tax planning may be required for him to avoid double taxation. In particular, the US allows foreign tax credits to be claimed on a paid basis, which means the date in which his UK tax is paid is very important. If the tax isn’t paid at the right time, Ian may not be able to claim the foreign tax credits in the corresponding tax year to when he received the investment income and gains, which could result in double taxation.

Accrual basis

It’s possible to elect the accrued basis for foreign tax credits purposes in the US. Ian had not previously elected the accrued basis, but if he ever did in the future, foreign tax credit planning could get trickier. If the election is ever performed, the dates in which Ian makes any capital disposals would then be very important. The investments would ideally need to be a sold at a time when there is an alignment between the US and UK tax years, which would allow a foreign tax credit to be claimable at the correct time.

Gifting

Another planning opportunity was for Ian to gift assets to his spouse such as gifting some of his assets to his spouse. The UK taxes individuals separately, and it's not possible for spouses to file jointly, so gifting can be a good way to utilise the lower tax rates and thresholds for both spouses, and therefore optimise their joint tax position.

How we can help

Investments can be an important part of your life and future plans, so we are here to simplify the tax side of things. Our dual-qualified US/UK tax experts can provide offer a review of your investments and analyse how these would be treated from a UK and US tax perspective, as well as provide solutions to optimise your worldwide tax position tax position, based on your personal circumstances. Furthermore, our Financial Planning team can help if you’re seeking independent financial advice.

Get in touch 

For professional advice tailored to your unique circumstances, please contact Dom directly, or fill out the form below and one of our experts will be in touch to discuss your requirements and how we can help. Please note that our advisory services are charged at our hourly rates and a formal engagement will need to be in place before any advice is provided.