US ETF , UK brokerage, UK resident, US citizen

I set out below some comments about the taxation of distributions which RobertUSA may incur if he were to purchase US domiciled EFTs. 

Remittance basis user
Robert mentions that he is a UK resident US citizen, but does not mention whether or not he is a remittance basis user for the purposes of UK taxation.

If Robert claims the remittance basis and does not remit the EFT distributions then he would not have any UK tax liabilities. His only concerns would then be US tax. This is reinforced by Article 1(8) of the DTR.

UK domestic rules
If Robert is not a remittance basis user, then he would be liable to UK tax on the distributions. Distributions from a non UK fund are generally taxed as dividends. (If the underlying income is from bonds the distributions would be taxed as interest income.) UK dividends are taxed in a different way from all other income-they are deemed to carry a 10% notional tax credit, and they are taxed at the special (lower) rates applying solely to dividend income. For instance, if Robert generally paid UK tax at a marginal rate of 40%, his dividends would effectively be taxed at a rate of 25%.

US domestic rules
As a US citizen, Robert would be taxed on the distributions as part of his worldwide income.

US withholding tax
My understanding is that while the US would impose a withholding tax on the EFT distributions if the payee was a non US citizen, it does not impose withholding on its own citizens, even when they are not US resident.

UK US DTR
My analysis of the DTR as applying to the distributions to Robert is-
•   As a US citizen, the general terms of the DTR do not apply to Robert. Instead on the limited provisions listed in Article 1(5) apply to Robert. The limited provisions do not include Article 10 on dividends. The only relevant provision is Article 24, relief from double taxation, and in particular Article 24(6) deals with the taxation of UK resident US citizens.
•   Under Article 24(6)(b) the UK is required to give credit for the US tax that would have been imposed on US source income if it had been paid to a non US citizen. If a non US citizen had received the distributions the US would be have imposed a withholding tax at the reduced rate of 15%. Therefore the UK gives credit for this 15% notional withholding tax. For instance, if Robert is generally liable to UK tax at a marginal rate of 40%, the UK liability at an effective rate of 25% is reduced by this notional withholding tax of 15%, leaving 10% payable in UK tax.
•   Article 24(6)(d) then requires the US to treat part of the distributions as if they were UK source income to prevent the double taxation of such income. The precise workings of this depends on the rate of tax payable by Robert in the US.
 

Thank you for the detailed clarification Dunedin. While I agree with everything you mention I have my doubts about this :

US withholding tax
My understanding is that while the US would impose a withholding tax on the EFT distributions if the payee was a non US citizen, it does not impose withholding on its own citizens, even when they are not US resident.

When I have found some UK brokerages as mentioned in my previous replies, that specifically state they will withhold 30% from their US citizen customers. If they do, there is no easy way of claiming a refund.  I suggest every US citizen domiciled in the UK and interested in entering the US market through a UK brokerage contact their brokerage about the specifics. In most cases the brokerage will not give tax advice, nor can you expect that they will be informed on US tax matters or guarantee to fulfil your US tax obligations. A US based brokerage strictly following US tax laws but operating internationally may indeed be the best resolve.

Thank you to Robert for this comment about withholding tax on dividends.

My understanding is that withholding does not apply to US citizens.
•   26 US Code 1441 is the source of the withholding tax rules, and applies them to payments to non-resident aliens.
https://www.law.cornell.edu/uscode/text/26/1441
•   The following links to the IRS website. This confirms that withholding applies to foreign persons. Further down that page is confirmation that a foreign person is, inter alia, someone who is not a US citizen.
http://www.irs.gov/Individuals/International-Taxpayers/Identifying-the-Payee
•   Form W-9 can be used by the payee to confirm that they are a US citizen. The IRS instructions say that the W-9 can be used to overcome a presumption of foreign status. I would assume that presumption of foreign status could arise from a non US address.
http://www.irs.gov/pub/irs-pdf/iw9.pdf

Purchase a US dollar denominated ETF can give rise to a loss in US dollars, but a gain in Sterling - or the reverse.  The treatment of capital gains and the timing of tax payments to achieve relief under the resourcing provisions of the treaty can be truly painful in some cases...

Thank you for the detailed clarification Dunedin. While I agree with everything you mention I have my doubts about this :

When I have found some UK brokerages as mentioned in my previous replies, that specifically state they will withhold 30% from their US citizen customers. If they do, there is no easy way of claiming a refund.  I suggest every US citizen domiciled in the UK and interested in entering the US market through a UK brokerage contact their brokerage about the specifics. In most cases the brokerage will not give tax advice, nor can you expect that they will be informed on US tax matters or guarantee to fulfil your US tax obligations. A US based brokerage strictly following US tax laws but operating internationally may indeed be the best resolve.

The brokerage is going to take the most conservative route possible to make sure they don't anger the IRS. You can argue to them that there should be no withholding because you are a US citizen, but they might not listen to you......frankly I'm amazed they are even dealing with you. Of course this would not be an issue for dividends if your brokerage was in the US.

There is a perfectly simple way to get any withholding back; take the appropriate credit for it on your UK and US taxes. It's a very similar situation to the reclaiming of tax that US administrators withhold from 401ks, IRA etc payments made to US citizens resident in the UK.

nun, a tax credit is great if you have taxes to pay. My US taxable income has always amounted to being 0 after taking the FEIE, the standard deductions and exemptions. I'm not interested in accumulating tax credits as I've never been above the thresholds to have to pay US tax. A FTC is a non refundable tax credit. I'm asking for a refund and as far as I understand this is only achievable through a 1099 form, line 64 on 1040 form. I do not trust a non-US business to provide me a 1099 form, which is why I say it's not easy to claim a refund in this situation. Although I'm not certain of this, I'm too hesitant to try. 

nun, a tax credit is great if you have taxes to pay. My US taxable income has always amounted to being 0 after taking the FEIE, the standard deductions and exemptions. I'm not interested in accumulating tax credits as I've never been above the thresholds to have to pay US tax. A FTC is a non refundable tax credit. I'm asking for a refund and as far as I understand this is only achievable through a 1099 form, line 64 on 1040 form. I do not trust a non-US business to provide me a 1099 form, which is why I say it's not easy to claim a refund in this situation. Although I'm not certain of this, I'm too hesitant to try.

You are under a misapprehension. You will end up paying the larger of either the UK or the US tax, but if the withholding is more than that tax bill you will get a refund. You need to use tax credits, FEIE can't be used for unearned income like dividends, you enter the total tax you've paid on your 1040, subtract the amount of tax due, and if the result is negative, then that's your refund. The treaty and US and UK domestic law are in place to avoid double taxation and to allow you to get a refund for any excess withholding. You will have to use Form 1116, resource the US dividends to the UK, and use 1040 line 48. The process is nicely explained in the Instructions to the US UK tax treaty starting on p103

http://www.treasury.gov/resource-center/tax-policy/treaties/Documents/teus-uk.pdf

before we start misunderstanding each other and confusing everybody that will ever read this in the future let's agree that

The treaty and US and UK domestic law are in place to avoid double taxation and to allow you to get a refund for any excess withholding.

Next, I fully understand that the FEIE can only be used for "earned" income, NOT "unearned" interest, capital gains, dividends etc. In my specific situation though all these "unearned" gains fall below the standard deduction and exemption and my tax return ends there. My US taxable income results in being zero so I do not need to waste my time claiming any further tax credits. This is the "Tax and Credits" section of the 1040 form.

However if excess tax was withheld from me by the IRS because of the incompetence of my non-US brokerage, I turn to the "Payments" section of the 1040 form where I can claim this refund. My only point was that I may have a difficult time getting any information from my non-US brokerage as regards the taxes withheld, and then proving this to the IRS. A bit more hassle.

I pay my UK tax on any foreign gains as required by UK tax laws.

It is absurd that the US can exercise it's laws outside its own borders and filter out its own citizens, but let's save that discussion for another time.

My only point was that I may have a difficult time getting any information from my non-US brokerage as regards the taxes withheld, and then proving this to the IRS. A bit more hassle.

Anytime you invest "outside" the US you will have a problem with documentation. I had a similar feeling of frustration when I learned about mandatory withholding from retirement income paid to US citizens abroad, but you just have to follow the rules, keep the BP down and know that eventually it all works out if you do things right.

I think there have been a few posts talking around this point, in various conversations on threading the needle with US ETFs and HMRC Reporting Funds, but has anyone been down the road of exchanging their holding in a Vanguard mutual fund for its HMRC-reporting Vanguard ETF equivalent after moving to the UK?

I'm just trying work through whether that exchange would give rise to taxation in either the US or UK--I wasn't privy to the issue before moving to the UK, and am now stuck looking at chunky gains on those funds, which are going to wilt under punitive UK treatment if I sell out.

I think there have been a few posts talking around this point, in various conversations on threading the needle with US ETFs and HMRC Reporting Funds, but has anyone been down the road of exchanging their holding in a Vanguard mutual fund for its HMRC-reporting Vanguard ETF equivalent after moving to the UK?

I'm just trying work through whether that exchange would give rise to taxation in either the US or UK--I wasn't privy to the issue before moving to the UK, and am now stuck looking at chunky gains on those funds, which are going to wilt under punitive UK treatment if I sell out.

The exchange has no US tax consequences. Read the Vanguard website about doing the transfer to the ETF. I have no idea how the UK would see this.


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I wish I had the ability to remember all this stuff......

The exchange has no US tax consequences. Read the Vanguard website about doing the transfer to the ETF. I have no idea how the UK would see this.


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This is only true for like to like funds.  For example I sold all my Stock Index mutual funds and bought the  equivallent ETF's.  The cost basis was transfered and there were no capital gains. I also had a balanced mutual fund that did not have an equivalent ETF so over a couple of years I sold the fund and bought index ETF's, paying Long Term capital gain taxes in the process.

This is only true for like to like funds.  For example I sold all my Stock Index mutual funds and bought the  equivallent ETF's.  The cost basis was transfered and there were no capital gains. I also had a balanced mutual fund that did not have an equivalent ETF so over a couple of years I sold the fund and bought index ETF's, paying Long Term capital gain taxes in the process.

The exchange has no US tax consequences. Read the Vanguard website about doing the transfer to the ETF. I have no idea how the UK would see this.

Many thanks, both. Yes--Vanguard offers equivalent ETFs for most of the mutual funds, so like durhamlad I'm only aiming to exchange those for now.

The UK side is where I'm less certain: I haven't seen anything that suggests the exchange would trigger a UK liability, but if anyone's spent more time thinking-about/looking-into that side of things, I'd be grateful to hear where/how they landed.

This is only true for like to like funds.  For example I sold all my Stock Index mutual funds and bought the  equivallent ETF's.  The cost basis was transfered and there were no capital gains. I also had a balanced mutual fund that did not have an equivalent ETF so over a couple of years I sold the fund and bought index ETF's, paying Long Term capital gain taxes in the process.

Good clarification....I was assuming that say Total Equity Index mutual fund would be exchanged for the Total Equity Index ETF.