What Americans need to know about PFICs before investing UK cash

You have £250,000 in a British savings account and have decided that some of it could support your longer-term plans. An adviser proposes a diversified portfolio, from a familiar investment house, with charges and risks you understand.

For an American living in London, there is another question to resolve before the first purchase: how will the investments be treated in the US as well as the UK?

Some funds available to British investors fall within the US rules for passive foreign investment companies, or PFICs. That can change the tax treatment, the reporting required and the cost of administering the portfolio. A recommendation needs to account for those consequences alongside investment risk and return.

What a PFIC is

A PFIC is a non-US corporation that meets either of two US tax tests: at least 75% of its gross income is passive, or at least 50% of its assets, on average, produce or are held to produce passive income. Interest and dividends are familiar examples.

Investment funds deserve particular attention. IRS Publication 54 warns that owning a mutual fund or exchange-traded fund domiciled outside the US may create a Form 8621 reporting obligation. An exchange-traded fund, or ETF, is a fund whose shares trade on an exchange.

PFIC is a tax classification. It tells you nothing about whether the manager is reputable or the underlying investments are sensible. The fund’s legal structure and the way you hold it still need checking.

A familiar name does not settle the question

A fund investing in American companies is not necessarily domiciled in America. Nor does buying it in dollars establish its domicile or US tax treatment. A familiar American investment brand can offer products with different legal structures in different countries.

Ask for the full legal fund name, domicile, structure and exact share class, with its International Securities Identification Number, or ISIN, where available. Your US tax adviser needs to assess the investment you would actually own. If the proposal invests through other funds, ask what those underlying holdings mean for the assessment too.

That is a useful check to complete while a portfolio is still a proposal.

The consequences go beyond another form

Under the default PFIC tax rules, gains on disposal and certain distributions receive special treatment. Amounts allocated to earlier PFIC years can attract tax calculated at the highest applicable rates for those years, plus an interest charge. The result can be less favourable than ordinary US long-term capital gains treatment.

Other treatment may be available through an election. A qualified electing fund, or QEF, election requires appropriate fund information. A mark-to-market election is limited to eligible marketable stock. Either can create annual taxable income without a cash payment to you. The IRS instructions set out the requirements; eligibility, timing and any earlier PFIC years need specialist review.

There can also be reporting when nothing has been sold. Form 8621 covers annual reporting as well as certain distributions, disposals and elections. Where filing is required, a separate form is generally needed for each PFIC, including relevant indirect holdings. Exceptions exist, but receiving no dividend does not by itself establish that there is nothing to report.

Before agreeing to a portfolio, ask what its annual tax preparation would involve and cost. A low fund charge is only part of the ongoing expense.

The UK assessment still matters

Choosing a US-domiciled fund does not complete the work.

For offshore funds, the exact share class’s UK reporting status needs checking. HMRC’s offshore fund guidance explains why gains from non-reporting funds can be taxed as income rather than capital gains, subject to exceptions. Reporting funds can create taxable income that has not been distributed in cash.

Your residence, holding period, account or wrapper and any applicable reliefs can affect the outcome. A UK tax advantage does not establish US treatment. Access through a particular provider also needs confirming.

The useful comparison is the proposed arrangement as a whole, including both countries’ treatment, administration and costs.

Get both advisers to review the same proposal

Ask your UK investment adviser and US tax adviser to work from the same written investment list. Before implementation, establish:

Which holdings may be PFICs, and what tax treatment and reporting are expected.

Whether any election is proposed, what information it requires and who will meet the deadline.

How the account and investments work for UK tax purposes.

Who will supply records, prepare returns and keep the assessment current when holdings change.

Then connect the proposal to the household financial plan. How much of the £250,000 is genuinely available for long-term investment? A home purchase, school fees or time between jobs may require part of it sooner.

If you already own a fund that may be a PFIC, gather the purchase, distribution and tax records before making changes. Selling or switching can itself have consequences; obtain advice on the existing position first.

Americans can invest while living in Britain. The starting point is a proposal whose risks, tax treatment and ongoing requirements have been assessed for the person who will own it.

This article provides general information, not an individual investment or tax recommendation. Obtain appropriately qualified UK and US advice for your circumstances. The £250,000 example is illustrative.

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