With the increasing regulatory scrutiny and operational framework to which investment managers in the UK and Europe are subject, the range of suitable investment options for American citizens residing in the UK has continued to narrow. In an effort to avoid having to comply with strict new requirements, some foreign financial institutions have closed their doors to Americans or, if they can maintain a relationship with American citizens, many may not be able to provide solutions which, whilst compliant from a regulatory perspective, are also tax efficient. In recent months, we have experienced an increasing number of individuals being asked to liquidate and close existing accounts as another wave of regulation gets rolled out.
As Americans in Britain have a dual reporting requirement to the IRS and HMRC, structuring one’s portfolio tax-efficiently from both a US and UK perspective is crucial for maximising post-tax returns. Investors must therefore be aware of what is tax inefficient from both a US and UK perspective when investing in collective investments (i.e. funds). From a US perspective, all non-US regulated funds are classified as Passive Foreign Investment Companies (PFICs) which attract punitive tax charges in the US. For example, capital gains are taxed by the US at the highest rate of marginal income tax (37% as of 2019) regardless of other sources of income. From a UK perspective, unless an election is made with HRMC by the fund to gain UK Reporting Status, any US fund is classified as Offshore Income Gains (OIGs) with GBP capital gains taxed at marginal income tax rates. By investing in US Mutual Funds with UK Reporting Status, Americans in Britain can invest tax efficiently from both a US and UK perspective.
Recognising the increasingly limited range of investment options for Americans and the demand for information, we have summarised two of the main regulatory drivers of change and how they have impacted Americans in Britain.
Foreign Account Tax Compliance Act (“FATCA”)
You have most likely heard the above phrase thrown around in passing, but what is it and what does it mean for you? FATCA, which was signed into law in 2010, created additional reporting mechanisms to ensure US persons abroad report all applicable income to the Internal Revenue Service (IRS) each year. The legislation assigns a two-pronged reporting approach that places responsibility on both the individual and the financial institution.
Individual reporting responsibility includes both the reporting of worldwide income, but also many informational reporting requirements (which carry high penalties for non-compliance) to allow the IRS to gain a deeper understanding of the extent to which US persons are holding foreign financial assets. Foreign financial institutions (FFI) were required to implement systems to identify all of their clients who met the FATCA definition of a US person and report applicable income to the IRS each year or face a 30% withholding on all US sourced payments. The approach is designed to make it impossible for US persons with foreign financial assets to remain undetected. An unintended consequence of this legislation has been the retraction of FFI’s in the US-expatriate market specifically to circumvent the regulation’s onerous reporting obligations.
FATCA legislation was not designed to affect the appropriate investment strategy for US persons. Foreign mutual funds, collectives, and Exchange Traded Funds (ETFs), otherwise classified by the US as PFICs, were previously and remain highly tax-inefficient investment choices for US persons and should be avoided in almost all situations. FATCA, along with some other regulations, has created certain restrictions related to the purchase of many offshore investments, as we have seen many funds specify in prospectuses that purchases are now off-limits for US persons. However, investing in many of these offshore vehicles previously brought little benefit to US persons and thus should have played a small role in any investment strategy anyway.
Alternative Investment Fund Managers Directive (“AIFMD”)
In 2013, Americans in Britain became the unintended victims in the fallout of another piece of legislation introduced following the global financial crisis in 2008 as the governments of European Union Member States felt that the lack of transparency of hedge funds, private equity funds, real estate funds (collective referred to as ‘alternative investment funds’) played a significant role in destabilising the European financial system. One of the aims of AIFMD is to increase the protection of investors investing in alternative investment funds which are not domiciled within an EU Member State and therefore not subject to the regulatory requirements of ‘domestic’ funds. The new regulation is intended to ensure that alternative investment funds do not operate outside of the scope of the regulatory authority of the country in which that fund may be being promoted, and introduced an EU-wide harmonised framework for monitoring and supervising risks posed by both the managers of alternative investment funds as well as the funds they manage. The resulting impact of the new regulation caught Americans in Britain by surprise, as US fund managers, caught up in the new regulation, decided to restrict their sales of US mutual funds to overseas residents.
As the directive applies to all US asset managers who manage funds in the EU or, manage funds in the US but simply market to investors living in the EU, it was MASECO’s experience that a number of US institutions chose to opt out of the burdensome requirements of AIFMD by restricting asset ownership to US residents only. Many Execution Only Broker Dealers did not force affected individuals to sell out of existing positions held. They only prevented the purchase of additional shares. The inability to make new purchases left many ‘DIY’ investors unable to properly rebalance portfolios without the help of an investment professional knowledgeable of these international issues. Inevitably, over time, this leads to hidden risks and potential negative consequences on maintaining an effective wealth management strategy.
Where Are We Today
The regulatory environment continues to evolve as governments continue to seek ways in which to protect their citizens by ensuring that investment services and products sold within their shores have appropriate levels of transparency, so investors are fully aware of what the service or product is designed to achieve and the concomitant risks as well as benefits such as fostering efficiencies within the markets. In light of regulatory changes, investment firms will need to review their business models and client base. We continue to see other investment firms decide that they can no longer work with Americans in Europe or, if they do continue to work with them, provide tax inefficient solutions for those Americans resident in the Europe.
Most notably, over the last two years we have seen some large UK and US Execution Only stockbrokers decide to no longer take orders into US based funds. The alternatives still available for unsuspecting European based US taxpayers for purchase can more often than not be tax inefficient for those unaware of the specific types of securities to avoid. This is a complicated area that is often difficult to navigate. We recommend US taxpayers seek professional advice before making any major investment decisions.
Summary
As outlined above, the widespread legislative changes that we have seen out of the US and the EU over the last decade has resulted in a reduction of both the range of institutions that can work with US citizens effectively and the range of available investment options and, in some cases, in our experience, has forced the closure of existing accounts at certain US institutions without clients being given a clear viable alternative for transferring out. The impact of these legislative changes has resulted in both an increased operational cost on those institutions choosing to maintain US connected relationships as well as an increased importance in understanding how to navigate through the restrictions in a manner that helps support long-term goals in a tax efficient manner.
Risk Warnings And Important Information
PMASECO LLP (trading as MASECO Private Wealth and MASECO Institutional) is registered in England and Wales as a Limited Liability Partnership (Companies House No. OC337650) and has its registered office at Burleigh House, 357 Strand, London WC2R 0HS.
MASECO LLP is authorised and regulated by the Financial Conduct Authority for the conduct of investment business in the UK and is an SEC Registered Investment Advisor in the United States of America.
This article does not take into account the specific goals or requirements of individuals and is not intended to be, nor should be construed as, investment or tax advice. Information contained in this article is based on MASECO’s understanding of current regulations and tax law and legislation which is subject to change. MASECO Private Wealth is not a tax specialist and does not provide either tax or legal advice. The tax treatment of any investment strategy or investment in a financial instrument depends on the individual circumstances of each person and may be subject to change in the future. You should carefully consider the suitability of any strategies along with your financial situation prior to making any decisions on an appropriate strategy. We strongly recommend that every person seeks their own tax advice prior to acting on any of the tax opportunities described in this article.
Patrick Bowen is a Wealth Manager at MASECO Private Wealth. Patrick studied Economics at the University of Birmingham and holds the certificate in Private Client Investment Advice & Management. Patrick specialises in advising high net worth Americans in the UK providing tax efficient wealth management solutions.
Kyle McClellan is a Senior Wealth Executive at MASECO Private Wealth. Kyle studied Economics and Finance at Bournemouth University and holds the certificate in Private Client Investment Advice and Management. During his time at MASECO, Kyle has worked closely with MASECO’s Head of Advanced Planning to assist in the design and implementation of tax efficient investment strategies for US expatriates based in the UK and foreign nationals in the US.
