US mutual fund/ETF tax ?

Hi All.

I was born and raised in India, and went to US to study and worked there for a long time and then moved to UK. I have been in UK for last 7 years. I still have my bank account, brokerage account, Vanguard account, 401(k) etc in US. But I am not a US citizen / green card holder. At this point, I dont even have a visa to enter US. 

I still have my Indian passport but I am a UK permanent resident. I am eligible to apply for British citizenship. I might do it one of these days.

I get a modest amount of bank interest, dividends etc from the US which I dont remit to UK.  The total income I get in US is well below the US minimum allowance. I still file a US tax return every year but usually there is not much tax to pay. I dont declare my UK funds to US because I am not a US citizen anyway.

Until last year, I did not have to declare my US funds to UK as I could claim to be non domiciled. However, since I have completed 7 years in UK, I am now taxed on an arising basis by UK and am supposed to declare my US assets to UK. [I cannot afford the £30,000 fee]. I am a high rate tax payer in UK.

I have a six figure sum in the US bank account which is idling earning 1.75% bank interest. I was planning on investing this in Vanguard Total Stock Market index fund ( a taxable account ). Obviously I will be declaring the dividend and capital gains when I sell it. What will be the UK tax on this ? The reason I ask is because of funds not recognized by HMRC as "distributing fund" and all that.

I guess it wont make a difference if I used the VTI ETF instead of Vanguard Total Stock Market Index fund ? It is basically the same from an investment standpoint but the ETF trades like a stock. Reason I ask is because if I bought a normal US stock, my tax would be same as if I bought a UK stock here.

If I moved the money from US to UK, what is the tax I am looking at ? This was money that I saved from my after tax income. includes somebank interest etc, but I did not seperate principal from income, nor did I do any source-ceasing tricks etc ...

Any help would be most appreciated.

Thanks

There is no "minimum allowance" for dividends for non-resident aliens.  These are taxable at a flat 30% on the 1040NR for non-UK domiciliaries (15% for UK domiciliaries or those not leecting the remittance basis) so this is hopefully the rate of tax you have paid to date.

Thanks Guya. My dividends in US is hardly a few bucks to mention. Normally I file US returns  thru my US tax attorney. I give all the papers to them, so I guess it is all taken care of.

I guess I need paid advice from someone who knows a bit of US tax laws as well as UK tax laws and knows a thing or two about simple US mutual funds such as Vanguard index funds ETF etc. Also someone who can advice me on whether it would work out more expensive for me to keep the funds in US itself or bring them to UK. I dont have 100% commitment to UK, for all you know I might get out of here to some other country, so no point in bringing the US funds to UK if it is going to be a tax hit rightaway.

Should I contact British American tax or another company perhaps Fry group ? Who is the best in this ? Unfortunately some of the tax attorneys I have contacted give wrong information first and then I have to do the research on the internet and challenge them at which point they correct the information they gave me. I dont want to name anyone but I had this experience with 2 tax offices in UK. But I dont want to pay 1000 pounds an hour. The max I can go is £250 per hour.

Please let me know. Guya, I have seen many of your posts here. Are you an attorney ? Can you offer paid advice ? Thanks a lot.

We have a similar worry, namely how the UK taxes US mutual funds owned by a UK resident taxed on an arising basis. There is a clear explanation here. It's in declarative sentences.

http://www.franklintempleton.co.uk/jsp_cm/funds/pdf/SICAV_dis_TaxPosition.pdf

The upshot is capital gains on US funds that are not recognized as distributing funds by HMRC will be taxed at your marginal income tax rate. This applies to most US funds. I asked Vanguard about their status and they said that they had no knowledge of the HMRC rules and that I'd have to ask HMRC. I haven't done that yet, but I bet they'll say it's up to Vanguard to apply for distributor status. The only hope is for there to be a change in UK law
so listen to Mr Darling, although I think he has bigger fish to fry at the moment.

We have a similar worry, namely how the UK taxes US mutual funds owned by a UK resident taxed on an arising basis. There is a clear explanation here. It's in declarative sentences.

http://www.franklintempleton.co.uk/jsp_cm/funds/pdf/SICAV_dis_TaxPosition.pdf

The upshot is capital gains on US funds that are not recognized as distributing funds by HMRC will be taxed at your marginal income tax rate. This applies to most US funds. I asked Vanguard about their status and they said that they had no knowledge of the HMRC rules and that I'd have to ask HMRC. I haven't done that yet, but I bet they'll say it's up to Vanguard to apply for distributor status. The only hope is for there to be a change in UK law
so listen to Mr Darling, although I think he has bigger fish to fry at the moment.

The UK law will change in April 2009.  The position will be no better for investors who choose to invest offshore.

Thanks Guya. My dividends in US is hardly a few bucks to mention. Normally I file US returns  thru my US tax attorney. I give all the papers to them, so I guess it is all taken care of.

I guess I need paid advice from someone who knows a bit of US tax laws as well as UK tax laws and knows a thing or two about simple US mutual funds such as Vanguard index funds ETF etc. Also someone who can advice me on whether it would work out more expensive for me to keep the funds in US itself or bring them to UK. I dont have 100% commitment to UK, for all you know I might get out of here to some other country, so no point in bringing the US funds to UK if it is going to be a tax hit rightaway.

Should I contact British American tax or another company perhaps Fry group ? Who is the best in this ? Unfortunately some of the tax attorneys I have contacted give wrong information first and then I have to do the research on the internet and challenge them at which point they correct the information they gave me. I dont want to name anyone but I had this experience with 2 tax offices in UK. But I dont want to pay 1000 pounds an hour. The max I can go is £250 per hour.

I imagine that the sole owner/proprietor of British American Tax is probably solely US qualified while the Fry Group will probably not be US qualified.  I suggest you use a dual US & UK qualified adviser so that you get a balanced view.

Thanks Guya.

Any names of dual US and UK qualified advisors ? It is good to have a choice rather than the name of one specialist alone.

Who else will know this short of Alistair Darling ? Can I walk into a Inland Revenue Office and get an answer ? I also posted on Motley Fool UK taxes board and I was told that if you file your UK tax return online, there is not even a place where you can declare your offshore funds. Does this mean that I can away without declaring it ? If HMRC's own online form does not have a place to declare offshore income, to me thats as good as saying "dont declare it".

But I also heard about an investment specialist who seems to be able to get around this issue by having US mutual funds "dually registered". I was not provided details tho.

What does it take for a fund to be dually registered ? Can we petition Vanguard to do this  for us ?

Does anyone know if DFA (Dimensional Fund Advisors) is dually registered ? I know DFA funds are available in US and UK and Australia. That doesnt mean that the US DFA funds are "dually registered" in UK.

The UK law will change in April 2009.  The position will be no better for investors who choose to invest offshore.

Bluesuedeshoes, the most salient word in Guya's post is "choose". Your citizenship/residency status means that the US doesn't tax you on worldwide income so you can get the 18% CGT and allowances if you invest in the UK. For someone use to the low cost, excellent service and range of investment options of US firms like Vanguard this can be a bitter pill to swallow, but it seems like the obvious solution.

I've tried to research US/UK dual registered funds, but I've found nothing, which suggests that they are strange beasts and probably loaded with initial fees and expense charges and no better than the retail funds offered in the UK. If you find something though I'd be interested to know.

As a US/UK citizen I fall into an even more invidious position if I return to the UK as US PFIC rules make UK funds a bad choice for me and the current UK rules will tax my US funds' capital gains as income. For those reasons I'm putting as much as I can into US based retirement funds which will grow tax free and then withdrawals will be taxed as income in both the US and the UK although I think the tax Treaty will have to be invoked to decide which country gets the lion's share of the tax. The situation gets even more complicated as my retirement accounts are 401k/IRAs and a pension from private companies and 403b/457s etc from US Government/State work.


I intend to sell all my US after tax investments before I return to the UK to realize my capital gains at the US 15% rate. I'll then use a fair amount of this cash to buy a house or flat and a car to minimize my income needs, hopefully keeping them well below the 40% band.

In the US it's generally though best to keep income and dividend producing stuff in your tax deferred retirement accounts and emphasize growth ie potential for capital gains in your after tax savings, but if I move to the UK this logic doesn't follow unless I use dual registered funds. So I'll either keep some US mutual funds, pay US tax on dividends and CGs and apply that against the UK tax bill or just move into a US CD ladder or UK high interest saving account. I'll look for the best interest rate and just live with the taxation.

> suggest you use a dual US & UK qualified adviser so that you get a balanced view.

I would like a name if anyone knows. I guess I would prefer to pay someone and sort it all out altho I have gathered quite a bit of info from here.

As nun says, it is probably in my best interest to move all taxable money out of US. But I hate missing out on investment opportunities in the Mecca of capitalism, good old USA ! Also, all these rules are only for mutual funds / ETFs, not for shares. So I could buy shares directly in the US (if only I knew how to pick companies to invest in) and then I would pay only the UK rates for dividend and cap gains tax.

I guess Governments on both sides of the pond want to make life difficult for ordinary "passive" investors who are typically the middle class people many of whom dont have the time or ability to pick individual stocks and just stick to "lazy portfolios".  The very fact that Government taxes stock-based-mutual-fund differently than direct stock purchases means that they have a different rule for the "Big Boys", "City boys" and others. Same old Governments with one rule for the rich, a pretense to "take care of the poor", and a totally screwy shafting rule for the middle class who are expected to bear the brunt of taxation. 

Speaking of this mutual fund / ETF taxation business, let me try to understand the logic here : And I am not blaming just UK Govt here. I guess something similar is there in US not recognizing UK mutual funds. (unit trusts). What is the Government's stance here really other than the beureucratic motto of "We dont recognize each other" ? I understood part of it. Some funds roll up the dividend distribution so everything comes into capital gain. Fair point. The investor is trying to disguise "dividend income" into "capital gain" and pay a lesser rate of tax. Agreed, but why is this restricted just to "foreign mutual funds" ? Why not apply the same rules to domestic unit trusts as well ? As a UK resident, if I invest in Vanguard mutual funds in America, Vanguard is not the kind of company that hides dividend distributions. I am more than happy to pay 32% tax on the dividend distribution. But why ask me to pay a further 40% when I sell the fund ? I already paid the tax on dividend distribution !! And even if the stock-based-mutual-fund was indeed rolling up income and not distributing dividends, even then, at the time of sale I should be taxed 32% (and not 40%) because it is not like "bank interest". What does the word "income" mean in the context of stock mutual fund ? It MUST be dividend, isnt it ? So why tax me dividend income at 40% and not 32% ?

On an aside, there is another problem with moving my US money into UK and investing in UK equities : insurance limit. In US, SIPC insurance is upto $500K. In UK, it looks like only £48,000 of investors money is protected should the company that hold the investors security go bust.

I'd also love to hear of good dual qualified companies and dual registered funds, but both seem to be mythical things that are spoken of in hushed and revered voices, but never actually seen.

If the offshore fund is a distributing fund the UK taxes it just like an UK fund. The rule is to catch funds that don't declare dividends and roll income back to try to pass it off as capital gains. You'd think that there'd be enough US expats resident in foreign countries for this to be more of an issue, but it just isn't. I'd love to see something in the US/UK tax treaty that would address the taxation "Catch 22" of a US citizen resident in the UK who wants to put a "lazy portfolio" of after tax mutual funds together. It's not a big issue if you are in the UK 20% tax bracket and might be even less of an issue if US capital gains taxes go up. Also it's not an issue for a UK citizen resident in the US as the UK taxes on residency not citizenship, but a UK/US dual citizens and UK citizen green card holders who return to the UK do get a bad deal under the current regulations, particularly if they are in the 40% income tax bracket.

I can understand your reluctance to move the money back to the UK so why not buy Berkshire Hathaway, GE, Proctor and Gamble or other diversified companies. That way you avoid the offshore funds rules and get some diversification. For some fixed income you could just do CDs, but as you aren't a US citizen and are not resident in the US I don't think you can buy T-bills, I-bonds etc from the US Government.

> I'd also love to hear of good dual qualified companies and dual registered funds

There is apparently one dual registered mutual fund that requires significant investment. No further details on it.

Sorry nun, I kind of lost you there on the 2nd para. Mind if I go thru it line by line ?

> If the offshore fund is a distributing fund the UK taxes it just like an UK fund.

So the definition of "distributing fund" is one that pays out dividends instead of "rolling it up". Well, Vanguard S&P500 index fund and Total stock Market Index fund do declare dividend and dont "roll it up". So why consider them as "non distributing funds" ? What exactly are they failing to "distribute" ?

> The rule is to catch funds that don't declare dividends and roll income back to try to pass it off as capital gains

Okay, but if a mutual fund completely rolled up the "income" into capital gain, I agree that the "dividend income" has been "converted" into capital gain, and so the investor ought to be charged "dividend income" tax rate, not capital gain rate. I agree with this, but even using this logic, the tax due on sale of the fund (for a high rate tax payer) should be 32%(dividend income tax), not 40%. Where is the 40% coming from ? This is "dividend income" that has been rolled up, not "regular income" as in bank interest or salary. Thats the part I am not getting.

Another question : I guess in my case, when the time comes to selling the find, if I leave the UK for 8 months or reduce my income to 20% tax bracket, then it is a non-issue as you say, i.e I will pay 20% tax. What happens if I remit the gains to UK in the next year  following the sale ? Any further taxes to pay ?!

After knowing all the facts, it does appear that UK is indeed more liberal in taxation than US. The 40% bracket hurts, but being not taxed as a non resident as well as the non domicile rules they had until last year seem liberal.

The fund has to be on the HMRC offshore distributing funds list to get the 18% CGT. US Vanguard funds aren't on there so they don't qualify, even if they pay dividends and distribute 85% of their income. This is an area where there may be some change, but Guya says it won't be for the better.

The 32.5% rate for dividend taxation is apparently an error on HMRC's part that they have corrected now

http://www.hmrc.gov.uk/budget2008/bn101.pdf

HMRC just classifies gains and dividends from offshore non distributing funds as income. Its like the PFIC rules it's unfair for a reason, to discourage residents from investing offshore.

If you are taxed on an arising basis I'd imagine that it doesn't matter when you remit the money to the UK.