Interesting thread for UK residents with US funds

This thread started as a question about how the UK taxes the dividends and capital gains of US mutual funds owned by UK residents that are taxed on their worldwide income on an arising basis. But I decided to edit it for various reasons including that I found this very useful explanation that underlines all of Guya's advice.

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

Here is something people might find useful.

I have been trying to do further research on this and at least attempting to understand the principle of why the UK taxes offshore mutual funds without "distributor status" at "income tax" rates and not capital gains tax rates. My intention is not to criticize the UK, I do realize the US also does the same with PFIC etc, but my interest is in the UK taxation since I live here.

Let me also add that I have no formal qualifications in law or tax law but just trying to make sense of all this. But I do want to raise doubts and share whatever I have learnt in case it is helpful to others. Do feel free to correct me tho'.

The principle of "distributor status" for "offshore funds" seems to be that many offshore funds used to "roll up income" and pass it off as "capital gain" and I understand this is clearly wrong. The investor is getting away with lower rates of CGT when they should have paid income tax. So I understand this part.

But what if the so-called offshore fund is a simple index tracker, much like the FTSE AllShare Index tracker in the UK ? What if this fund distributes / declares all its dividends to the investor ? This is what the Vanguard Total Stock Market index fund (VTSMX) does. Nothing secretive going on here. Yes, dividends are reinvested, but at the end of the year, a statement is sent out declaring all dividends paid. I believe this is the 1099-DIV. I am happy to pay dividend tax rates on this and 18% upon sale, just like I would do in a UK-based index tracker.

I called up one of the people in UK HMRC listed here http://www.hmrc.gov.uk/offshorefunds/dist_fundlist.htm [nofollow] and explained my predicament. I was not trying to move UK funds offshore. This was money I earned in America and it is invested in American mutual funds.

I also told her that Vanguard the company, probably wont bother applying for UK distributor status, since it primarily targets American investors. She replied to me that I have an option as per Page 18, Schedule 27 ICTA 1988, in this case, if I can show that the mutual fund does indeed distribute 85% of its income and does not have more than 5% of its investments in other offshore funds, then I am fine and I will be taxed as if the fund does have distributor status.

I am planning to meet a top expert from the Fry Group on these matters and I will share that info as well.

I would be very interested in hearing what you learn from Fry's.

 I share your disbelief in the lack of interest in what happens with the tax situation for US investments of Americans in the UK under the new tax regulations.  I actually tried to drum up some interest in the American Society about 15 months ago when the proposals first came out but they seemed oblivious to the implications and I never heard back from them.   

In any event I fear you will find that the way in which these investments are taxed are even more unjust than you could have ever imagined.  First off the list of registered distributing funds seems to be completely out of date.  The effective dates almost all have expired.  So then you are faced with paying tax at Ordinary Income rates for what are Capital Gains.  But I think it still gets worse.  You could have gains and losses from exactly the same fund.  The gains are taxed as Ordinary Income, max 40%, but the losses are classified as Capital Losses,  usable only against Capital Gains that are taxed at 18%.  But the trick is to get a Capital Gain to offset them against, one that is not classified in the UK as Ordinary Income.  Then I thought, oh well I'll just put the gains in my pension fund and get relief from the UK tax man that way…  But no it's classified as yet another type of income so you can't use it for pension contributions, that's reserved for Earned Income, which this is not.  Anyhow that's what I imagine is the case but I am not a tax advisor so I may not be right. 

I was also interested in the comment about being able to effectively self certify a fund if you can establish that they distributed 85% and had no less than 5%  in other offshore funds.  But how do you match up the dates?  So say you had a Mutual Fund that you bought in April 08 and sold in July 08.  Is it sufficient to establish that they met the criteria for the Calendar year 08, or perhaps the UK tax year Apr 08 through Mar 09,  or the plan year for the fund that incorporates the holding period, or perhaps the plan year that includes the date at which you sold?  And then yet another twist is that recently you will find that almost all mutual funds have lost money, so if the fund lost money for the relevant period is that in itself sufficient to establish that they have distributed over 85% of the gains, of which there were none.?