Busting some common myths about HMRC non-reporting funds

It's been stated many times on this forum that most US mutual funds don't have HMRC reporting status and that any gains will be taxed as income rather than capital gains.

I recently came across the following section of the Offshore Funds Manual:

OFM10200 Investors in non-reporting funds: exceptions to the charge to tax: interests in certain transparent funds – Regulation 29
...
The purpose of the offshore fund regime is to ensure that income cannot be rolled up free of tax, with any subsequent gain on disposal being charged only as a capital gain. If a fund is transparent for income, such as would be the case for certain unit trusts and contractual funds, then any income arising to the fund is treated as arising to an investor in proportion to his rights. This means that income is charged to tax as it arises.

However, it might be the case that an income transparent fund that came within paragraph (b) or (c) of section 40A(2) of FA 2008 itself invested in a non-reporting fund, and if that were the case then income could be rolled up in the underlying fund, because income would only be credited to the top fund if it was distributed. In order to counter potential roll-up of income by an income transparent fund in underlying non-reporting funds, whilst also preventing unnecessary administrative burdens for transparent arrangements coming within the definition of an offshore fund and for their investors, any gain on disposal of an interest in an income transparent offshore fund will not be taxed as an offshore income gain unless

   during a period beginning on the date the interest (or any part of it) was acquired and ending on the date of the disposal, the offshore fund at any time held interests in other non-reporting funds (except for certain other transparent funds – see below) which amounted in total to more than 5% by value of the offshore fund’s assets (Regulation 29(2)) , or

   the transparent fund is a non-reporting fund, and the fund fails to make sufficient information available to participants in the fund to enable those participants to meet their tax obligations in the United Kingdom with respect to their shares of the income of the fund (Regulation 29(3)).

Whilst this does mean that transparent funds will have to monitor their underlying investments, it allows such funds to avoid the need to apply for reporting fund status (and for their UK investors to be charged only capital gains tax or corporation tax on an capital gain arising, rather than incurring an offshore income gain, provided the fund has complied with Regulation 29(2)).
...
Provision of information to participants
If a fund is unable to provide sufficient information to its UK investors to enable them to meet their UK tax obligations then an offshore income gain will be charged on any gains realised on subsequent disposals of relevant interests. The provision of ‘sufficient information’ would include details of an investor’s proportionate share of both income arising to the fund and reported income or offshore income gains arising to it, as well as confirmation as to whether or not the fund has invested more than 5% by value of its assets in non-reporting funds. In practice, many existing income transparent funds with UK investors already provide vouchers to those clients detailing income arising to the fund, for example interest income, and foreign or UK dividends.

Most if not all US mutual funds will already fall within this exception because US law requires them to:

• operate in an income transparent fashion by distributing all their income (both dividends and capital gains) instead of accumulating it within the fund
• provide statements of any such distributions to their investors

Therefore investors in US based funds qualify for the same tax treatment regardless whether the fund has HMRC reporting status - it's a bit of a distinction without a difference. The language suggests that reporting fund status only makes a difference where a fund (say one based in a third country) accumulates its income rather than distributing it, or invests in other accumulating funds.

This should help any UK residents who invest in the US breathe a little easier! For my own part I feel sufficiently confident in my position that I have made such a claim on my own UK self assessment return.

I would be interested in hearing if some of the folks who take the opposite position could point to any additional evidence that should be considered.

Interesting. The regulations applied to US mutual funds are pretty strict and it sounds as if you'd be ok. I'd be careful with the more esotectic things like hedge funds though. Opening up the world of US investing beyond Vanguard ETFs would be nice, but I'd like to see something in writing from HMRC. Maybe you can write to them.

Interesting. The regulations applied to US mutual funds are pretty strict and it sounds as if you'd be ok. I'd be careful with the more esotectic things like hedge funds though. Opening up the world of US investing beyond Vanguard ETFs would be nice, but I'd like to see something in writing from HMRC. Maybe you can write to them.

Agreed, investors in hedge funds and other esoteric types of arrangements still need to be careful as those may not be income transparent (though such funds can still enjoy preferential tax treatment if they apply for reporting fund status). But this won't be a concern for the average retail investor.

I did think about writing to HMRC, but I thought they had already put it pretty unambiguously in writing in the Offshore Funds Manual, so I decided to go ahead and prepare my own tax return on that basis and claim capital gains treatment for some Vanguard mutual funds I sold. I simply wrote a brief statement under the "Other information" section on the capital gains form: "These are income transparent offshore funds (as defined in OFM10200) and are therefore taxed under the capital gains regime, not as offshore income gains." If HMRC disagree, they would need to provide some evidence to back up their alternative interpretation.

I can't imagine why so many so-called "professionals" who post on this board have been harping for so long on the dangers of US investing, without doing some basic research first. It would be great if those folks could add their voices here - debate is welcome!

I can't imagine why so many so-called "professionals" who post on this board have been harping for so long on the dangers of US investing, without doing some basic research first. It would be great if those folks could add their voices here - debate is welcome!

Professionals are often conservative as they have an obligation not to screw things up. There is also an inclination to protect information. The professionals on here provide very useful comments and guidance and don't need to do that so I cannot blame them for being cautious on a public forum.

I have certainly pushed Vanguard ETFs as a good solution to the PFIC/distributing funds Catch 22 situation for US expats living in the UK because I didn't research the subject as deeply as you have. I'm a big Vanguard fan so once I saw their ETFs on the HMRC distributing funds list I'd found my solution. But it would be great if mutual funds from Vanguard, Fidelity, T Row Price, Pimco etc, etc are also ok.

I just looked at the distributing fund list and see that Vanguard Wellesley is now included along with some other of their mutual funds. That's new, before it was just the ETFs and not the mutual funds.

I imagine HMRC will accept your SA without too much trouble and you won't hear anything from them at all.

I simply wrote a brief statement under the "Other information" section on the capital gains form: "These are income transparent offshore funds (as defined in OFM10200) and are therefore taxed under the capital gains regime, not as offshore income gains." If HMRC disagree, they would need to provide some evidence to back up their alternative interpretation.

I think the onus is on you. HMRC could simply say "not on the list so pay at income tax rates". But I bet that nothing will happen.

Professionals are often conservative as they have an obligation not to screw things up. There is also an inclination to protect information. The professionals on here provide very useful comments and guidance and don't need to do that so I cannot blame them for being cautious on a public forum.

nun, I agree with the spirit of your comment and appreciate that many of the professionals are genuinely trying to be helpful. I'd suggest, though, that if folks are trying to be cautious in an area where there is uncertainty or complexity, the correct approach would be to acknowledge that it's a grey area or that a difference of opinion exists. The issue is when someone calling themselves a professional makes authoritative sounding statements that aren't backed up by concrete evidence, because they can misinform or scare people that way.

I just looked at the distributing fund list and see that Vanguard Wellesley is now included along with some other of their mutual funds. That's new, before it was just the ETFs and not the mutual funds.

My understanding (although correct me if I'm wrong) was that the Distributing Fund List you mentioned hasn't been relevant since 2009, when the old "distributing fund" rules were replaced by the newer "reporting fund" rules - see here for details of both regimes. The list to use instead is the Reporting Funds List. There are no Vanguard mutual funds on that list, only Vanguard ETFs. Again, this shouldn't make a difference as to the tax treatment.

I don't really recall many professionals talking much about UK reporting funds......I have quite a bit, but I'm not a professional when it comes to tax/investing.

Good catch on the old distributing funds list I was looking at. I wondered where the CUSIP numbers had gone.

It's interesting that Hargreaves and Lansdown (UK brokers) sell many US Vanguard ETFs, but not the mutual funds and I imagine the only way to buy the US mutual funds is through a US broker and as a UK resident you'll only have one of those if you opened one when you were a US resident.

It's interesting that Hargreaves and Lansdown (UK brokers) sell many US Vanguard ETFs, but not the mutual funds and I imagine the only way to buy the US mutual funds is through a US broker and as a UK resident you'll only have one of those if you opened one when you were a US resident.

I believe there is an SEC regulation preventing US mutual fund companies from marketing to non-US investors, but this does not apply to ETFs. I'm sure Vanguard figured that 99% of UK based investors would only have access to the ETFs so those were the only ones for which an explicit reporting fund designation would have value.

This is good stuff for me to know.......thanks.

Just a note of caution here. I was looking through the Vanguard website and found this useful information about the UK reporting status of US domiciled Vanguard ETFs. Some of them do seem to accumulate income. The list in the link below shows the "Distributions per share" and also the "Excess of reportable income over distributions".

So comparing the first two funds on the list for the "Vanguard Consumer Discretionary Index Fund ETF Shares" you'd have to report more income than the actual distributions whereas for the next fund "Vanguard Consumer Staples Index Fund - ETF Shares" you only have to report the distributions

https://advisors.vanguard.com/iwe/pdf/TIDQAUK.pdf

The next question is whether other ETFs and US mutual funds do something similar and how you'd find out. Do US mutual funds have any "excess of reportable income over distributions"? The SEC requires that US mutual funds pay dividends and capital gains to investors, so maybe ETF regulation is a little less rigorous......some research is required. The question is whether the information on your 1099-DIV is sufficient to file your UK taxes, it seems that for some ETFs it isn't, is that the case for any US mutual funds?

Just a note of caution here. I was looking through the Vanguard website and found this useful information about the UK reporting status of US domiciled Vanguard ETFs. Some of them do seem to accumulate income. The list in the link below shows the "Distributions per share" and also the "Excess of reportable income over distributions".

So comparing the first two funds on the list for the "Vanguard Consumer Discretionary Index Fund ETF Shares" you'd have to report more income than the actual distributions whereas for the next fund "Vanguard Consumer Staples Index Fund - ETF Shares" you only have to report the distributions

https://advisors.vanguard.com/iwe/pdf/TIDQAUK.pdf

The next question is whether other ETFs and US mutual funds do something similar and how you'd find out. Do US mutual funds have any "excess of reportable income over distributions"? The SEC requires that US mutual funds pay dividends and capital gains to investors, so maybe ETF regulation is a little less rigorous......some research is required. The question is whether the information on your 1099-DIV is sufficient to file your UK taxes, it seems that for some ETFs it isn't, is that the case for any US mutual funds?

Interesting and good find - probably the only way is to ring each mutual fund company and ask. I'll try calling Vanguard if I get a chance in the next few days.

Spoke to a rep from Vanguard, who made some calls and determined that Vanguard mutual funds DO distribute 100% of income - so they would qualify as income transparent offshore funds. I suggested they should publish this information for the benefit of UK resident investors in their mutual funds.

As nun found, some of the ETFs have undistributed income, so ETF investors should check the Schedule of Taxable Amounts linked above.

The Vanguard rep also passed along some additional information provided by their advisor department, summarizing various sections of the Investment Company Act of 1940, which is foundational to US securities regulation. All mutual funds and other Regulated Investment Companies are required by law to distribute at least 90% of income. However, they are still subject to a 4% excise tax unless they distribute at least 98% of income, so in practice most mutual funds are likely to meet or exceed the higher figure in order to avoid the tax.

I personally don't have any money invested outside Vanguard, but anyone who does is urged to ask these questions of their mutual fund company and report back!

So a US mutual fund might be ok if it distributes 100% of their income, but how are you to know. At least with the Vanguard ETFs that are reporting funds publish the information required for your UK taxes.

If I return to the UK I think I'll just invest in Vanguard ETFs that distribute 100% of their income. That won't be much of a hardship because I basically invest in Total Stock Market and Total International Stock Market already

So a US mutual fund might be ok if it distributes 100% of their income, but how are you to know.

You know because you call the fund company and ask them whether their funds have any income in excess of what they distribute to investors (and I've already asked Vanguard so you don't have to). Or send them a letter asking the same question, if you'd feel safer having their response in writing.

Even if the fund does have undistributed income, just ask how much it is, or if the information is elusive, you might even be able to figure it out from the fund's quarterly or yearly financial statements (I haven't tried). As long as you report any undistributed income on your UK tax return you're fine.

The object isn't to disparage Vanguard ETFs, which are great (my entire taxable investment portfolio is invested in them). The whole point is that funds not on the reporting list can also be good choices for a UK based investor, and that we have a wider choice of tax-efficient investments than has previously been acknowledged.

The object isn't to disparage Vanguard ETFs, which are great (my entire taxable investment portfolio is invested in them). The whole point is that funds not on the reporting list can also be good choices for a UK based investor, and that we have a wider choice of tax-efficient investments than has previously been acknowledged.

I agree with you, and being able to tax efficiently invest in US mutual funds is a good thing. My point was that you don't have to do the little bit of extra "due diligence" with Vanguard ETFs as they are Reporting Funds and as I'm already invested in then in the US they are a great solution for both UK and US investing. Also they can be purchased through UK brokers so are a way for the US expat without a US brokerage account to invest in a pooled investment.