Tax treatment of foreign "accumulating" ETFs for a US investor

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kirk1299
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Tax treatment of foreign "accumulating" ETFs for a US investor

Post by kirk1299 »

Hello all!

I was looking at some of the iShares FTSE 100 ETFs traded on the LSE - management fees are lower than the equivalent US listed ETFs.

I note that there are two FTSE 100 iShares ETFs: one of them distributes dividends normally; the other is an 'accumulating' ETF where the dividends are reinvested in the index automatically and there are no distributions.

I am wondering, for a US citizen/resident, is there a tax difference between owning the two? Ie, would one still end up paying annual taxes on the dividends even if they are not actually distributed as cash?

All things being equal, I'd rather hold the regular ETF (bigger and more liquid, I'd rather reinvest my dividends manually) UNLESS there is a big tax advantage for holding the accumulating shares.

I note, also, that the UK has no foreign dividend tax witholding, so any difference would presumably be on the US side.
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Re: Tax treatment of foreign "accumulating" ETFs for a US investor

Post by LadyGeek »

Welcome! I moved your post to the Non-US Investing forum because it suggests that you may be a resident outside the US.

What is your home country?
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alex_686
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Re: Tax treatment of foreign "accumulating" ETFs for a US investor

Post by alex_686 »

The sole purpose of mutual fund dividend distribution is for tax reporting.

Owing either for a US citizen / resident is complicated.

Non-distribution funds fall under PFIC rules. Check out the forms you have to file. You will want to stay away.
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Re: Tax treatment of foreign "accumulating" ETFs for a US investor

Post by glorat »

Awaiting the TedSwippet reply but my first reaction...

Double whammy bad. You're seeing lower management fees. I'm seeing death by taxes.

The US based ETFs internally pay 0% taxes on dividends, the UK ones will internally pay 15% taxes on dividends. That will hurt returns as much as the fee difference. That's the taxes the funds pay on your behalf.

And then there are the taxes you have to pay yourself. As a US citizen, I have only one word. PFIC! Learn about it or regret your investment forever
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kirk1299
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Re: Tax treatment of foreign "accumulating" ETFs for a US investor

Post by kirk1299 »

Thanks - I will read up on PFIC's.

Just to clarify, is it a bad idea to buy ANY ETF located outside the US, or just an accumulating ETF?

And to answer the prior question, I am a US investor investing in things outside the US! So I'm not sure if this topic falls in "Non-US Investors" as the mod moved it here.
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kirk1299
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Re: Tax treatment of foreign "accumulating" ETFs for a US investor

Post by kirk1299 »

I googled a bit on PFIC's and admittedly don't really understand what I am reading, other than the need to file form 8621 which sounds insanely complicated!

Does anyone have a pointer on where to read about this in terms a non-tax expert would understand?

thanks!
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kirk1299
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Re: Tax treatment of foreign "accumulating" ETFs for a US investor

Post by kirk1299 »

I found this article which explains better than some others I've seen. https://www.thetaxadviser.com/issues/20 ... ry-04.html

Sounds like the issue is, best case, owning a foreign ETF you'd have to elect an annual mark to market and pay capital gains on that mark! WHich would be very unappealing.

In addition to the fact that gains are taxed at normal income tax rate.

So, I'll sell them! THanks for the pointers.
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BeBH65
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Re: Tax treatment of foreign "accumulating" ETFs for a US investor

Post by BeBH65 »

glorat wrote: Mon Oct 12, 2020 9:23 pm Awaiting the TedSwippet reply but my first reaction...
Luckily he has written down a lot in the Boglehead wiki.

Passive foreign investment company — Describes punitive US tax rules for US persons who hold non-US domiciled funds
Mutual funds, exchange-traded funds (ETFs), real estate investment trusts (REITs) and other collective investment vehicles, if they are not registered with the US Securities Exchange Commission (SEC), are classified under US tax law as Passive Foreign Investment Companies, or PFICs. The taxation on these under US law is extremely unfavorable, and requires the submission of Form 8621, Information Return by a Shareholder of a Passive Foreign Investment Company or Qualified Electing Fund[34] with your tax return, which can be an extremely time consuming task.[35]
BeBH65. (only an investment enthusiast, not a financial adviser, perform your due diligence). | Have a look at https://www.bogleheads.org/wiki/Outline_of_Non-US_domiciles
typical.investor
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Re: Tax treatment of foreign "accumulating" ETFs for a US investor

Post by typical.investor »

kirk1299 wrote: Mon Oct 12, 2020 8:08 pm Hello all!

I was looking at some of the iShares FTSE 100 ETFs traded on the LSE - management fees are lower than the equivalent US listed ETFs.

I note that there are two FTSE 100 iShares ETFs: one of them distributes dividends normally; the other is an 'accumulating' ETF where the dividends are reinvested in the index automatically and there are no distributions.

I am wondering, for a US citizen/resident, is there a tax difference between owning the two? Ie, would one still end up paying annual taxes on the dividends even if they are not actually distributed as cash?

All things being equal, I'd rather hold the regular ETF (bigger and more liquid, I'd rather reinvest my dividends manually) UNLESS there is a big tax advantage for holding the accumulating shares.

I note, also, that the UK has no foreign dividend tax witholding, so any difference would presumably be on the US side.
For a US person (citizen or permanent resident i.e. green card holder) residing in the UK, one should hold US domiciled (traded on a US exchange ) Vanguard ETFs that have UK reporting status. Capital gains taxes are 25% higher if you don't, I believe. The list is here and last time I checked included the major total market ones. https://www.gov.uk/government/publicati ... ting-funds

Schwab International and Interactive Brokers both used to serve UK residents, but until Brexit is finished believe EU regulations will prevent them from selling you US domiciled ETFs unless you meet the professional trader criteria.

As for PFIC funds, I would just say avoid them unless you have to participate in a foreign retirement plan and PFIC funds are the only option. And in that case, you should look at the criteria of whether the retirement plan can be considered as an Employees' trust.

https://www.thetaxadviser.com/issues/20 ... reaty.html
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Re: Tax treatment of foreign "accumulating" ETFs for a US investor

Post by TedSwippet »

typical.investor wrote: Tue Oct 13, 2020 4:21 am For a US person (citizen or permanent resident i.e. green card holder) residing in the UK, one should hold US domiciled (traded on a US exchange ) Vanguard ETFs that have UK reporting status. Capital gains taxes are 25% higher if you don't, I believe. The list is here and last time I checked included the major total market ones. https://www.gov.uk/government/publicati ... ting-funds
On my reading, the topic author is perhaps a US resident US citizen, but just to correct the above for any future readers ...

The UK treatment for 'non-reporting' funds is that any capital gains are taxed by the UK at UK income tax rates, rather than the generally lower UK capital gains tax rates (there is no "25%" relationship between these).

In case it helps, there is a wiki page that shows which Vanguard US domiciled ETFs are 'reporting' funds, and so avoid this tax treatment. It comes from filtering the HMRC list of reporting funds you linked to. Not new information then, just the same stuff as in HMRC's list, but much more readable:

Vanguard US domiciled ETFs that are UK HMRC reporting funds - Bogleheads
typical.investor wrote: Tue Oct 13, 2020 4:21 am Schwab International and Interactive Brokers both used to serve UK residents, but until Brexit is finished believe EU regulations will prevent them from selling you US domiciled ETFs unless you meet the professional trader criteria.
It seems very likely that UK resident investors will be mostly unable to easily buy US domiciled ETFs after Brexit completes, too. At least, for the foreseeable future. In preparation for Brexit, the UK 'onshored' the entirety of EU PRIIPs into UK PRIIPs. There are a few potential changes to UK PRIIPs post-Brexit, but it doesn't look like anything will be changing for ordinary US based retail investors.

https://www.gov.uk/government/publicati ... nformation
https://assets.publishing.service.gov.u ... mplate.pdf
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Re: Tax treatment of foreign "accumulating" ETFs for a US investor

Post by LadyGeek »

Via PM, the OP has clarified that he is a US citizen. This thread is now in the Personal Investments forum (for US investors).
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Re: Tax treatment of foreign "accumulating" ETFs for a US investor

Post by UpperNwGuy »

kirk1299 wrote: Mon Oct 12, 2020 10:14 pm Thanks - I will read up on PFIC's.

Just to clarify, is it a bad idea to buy ANY ETF located outside the US, or just an accumulating ETF?

And to answer the prior question, I am a US investor investing in things outside the US! So I'm not sure if this topic falls in "Non-US Investors" as the mod moved it here.
If you're a US investor living in the US, why do you want to invest in things outside the US? It seems to be a suboptimal strategy. Did you misinterpret some of the descriptions of these non-US ETFs?
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Re: Tax treatment of foreign "accumulating" ETFs for a US investor

Post by TedSwippet »

UpperNwGuy wrote: Tue Oct 13, 2020 8:30 am If you're a US investor living in the US, why do you want to invest in things outside the US? It seems to be a suboptimal strategy. Did you misinterpret some of the descriptions of these non-US ETFs?
Cheaper TER. Holding non-US domiciled funds or ETFs is only suboptimal because of protectionist and punitive US tax rules for US citizens and US residents.

Compare iShares EWU (MSCI United Kingdom ETF, US domiciled, 0.5% TER) with iShares CSUK (MSCI UK UCITS ETF, EU domiciled, 0.33% TER) and Vanguard VUKE (UK FTSE 100 UCITS ETF, EU domiciled, 0.09% TER).
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Re: Tax treatment of foreign "accumulating" ETFs for a US investor

Post by UpperNwGuy »

TedSwippet wrote: Tue Oct 13, 2020 9:30 am
UpperNwGuy wrote: Tue Oct 13, 2020 8:30 am If you're a US investor living in the US, why do you want to invest in things outside the US? It seems to be a suboptimal strategy. Did you misinterpret some of the descriptions of these non-US ETFs?
Cheaper TER. Holding non-US domiciled funds or ETFs is only suboptimal because of protectionist and punitive US tax rules for US citizens and US residents.

Compare iShares EWU (MSCI United Kingdom ETF, US domiciled, 0.5% TER) with iShares CSUK (MSCI UK UCITS ETF, EU domiciled, 0.33% TER) and Vanguard VUKE (UK FTSE 100 UCITS ETF, EU domiciled, 0.09% TER).
Yes, but since those tax rules are inescapable, my question remains: why bother?
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Re: Tax treatment of foreign "accumulating" ETFs for a US investor

Post by TedSwippet »

UpperNwGuy wrote: Tue Oct 13, 2020 10:22 am Yes, but since those tax rules are inescapable, my question remains: why bother?
And my answer would be, because the topic author didn't know about these appalling US tax rules when they considered this option. And now they do.
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Re: Tax treatment of foreign "accumulating" ETFs for a US investor

Post by alex_686 »

kirk1299 wrote: Mon Oct 12, 2020 10:20 pm I googled a bit on PFIC's and admittedly don't really understand what I am reading, other than the need to file form 8621 which sounds insanely complicated!

Does anyone have a pointer on where to read about this in terms a non-tax expert would understand?

thanks!
It is generally a poor idea for a US citizen to purchase a foreign mutual fund. It vastly increases complexity. You would need a compelling reason to do so.

Specifically, PFIC tries to harmonize foreign income to US tax law. Consider the following principle - You should pay the same tax regardless of the wrapper.

For example, Stock X pays a dividend in 2020.

You buy Stock X directly, it pays a dividend, you get a 1099.

You buy a US fund that holds Stock X, it pays a dividend to the fund, the fund is required by the tax code to pay a dividend exactly matching what Stock X pays.

You buy a international fund that holds Stock X, the fund pays a dividend. There may be withholding tax going both ways. You may be able to claim this all back. The fund does not issue a 1099. You now have to create a 1099 for yourself.

You buy a international fund that holds Stock X. The fund does not pay a dividend. Thanks to PFIC, you now have to calculate what that dividend would have been.

You buy a bed & breakfast overseas. That entity buys Stock X. Thanks to PFIC, you now have to calculate what that dividend would have been.

In theory you should not be able to escape paying taxes on Stock X's dividend no matter where you package it.

I used to do this professionally - kind of. Worked in a mutual fund and we outsourced all of this work out to specialized parties.
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Re: Tax treatment of foreign "accumulating" ETFs for a US investor

Post by LadyGeek »

Could there be some confusion on investing in "things outside the US" vs. a US mutual fund that holds stock of companies which are located outside the US?

VTIAX - Vanguard Total International Stock Index is one such example of a US fund that invests in companies outside the US. Since the fund is registered in the US, it's not subject to the foreign tax regulations.
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Re: Tax treatment of foreign "accumulating" ETFs for a US investor

Post by alex_686 »

LadyGeek wrote: Tue Oct 13, 2020 12:26 pm VTIAX - Vanguard Total International Stock Index is one such example of a US fund that invests in companies outside the US. Since the fund is registered in the US, it's not subject to the foreign tax regulations.
To extend a bit, VTIAX is subject to foreign tax regulations. It is just that they have accountants that do all of the work and make it look seamless.
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Re: Tax treatment of foreign "accumulating" ETFs for a US investor

Post by grabiner »

alex_686 wrote: Tue Oct 13, 2020 11:58 am Specifically, PFIC tries to harmonize foreign income to US tax law. Consider the following principle - You should pay the same tax regardless of the wrapper.
However, it harmonizes them making the most unfavorable tax assumptions possible. If a PFIC pays a dividend, that dividend is taxed at your full tax rate, even if the dividend came from what would be a qualified dividend on the PFIC's holdings. And depending on which PFIC tax rules it qualifies for, gains on the sale of the PFIC may be taxed as capital gains (requires the PFIC to report as if it were a US fund), ordinary income marked-to-market every year (if the PFIC is traded on an exchange), or with the gains prorated over the holding period, with the current year's gains taxed as ordinary income and previous years' gains taxed at the maximum tax rate for that year plus interest (default). An investor is not allowed to look through the PFIC and determine what the tax would be for an equivalent US-based investment.
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