US tax on UK dividends?

BACKGROUND

•   I am a British citizen resident in the UK.  I do not have a green card.
•   My wife is a US citizen and she has been living in the UK for over 4 years.  She has no other ties to the US except that we return for a 2-3 week holiday each year to visit family.
•   I have a UK resident company.  The company has no ties to the US.
•   I would like to issue my wife with shares in the UK company so that she can receive dividends from the UK company.  It is proposed that my wife’s shares would entitle her to: (a) 50% of the company’s capital/equity value, (b) 50% of shareholder voting rights, and (c) dividends of such amount as we decide each year.  However, as the shares have not yet been issued, we can implement a different share structure if this proposal causes any issues from a US perspective.

QUESTIONS

1.   Does the proposed share structure of the UK company cause any issues from a US perspective?

2.   What tax (if any) will my wife be liable to pay in the US on the dividend income she receives from the UK company? 

The UK/USA Double Taxation Convention that came into force on 31 March 2003 (DTC) seems to state (at article 10.6) that the US cannot tax dividends paid by a UK resident company unless the dividends are paid to a US resident.  For the purposes of the DTC, based on article 4.2 of the DTC, I do not believe my wife is a US resident.  If this is correct, does this mean that my wife is not liable to pay any US tax on the dividend income she receives from the UK company?

3.   What are the filing requirements for my wife and the UK company in respect of: (a) my wife acquiring and holding shares in the UK company, and (b) my wife receiving dividend income from the UK company.  (NB: It is unlikely that my wife will have any other income besides the dividend income from the UK company). 

Any pointers would be gratefully received!

Did your wife file a 5471 for the year you were married, or the year the company was formed if later?

No, but she doesn't (as yet) hold any shares in the company.

Hello PJ, this is a soft way of saying you are opening yourself to a lot of US tax compliance (and costs!) the moment your wife gets the shares.  I know of people that did that to take advantage of the fact the UK allows a dividend exemption on the first (two?) thousands and a reduced income rate if the spouse is in a lower tax bracket.  When it was revealed the spouse  was a USC, they spent thousands of ££ in undoing the whole scheme.  This was after they had to pay a hefty US tax bill to settle any US tax due on the prior year's dividend distribution.  In their case, it was not worth the effort. 

Thanks Guildford.  I knew it wasn't going to be straightforward and accept that I'll have to take professional advice on this.  I certainly don't want to accrue a big tax liability or fine further down the line!

It sounds like the Double Tax Convention might not apply as I had thought it would.  Either way, if the US tax (with cost of filings etc factored in) is significantly less than a UK tax of 32.5% (the amount I will have to pay on dividends exceeding roughly £45k) then it might still be worthwhile.

I was in a similar position to you. The paperwork is not that bad - 5471 as Guya said for anyone with more than 10% share. I certainly declared the dividends on my US taxes - as "qualified dividends" if I remember correctly.

I had a US accountant file 5471s  and the usual other personal forms, FBARs 8938 etc. and he was very reasonable (less than $500 US). PM me if you want a referral.

A

I forgot to mention - see if you can get your UK company tax year the same as the US tax year if you do this - otherwise you'll need to prepare two sets of accounts for the UK...

I agree with the comments that there are substantial US tax issues for US citizens who own shares in non-US companies. However I also thought that it might be helpful to add some remarks about the taxation of UK dividends received by US citizens.

The starting point is to consider that the UK US double tax treaty should be best approached as follows-
•   The main treaty provisions apply to individuals who are not US citizens. This will cover UK resident individuals who are not US citizens who are in receipt of US income.
•   The US taxes its citizens even when they are not US resident. The tax treaty accommodates this by providing a reduced number of treaty provisions that apply to UK resident US citizens.

In more detail, for UK resident US citizens the key provisions are-
•   Article 1(4) gives the general rule that that US citizens are to be taxed as if the treaty did not exist.
•   Article 1(5) then lists a limited number of exceptions to this general rule, with the few treaty provisions that still apply.

The taxation of dividends is dealt with under Article 10. But the provisions of Article 10 are not within the list contained in Article 1(5). Accordingly there is nothing in the treaty that limits the UK or the US’s rights to tax UK dividends received by UK resident US citizens. The only remaining applicable provisions are those in Article 24, dealing with double tax relief.

The overall effect of the above, as regards UK dividends received by UK resident US citizens is-
•   The dividends are taxed under UK domestic rules. The taxation depends on the income and circumstances of the individual, but the marginal rates can be 0%, 7.5%, 32.5% or 38.1%.
•   The US is required to give relief for the above UK tax in charging the individual to US tax.