u.s.-u.k. dual taxation pitfalls: reporting issues and planning opportunities...

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U.S.-U.K. Dual Taxation Pitfalls: Reporting Issuesand Planning Opportunities for U.S. Taxpayers

TUESDAY, JUNE 13, 2017, 1:00-2:50 pm Eastern

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IMPORTANT INFORMATION FOR THE LIVE PROGRAM

This program is approved for 2 CPE credit hours. To earn credit you must:

• Participate in the program on your own computer connection (no sharing) – if you need to registeradditional people, please call customer service at 1-800-926-7926 x10 (or 404-881-1141 x10). Straffordaccepts American Express, Visa, MasterCard, Discover.

• Listen on-line via your computer speakers.

• Respond to five prompts during the program plus a single verification code. You will have to writedown only the final verification code on the attestation form, which will be emailed to registeredattendees.

• To earn full credit, you must remain connected for the entire program.

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June 13, 2017

U.S.-U.K. Dual Taxation Pitfalls

Joshua Ashman, CPA, Partner

Expat Tax Professionals, New York

[email protected]

Stuart E. Horwich, Partner

D&H Global Tax Group, London

[email protected]

Ephraim Moss, Esq., Partner

Expat Tax Professionals, New York

[email protected]

Jeffrey M. Rosenfeld, Esq.

Blank Rome, Philadelphia

[email protected]

Notice

ANY TAX ADVICE IN THIS COMMUNICATION IS NOT INTENDED OR WRITTEN BYTHE SPEAKERS’ FIRMS TO BE USED, AND CANNOT BE USED, BY A CLIENT OR ANYOTHER PERSON OR ENTITY FOR THE PURPOSE OF (i) AVOIDING PENALTIES THATMAY BE IMPOSED ON ANY TAXPAYER OR (ii) PROMOTING, MARKETING ORRECOMMENDING TO ANOTHER PARTY ANY MATTERS ADDRESSED HEREIN.

You (and your employees, representatives, or agents) may disclose to any and all persons,without limitation, the tax treatment or tax structure, or both, of any transactiondescribed in the associated materials we provide to you, including, but not limited to,any tax opinions, memoranda, or other tax analyses contained in those materials.

The information contained herein is of a general nature and based on authorities that aresubject to change. Applicability of the information to specific situations should bedetermined through consultation with your tax adviser.

ANY TAX ADVICE IN THIS COMMUNICATION IS NOT INTENDED OR WRITTEN BYTHE SPEAKERS’ FIRMS TO BE USED, AND CANNOT BE USED, BY A CLIENT OR ANYOTHER PERSON OR ENTITY FOR THE PURPOSE OF (i) AVOIDING PENALTIES THATMAY BE IMPOSED ON ANY TAXPAYER OR (ii) PROMOTING, MARKETING ORRECOMMENDING TO ANOTHER PARTY ANY MATTERS ADDRESSED HEREIN.

You (and your employees, representatives, or agents) may disclose to any and all persons,without limitation, the tax treatment or tax structure, or both, of any transactiondescribed in the associated materials we provide to you, including, but not limited to,any tax opinions, memoranda, or other tax analyses contained in those materials.

The information contained herein is of a general nature and based on authorities that aresubject to change. Applicability of the information to specific situations should bedetermined through consultation with your tax adviser.

Stuart E. Horwich

• In effect since 2001 and follows the normal type of U.S. taxtreaty based upon the U.S. Treasury Model Treaty.

• Designed to assign taxing rights to one or the otherjurisdiction to mitigate double taxation, while ensuring thattax is paid.

• In effect since 2001 and follows the normal type of U.S. taxtreaty based upon the U.S. Treasury Model Treaty.

• Designed to assign taxing rights to one or the otherjurisdiction to mitigate double taxation, while ensuring thattax is paid.

6

1. Eliminates withholding tax on interest and on royalties.

2. Reduces dividend withholding tax to 15% for portfolioinvestments (less than 10% voting stake), 5% for substantialshareholdings, and 0% for publicly traded companiesholding at least 80% of the subsidiary's vote.

3. Requires a permanent establishment in order to allowtaxation of income effectively connected with a trade orbusiness.

1. Eliminates withholding tax on interest and on royalties.

2. Reduces dividend withholding tax to 15% for portfolioinvestments (less than 10% voting stake), 5% for substantialshareholdings, and 0% for publicly traded companiesholding at least 80% of the subsidiary's vote.

3. Requires a permanent establishment in order to allowtaxation of income effectively connected with a trade orbusiness.

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Like all U.S. treaties in the past 50 years, the U.S. retains right totax its citizens without regard to the treaty (the so-called“savings clause”). Thus, U.S. citizens living in the U.K. are notable to eliminate U.S. tax based upon the treaty.

There are limited exceptions to the savings clause:. U.K. pensions are generally exempt from U.S. tax until

pension distributions are made.. U.S. social security is exempt from U.S. tax if the recipient

is a U.S. citizen living in the U.K.

Like all U.S. treaties in the past 50 years, the U.S. retains right totax its citizens without regard to the treaty (the so-called“savings clause”). Thus, U.S. citizens living in the U.K. are notable to eliminate U.S. tax based upon the treaty.

There are limited exceptions to the savings clause:. U.K. pensions are generally exempt from U.S. tax until

pension distributions are made.. U.S. social security is exempt from U.S. tax if the recipient

is a U.S. citizen living in the U.K.

8

The treaty has a provision dealing with hybrid entities (e.g. anentity treated as a flow through for U.S. tax purposes, but ataxpayer for U.K. purposes). See Article 1(8).

The treaty basically looks to the residence of the person receivingthe income to determine if treaty benefits apply. So, a U.K. entityreceiving U.S. source interest will apply will apply the treaty if theU.K. entity is subject to U.K. tax but will otherwise look to itsowners if the U.K. entity is a flow through. The U.S. tax treatmentis irrelevant.

The treaty has a provision dealing with hybrid entities (e.g. anentity treated as a flow through for U.S. tax purposes, but ataxpayer for U.K. purposes). See Article 1(8).

The treaty basically looks to the residence of the person receivingthe income to determine if treaty benefits apply. So, a U.K. entityreceiving U.S. source interest will apply will apply the treaty if theU.K. entity is subject to U.K. tax but will otherwise look to itsowners if the U.K. entity is a flow through. The U.S. tax treatmentis irrelevant.

9

Generally, the treaty will require sufficient nexus between theunderlying beneficial owner and the U.K. to justify allowing treatybenefits. Such nexus includes:1. Individual residents of each country2. Special tax exempt entities (pension funds, charities etc.) formed

in either jurisdiction3. Publicly traded companies4. Private companies provided the majority of the company’s

shareholders are resident and the company does not makedeductible payments to non-residents (so-called “base erosion”)

5. Derivative benefits for (EU/NAFTA shareholders)

There will be a much more detailed discussion of the limitation ofbenefits provision later in this session.

Generally, the treaty will require sufficient nexus between theunderlying beneficial owner and the U.K. to justify allowing treatybenefits. Such nexus includes:1. Individual residents of each country2. Special tax exempt entities (pension funds, charities etc.) formed

in either jurisdiction3. Publicly traded companies4. Private companies provided the majority of the company’s

shareholders are resident and the company does not makedeductible payments to non-residents (so-called “base erosion”)

5. Derivative benefits for (EU/NAFTA shareholders)

There will be a much more detailed discussion of the limitation ofbenefits provision later in this session.

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Only applies to residents (see Article 4). A resident does notinclude U.S. citizen who lives outside the U.S. or U.K.

If a U.K. resident can avoid U.K. tax based upon non-domicilerules, the treaty will not apply unless U.K. tax is actually paid.

Lump sum pension benefits, which typically are exempt in theU.K., are not eligible for exemption from U.S. withholding (e.g.lump sum IRA distribution to a U.K. resident is subject to U.S.withholding tax)

Only applies to residents (see Article 4). A resident does notinclude U.S. citizen who lives outside the U.S. or U.K.

If a U.K. resident can avoid U.K. tax based upon non-domicilerules, the treaty will not apply unless U.K. tax is actually paid.

Lump sum pension benefits, which typically are exempt in theU.K., are not eligible for exemption from U.S. withholding (e.g.lump sum IRA distribution to a U.K. resident is subject to U.S.withholding tax)

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The Treaty also has rules associated with foreign tax credits.For U.S. purposes, these rules, with a few notable exceptions(discussed below) are not relevant since they mirror domesticrules.

For U.K. tax purposes, the foreign tax credit rules are veryimportant as they supersede U.K. domestic rules.

The Treaty also has rules associated with foreign tax credits.For U.S. purposes, these rules, with a few notable exceptions(discussed below) are not relevant since they mirror domesticrules.

For U.K. tax purposes, the foreign tax credit rules are veryimportant as they supersede U.K. domestic rules.

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The U.S. will give a foreign tax credit with respect to foreigntaxes paid. In the case of U.K. income taxes, capital gains taxesand company taxes, these are all creditable under basic U.S.rules (as well as the treaty).

Foreign tax credits are limited by the amount of U.S. tax arisingon foreign source income. Moreover, the limitation is furthernarrowed by baskets – e.g. U.K. tax on active (generallimitation) income can only offset foreign source active income.

The U.S. will give a foreign tax credit with respect to foreigntaxes paid. In the case of U.K. income taxes, capital gains taxesand company taxes, these are all creditable under basic U.S.rules (as well as the treaty).

Foreign tax credits are limited by the amount of U.S. tax arisingon foreign source income. Moreover, the limitation is furthernarrowed by baskets – e.g. U.K. tax on active (generallimitation) income can only offset foreign source active income.

13

On occasion, the treaty “re-sources” income to allow for aforeign tax credit. For example, a U.S. citizen U.K. resident whoreceives U.S. source interest on which U.K. tax is paid may “re-source” such U.S. source interest as foreign source.

A similar rule applies for dividend income, but with a muchmore elaborate set of rules.

On occasion, the treaty “re-sources” income to allow for aforeign tax credit. For example, a U.S. citizen U.K. resident whoreceives U.S. source interest on which U.K. tax is paid may “re-source” such U.S. source interest as foreign source.

A similar rule applies for dividend income, but with a muchmore elaborate set of rules.

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The U.K. has a special taxing regime for non-domiciledindividuals. For these purposes, “domicile” should not beconfused with “residence”.

Domicile is typically based on a person’s origin – a U.S. citizenborn in the U.S. to American parents presumptively will havedomicile of origin based upon his or her state of birth.

Domicile of origin is very hard to lose. It may ultimately bepossible to have “domicile of choice”, but this requires anintention never to return to the person’s domicile of origin.

The U.K. has a special taxing regime for non-domiciledindividuals. For these purposes, “domicile” should not beconfused with “residence”.

Domicile is typically based on a person’s origin – a U.S. citizenborn in the U.S. to American parents presumptively will havedomicile of origin based upon his or her state of birth.

Domicile of origin is very hard to lose. It may ultimately bepossible to have “domicile of choice”, but this requires anintention never to return to the person’s domicile of origin.

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A non U.K. domiciled individual does not pay U.K. tax on nonU.K. source income unless that income is “remitted” to the U.K.

In simple terms, a U.S. citizen generating, say, rental incomefrom a U.S. property would not pay U.K. tax on that rentalincome unless the rental income is actually sent to a U.K. bankaccount.

Remittance issues create a huge premium on maintainingseparate bank accounts for U.K source income (which the U.K.will always tax) and non U.K. source income (which is only taxedif remitted.)

A non U.K. domiciled individual does not pay U.K. tax on nonU.K. source income unless that income is “remitted” to the U.K.

In simple terms, a U.S. citizen generating, say, rental incomefrom a U.S. property would not pay U.K. tax on that rentalincome unless the rental income is actually sent to a U.K. bankaccount.

Remittance issues create a huge premium on maintainingseparate bank accounts for U.K source income (which the U.K.will always tax) and non U.K. source income (which is only taxedif remitted.)

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Since 2008, the U.K. has cut back on allowing non-domicileincome tax claims by long time residents. In order to claimremittance based tax treatment, residents for the 7 of the last 9years must pay £30,000 per annum to avoid U.K. tax on foreignunremitted income. This charge is increased to £60,000 forresidents for 12 of the past 14 years.

As of April 7, 2017 a U.K. resident for 15 of the past 20 years isno longer eligible for non-domicile treatment. Transition andplanning rules have mitigated the effect of this provision to alarge extent.

Since 2008, the U.K. has cut back on allowing non-domicileincome tax claims by long time residents. In order to claimremittance based tax treatment, residents for the 7 of the last 9years must pay £30,000 per annum to avoid U.K. tax on foreignunremitted income. This charge is increased to £60,000 forresidents for 12 of the past 14 years.

As of April 7, 2017 a U.K. resident for 15 of the past 20 years isno longer eligible for non-domicile treatment. Transition andplanning rules have mitigated the effect of this provision to alarge extent.

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Domicile also affects inheritance tax as persons not domiciled inthe U.K. only pay U.K. inheritance tax on U.K. situs assets.

After 15 of the last 20 years resident in the U.K., a non-domiciled individual will be deemed to be U.K. domiciled,meaning that all assets will be subject to U.K. inheritance tax.

Several planning techniques exist to void some of the effects ofthis rule, including creating offshore excluded property trusts.

Domicile also affects inheritance tax as persons not domiciled inthe U.K. only pay U.K. inheritance tax on U.K. situs assets.

After 15 of the last 20 years resident in the U.K., a non-domiciled individual will be deemed to be U.K. domiciled,meaning that all assets will be subject to U.K. inheritance tax.

Several planning techniques exist to void some of the effects ofthis rule, including creating offshore excluded property trusts.

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III. Passive and unearned incometreatment

Joshua Ashman, CPA(718) 887-9933 (ext. 102) • [email protected]

Ephraim Moss, Esq.(718) 887-9933 (ext. 101) • [email protected]



Table of Contents

Introduction / 3-6Sourcing and Taxation of FDAP Income / 7-9US-UK Cross-Border Scenarios / 10-16Practical Scenarios – Pensions / 17-20Practical Scenarios – Social Security / 21

Introduction / 3-6Sourcing and Taxation of FDAP Income / 7-9US-UK Cross-Border Scenarios / 10-16Practical Scenarios – Pensions / 17-20Practical Scenarios – Social Security / 21

20

Introduction – What is “unearned” income? (Treas. Reg. 1.911-3)

Earned Income Unearned Income Variable Income

-- Salaries and wages -- Dividends -- Business profits-- Commissions -- Interest -- Royalties-- Bonuses -- Capital Gains -- Rents-- Professional fees -- Gambling winnings-- Tips -- Alimony-- Professional fees -- Gambling winnings-- Tips -- Alimony-- Certain Allowances -- Social security

benefits-- Pensions-- Annuities-- Employercontributions to foreignpensions

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Introduction – Unearned income in cross-border context

Foreign Earned Income Exclusion (IRC Sec 911)Provided an individual is able to establish that his “tax home” is outside theU.S., including no U.S. “abode,” and can satisfy either the “bona fideresidence test” or the “physical presence test,” such individual can exclude aportion of their earned income earned overseas.

Example of Practical Challenge:US citizen with UK ISA• No earned income (no FEIE)• No tax in UK (no FTC)

Foreign Earned Income Exclusion (IRC Sec 911)Provided an individual is able to establish that his “tax home” is outside theU.S., including no U.S. “abode,” and can satisfy either the “bona fideresidence test” or the “physical presence test,” such individual can exclude aportion of their earned income earned overseas.

Example of Practical Challenge:US citizen with UK ISA• No earned income (no FEIE)• No tax in UK (no FTC)

22

Introduction – What is “passive” income? (IRC 871)

Passive income is defined in the Internal Revenue Code as “Fixed,Determinable, Annual, or Periodical” (“FDAP”) income.FDAP income generally includes items such as:-- Dividends-- Interest-- Rents-- Royalties-- Original issue discount-- Pensions and Annuities-- Alimony-- Scholarships and fellowship grants-- Others

Passive income is defined in the Internal Revenue Code as “Fixed,Determinable, Annual, or Periodical” (“FDAP”) income.FDAP income generally includes items such as:-- Dividends-- Interest-- Rents-- Royalties-- Original issue discount-- Pensions and Annuities-- Alimony-- Scholarships and fellowship grants-- Others

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Introduction – FDAP income in cross-border context

While the U.S. government taxes its citizens and tax residents on worldwideincome and subjects them to certain anti-deferral regimes, it taxes foreignpersons (Nonresident Aliens and Foreign Entities) in a more limited manner:

1) Tax on Effectively Connected Income (ECI)• Net Basis Tax• Graduated Rates• Generally not withheld at source

2) Tax on U.S. Source FDAP (that is not ECI)• Gross Basis Tax• Flat Rate of 30% (can be reduced by treaty)• Generally withheld at source

While the U.S. government taxes its citizens and tax residents on worldwideincome and subjects them to certain anti-deferral regimes, it taxes foreignpersons (Nonresident Aliens and Foreign Entities) in a more limited manner:

1) Tax on Effectively Connected Income (ECI)• Net Basis Tax• Graduated Rates• Generally not withheld at source

2) Tax on U.S. Source FDAP (that is not ECI)• Gross Basis Tax• Flat Rate of 30% (can be reduced by treaty)• Generally withheld at source

24

Sourcing and Taxation of FDAP Income (IRC 861)

Different rules for different types of items:

Interest:U.S. Source: Interest is US source if obligor is US government, US corporationor US non-corporate resident

Major Exceptions to Tax: Interest on bank deposits, portfolio interest

Dividends:U.S. Source: Dividend from US corporation is US source.

Dividend from foreign corp can also be US source if, among other things:- At least 25% of its gross income for the preceding 3 years was ECI, or- Dividends paid out of earnings and profits which FC acquired from a

domestic corporation

Different rules for different types of items:

Interest:U.S. Source: Interest is US source if obligor is US government, US corporationor US non-corporate resident

Major Exceptions to Tax: Interest on bank deposits, portfolio interest

Dividends:U.S. Source: Dividend from US corporation is US source.

Dividend from foreign corp can also be US source if, among other things:- At least 25% of its gross income for the preceding 3 years was ECI, or- Dividends paid out of earnings and profits which FC acquired from a

domestic corporation

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Sourcing and Taxation of FDAP Income (cont.)

Rent:U.S. Source: Rents from property, or interests in property, located in US areUS source

Net Basis Election – Treat rent as ECI (with deductions and using graduatedtax rates).

Real versus Personal Property Dispositions:Personal Property: Gain is generally sourced according to the tax residence ofthe seller (with exceptions)

Real Property: Gain is treated essentially as ECI (FIRPTA), with specialwithholding rules

Rent:U.S. Source: Rents from property, or interests in property, located in US areUS source

Net Basis Election – Treat rent as ECI (with deductions and using graduatedtax rates).

Real versus Personal Property Dispositions:Personal Property: Gain is generally sourced according to the tax residence ofthe seller (with exceptions)

Real Property: Gain is treated essentially as ECI (FIRPTA), with specialwithholding rules

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Sourcing and Taxation of FDAP Income (cont.)

Royalties:U.S. Source: royalties from property located in the United States or from anyinterest in such property, including royalties for the use of or for the privilege ofusing in the United States, are US Source

Note: Gain from the sale of IP treated as royalties for purpose of determiningsource if payments contingent upon productivity, use or disposition of IP

U.S.-U.K. Treaty Rate Reductions:Interest: 0%

Dividends: 0-15%

Royalties: 0%

Treaty can “re-source” income to prevent double taxation

Royalties:U.S. Source: royalties from property located in the United States or from anyinterest in such property, including royalties for the use of or for the privilege ofusing in the United States, are US Source

Note: Gain from the sale of IP treated as royalties for purpose of determiningsource if payments contingent upon productivity, use or disposition of IP

U.S.-U.K. Treaty Rate Reductions:Interest: 0%

Dividends: 0-15%

Royalties: 0%

Treaty can “re-source” income to prevent double taxation

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U.S. Tax Residence

• Scenario 1 - U.S. citizen / Green card holder living in the U.K.

• Scenario 2 - U.K. citizen tax resident in the U.S.

Non-U.S. Tax Residence

• Scenario 3 - U.K. citizen not tax resident in the U.S.

US-UK Cross-Border Scenarios

U.S. Tax Residence

• Scenario 1 - U.S. citizen / Green card holder living in the U.K.

• Scenario 2 - U.K. citizen tax resident in the U.S.

Non-U.S. Tax Residence

• Scenario 3 - U.K. citizen not tax resident in the U.S.

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Scenario 1: U.S. citizen and green card holder living in the U.K.

• Dividend and interest income from the U.K.

• Capital gains on sale of U.K. property (personal residenceexemption)

Scenario 2: U.K. citizen tax resident in the U.S.

• Sale of shares in U.K. company (CFC / PFIC rules)

• ISA income

Scenario 3: U.K. citizen not tax resident in the U.S.

• U.S. investment income

• U.S. rental income

Practical Scenarios – General

Scenario 1: U.S. citizen and green card holder living in the U.K.

• Dividend and interest income from the U.K.

• Capital gains on sale of U.K. property (personal residenceexemption)

Scenario 2: U.K. citizen tax resident in the U.S.

• Sale of shares in U.K. company (CFC / PFIC rules)

• ISA income

Scenario 3: U.K. citizen not tax resident in the U.S.

• U.S. investment income

• U.S. rental income

29

Lawful Permanent Residence Test - Person has been admitted to US as alawful permanent resident (i.e., receives a “green card”), even if living outsidethe United States

Substantial Presence Test - Person is resident alien in a particular calendaryear if:• He is present in US for at least 31 during that year, and• Weighted count of his days in US for that year and 2 previous years is at

least 183 days- Current year: Number of days present- 1st prior year: Number of days present * 1/3- 2nd prior year: Number of days present * 1/6

Determining U.S. Tax Residence – 2 Basic Tests

Lawful Permanent Residence Test - Person has been admitted to US as alawful permanent resident (i.e., receives a “green card”), even if living outsidethe United States

Substantial Presence Test - Person is resident alien in a particular calendaryear if:• He is present in US for at least 31 during that year, and• Weighted count of his days in US for that year and 2 previous years is at

least 183 days- Current year: Number of days present- 1st prior year: Number of days present * 1/3- 2nd prior year: Number of days present * 1/6

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Tie-Breaker Test – Article 4(4)If an individual is a resident of both Contracting States, then his status shall bedetermined as follows:

a) State in which he has a permanent home available to him;

b) State with which his personal and economic relations are closer (centre ofvital interests);

c) State in which he has an habitual abode;

d) State of which he is a national;

e) Determination by competent authorities

Determining U.S. Tax Residence – U.S.-U.K. Treaty (cont.)

Tie-Breaker Test – Article 4(4)If an individual is a resident of both Contracting States, then his status shall bedetermined as follows:

a) State in which he has a permanent home available to him;

b) State with which his personal and economic relations are closer (centre ofvital interests);

c) State in which he has an habitual abode;

d) State of which he is a national;

e) Determination by competent authorities

31

Other Rules:Article 1(4)

Notwithstanding any provision of this Convention except paragraph 5 of thisArticle, a Contracting State may tax its residents (as determined under Article4 (Residence)), and by reason of citizenship may tax its citizens, as if thisConvention had not come into effect (“Saving Clause”)

Article 4(2)

An individual who is a United States citizen or an alien admitted to the UnitedStates for permanent residence (a “green card” holder) is a resident of theUnited States only if the individual has a substantial presence, permanenthome or habitual abode in the United States and if that individual is not aresident of a State other than the United Kingdom

Determining U.S. Tax Residence – U.S.-U.K. Treaty

Other Rules:Article 1(4)

Notwithstanding any provision of this Convention except paragraph 5 of thisArticle, a Contracting State may tax its residents (as determined under Article4 (Residence)), and by reason of citizenship may tax its citizens, as if thisConvention had not come into effect (“Saving Clause”)

Article 4(2)

An individual who is a United States citizen or an alien admitted to the UnitedStates for permanent residence (a “green card” holder) is a resident of theUnited States only if the individual has a substantial presence, permanenthome or habitual abode in the United States and if that individual is not aresident of a State other than the United Kingdom

32

Tax Considerations – Unearned and Passive Income• Subject to U.S. federal income tax on worldwide income (i.e., U.S. source

and foreign source income)

• NIIT (Trump proposal)

• Anti-deferral regimes – CFC and PFIC

• FEIE not available

- U.S. citizen in the U.K. – no earned income

- U.K. citizen tax resident in the U.S. – no foreign income

• FTC available

Scenario 1 and 2 - U.S. citizen and green card holder living in theU.K. / U.K. citizen tax resident in the U.S.

Tax Considerations – Unearned and Passive Income• Subject to U.S. federal income tax on worldwide income (i.e., U.S. source

and foreign source income)

• NIIT (Trump proposal)

• Anti-deferral regimes – CFC and PFIC

• FEIE not available

- U.S. citizen in the U.K. – no earned income

- U.K. citizen tax resident in the U.S. – no foreign income

• FTC available

33

Tax Considerations – Unearned and Passive Income• Generally subject to U.S. federal income tax on U.S. source FDAP at flat

rate of 30% (unless reduced by treaty)

• Income withheld at source

• Generally no tax filing requirement if proper certification submitted to payor(e.g., W-8BEN)

• No NIIT

• No anti-deferral regimes

• No FEIE

Scenario 3 - U.K. citizen not tax resident in the U.S.

Tax Considerations – Unearned and Passive Income• Generally subject to U.S. federal income tax on U.S. source FDAP at flat

rate of 30% (unless reduced by treaty)

• Income withheld at source

• Generally no tax filing requirement if proper certification submitted to payor(e.g., W-8BEN)

• No NIIT

• No anti-deferral regimes

• No FEIE

34

There are many potential scenarios involving cross-border pensions, eachwith a host of U.S. and U.K. tax implications. For the sake of illustration, wereview the following scenario:

Scenario 1:

U.S. citizen living in the U.K. with a U.K. pension

U.S. Federal Tax Issues:• Pension Contributions

• Pension Earnings

• Pension Distributions

Practical Scenarios – Pensions

There are many potential scenarios involving cross-border pensions, eachwith a host of U.S. and U.K. tax implications. For the sake of illustration, wereview the following scenario:

Scenario 1:

U.S. citizen living in the U.K. with a U.K. pension

U.S. Federal Tax Issues:• Pension Contributions

• Pension Earnings

• Pension Distributions

35

U.S. Domestic (Non-Treaty) Law:

Contributions and EarningsIRC Section 402(b) - Non-Exempt Employees’ Trust

In the case of “non-discriminatory” pension plans – employees must include employercontributions in income but not pension earnings. Earnings are taxed upon the ultimatedistribution to the employee.

In the case of “discriminatory” pension plans, a highly compensated employee must recognize thedifference between the current year ending value of the account and the previously taxedamounts as compensation income each year. This essentially includes employer contributions andplan earnings. It should be noted that as such, not only is the current-year-realized incomesubject to tax, but also any unrealized appreciation in the plan is taxed.

An example of a plan that is non-discriminatory is one that benefits at least 70% of employeesthat are not highly compensated employees ($120,000 in 2017).

DistributionsTaxable ordinary income – but taxpayer may have basis in the trust.

Practical Scenarios – Pensions (cont.)

U.S. Domestic (Non-Treaty) Law:

Contributions and EarningsIRC Section 402(b) - Non-Exempt Employees’ Trust

In the case of “non-discriminatory” pension plans – employees must include employercontributions in income but not pension earnings. Earnings are taxed upon the ultimatedistribution to the employee.

In the case of “discriminatory” pension plans, a highly compensated employee must recognize thedifference between the current year ending value of the account and the previously taxedamounts as compensation income each year. This essentially includes employer contributions andplan earnings. It should be noted that as such, not only is the current-year-realized incomesubject to tax, but also any unrealized appreciation in the plan is taxed.

An example of a plan that is non-discriminatory is one that benefits at least 70% of employeesthat are not highly compensated employees ($120,000 in 2017).

DistributionsTaxable ordinary income – but taxpayer may have basis in the trust.

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U.S.-U.K. Treaty

Contributions and EarningsArticle 18(5)For qualifying UK pensions of US citizens – employer contributions and pensionearnings are U.S. tax exempt.

DistributionsArticle 17(1)-(2)Periodic: Taxable in the state of residence only (with saving clause override). However,the state of residence must exempt from tax any amount that would be exempt fromtax in the state in which the pension scheme is established if the recipient were aresident of that state (with no saving clause override).Lump-sum: Taxable in the state of pension only (with saving clause override).


U.S.-U.K. Treaty

Contributions and EarningsArticle 18(5)For qualifying UK pensions of US citizens – employer contributions and pensionearnings are U.S. tax exempt.

DistributionsArticle 17(1)-(2)Periodic: Taxable in the state of residence only (with saving clause override). However,the state of residence must exempt from tax any amount that would be exempt fromtax in the state in which the pension scheme is established if the recipient were aresident of that state (with no saving clause override).Lump-sum: Taxable in the state of pension only (with saving clause override).

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• Examples of U.K. Pensions

Treaty Benefits:Workplace Pension (WPP), Executive Pension Plan (EPP), Stake Holder

Treaty Benefits, but additional reporting requirements under 402(b):Self-invested Pension Plan (SIPP), Personal Pension Plan (PPP)

No Treaty Benefits and 402(b) treatment unavailable:ISA

• Examples of U.K. Pensions

Treaty Benefits:Workplace Pension (WPP), Executive Pension Plan (EPP), Stake Holder

Treaty Benefits, but additional reporting requirements under 402(b):Self-invested Pension Plan (SIPP), Personal Pension Plan (PPP)

No Treaty Benefits and 402(b) treatment unavailable:ISA

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Practical Scenarios – Social Security

Coverage and TaxesU.S.-U.K. Totalization Agreement:Working in the U.K. for a non-U.S. employer: U.K. Coverage and TaxesWorking in the U.K. for U.S. employer: U.K. Coverage and Taxes, unless youwere sent by employer to work in the U.K. for five years or less.

Payments from Social Security:Article 17(3):Payments made by a Contracting State under the provisions of the socialsecurity or similar legislation of that State to a resident of the other ContractingState shall be taxable only in that other State.

Coverage and TaxesU.S.-U.K. Totalization Agreement:Working in the U.K. for a non-U.S. employer: U.K. Coverage and TaxesWorking in the U.K. for U.S. employer: U.K. Coverage and Taxes, unless youwere sent by employer to work in the U.K. for five years or less.

Payments from Social Security:Article 17(3):Payments made by a Contracting State under the provisions of the socialsecurity or similar legislation of that State to a resident of the other ContractingState shall be taxable only in that other State.

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IV. US Tax ReportingRequirements of UK-SourcedInvestments





Table of Contents

Introduction / 3Form 8938 – Foreign Assets / 4-8Form 114 (FBAR) – Foreign Accounts / 9-13Forms 3520 and 3520-A – Foreign Trusts/Pensions / 14-17Form 8621 – PFICs / 18-23Other Forms / 24

Introduction / 3Form 8938 – Foreign Assets / 4-8Form 114 (FBAR) – Foreign Accounts / 9-13Forms 3520 and 3520-A – Foreign Trusts/Pensions / 14-17Form 8621 – PFICs / 18-23Other Forms / 24

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Introduction - The “Big Four” IRS Forms for Reporting ForeignPassive Income & Accounts

Form 8938FATCA reporting of specified foreign financial assets

FBAR – FinCEN Form 114Foreign bank and financial account report

Form 3520Dealings with a foreign trust including foreign trusts and the receipt of largegifts from nonresidents

Form 8621Ownership interest in Passive Foreign Investment Company (PFIC)

Form 8938FATCA reporting of specified foreign financial assets

FBAR – FinCEN Form 114Foreign bank and financial account report

Form 3520Dealings with a foreign trust including foreign trusts and the receipt of largegifts from nonresidents

Form 8621Ownership interest in Passive Foreign Investment Company (PFIC)

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IRS Form 8938 – FATCA Reporting

BackgroundAs part of FATCA, beginning in 2011, U.S. citizens, including those livingabroad, became obligated to report their holdings in “specified foreign financialassets” on an annual basis to the IRS, assuming certain asset valuethresholds are met.

In addition, foreign financial institutions (FFIs) (which include just about everyforeign bank, investment house and even some foreign insurance companies)became required to report the balances in the accounts held by customerswho are US citizens.

While Form 8938 is relevant to several types of U.S. taxpayers, we focus onits relevance for US citizens living abroad.

BackgroundAs part of FATCA, beginning in 2011, U.S. citizens, including those livingabroad, became obligated to report their holdings in “specified foreign financialassets” on an annual basis to the IRS, assuming certain asset valuethresholds are met.

In addition, foreign financial institutions (FFIs) (which include just about everyforeign bank, investment house and even some foreign insurance companies)became required to report the balances in the accounts held by customerswho are US citizens.

While Form 8938 is relevant to several types of U.S. taxpayers, we focus onits relevance for US citizens living abroad.

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IRS Form 8938 (cont.)

Specified Foreign Financial Assets1. Financial accounts maintained by a foreign financial institution.

2. The following foreign financial assets if they are held for investment andnot held in an account maintained by a financial institution:

a) Stock or securities issued by someone that is not a U.S. person(including stock or securities issued by a person organized underthe laws of a U.S. possession)

b) Any interest in a foreign entityc) Any financial instrument or contract that has an issuer or

counterparty that is not a U.S. person (including a financial contractissued by, or with a counterparty that is, a person organized underthe laws of a U.S. possession).

Examples: UK bank account, ISA, Pension, UK Shares

Specified Foreign Financial Assets1. Financial accounts maintained by a foreign financial institution.

2. The following foreign financial assets if they are held for investment andnot held in an account maintained by a financial institution:

a) Stock or securities issued by someone that is not a U.S. person(including stock or securities issued by a person organized underthe laws of a U.S. possession)

b) Any interest in a foreign entityc) Any financial instrument or contract that has an issuer or

counterparty that is not a U.S. person (including a financial contractissued by, or with a counterparty that is, a person organized underthe laws of a U.S. possession).

Examples: UK bank account, ISA, Pension, UK Shares

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Who Must File?If you reside outside the U.S. and have a bank account or investment accountin a foreign financial institution, you are generally required to include Form8938 with your U.S. federal income tax return if you meet the followingthresholds:

• You are filing a return other than a joint return and the total value of yourspecified foreign assets is more than $200,000 on the last day of the taxyear or more than $300,000 at any time during the year; or

• You are filing a joint return and the value of your specified foreign asset ismore than $400,000 on the last day of the tax year or more than $600,000at any time during the year.

If you reside within the U.S., the thresholds are significantly lower than theabove amounts and depend on your filing status.

Who Must File?If you reside outside the U.S. and have a bank account or investment accountin a foreign financial institution, you are generally required to include Form8938 with your U.S. federal income tax return if you meet the followingthresholds:

• You are filing a return other than a joint return and the total value of yourspecified foreign assets is more than $200,000 on the last day of the taxyear or more than $300,000 at any time during the year; or

• You are filing a joint return and the value of your specified foreign asset ismore than $400,000 on the last day of the tax year or more than $600,000at any time during the year.

If you reside within the U.S., the thresholds are significantly lower than theabove amounts and depend on your filing status.

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What type of information is requested on Form 8938?In addition to listing the accounts and their maximum values during the taxyear, the form requires the taxpayer to list income reported on the tax returnrelating to the accounts.

As to these, various tax items must be specified (interest, dividends, royalties,etc.), the amount reported must be provided, and the corresponding reportingon the tax return must be provided (i.e., which form and line or which scheduleand line).

What type of information is requested on Form 8938?In addition to listing the accounts and their maximum values during the taxyear, the form requires the taxpayer to list income reported on the tax returnrelating to the accounts.

As to these, various tax items must be specified (interest, dividends, royalties,etc.), the amount reported must be provided, and the corresponding reportingon the tax return must be provided (i.e., which form and line or which scheduleand line).

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Due DateSame as due date (including extensions) of income tax return.

PenaltiesFailure to file Form 8938 comes with a pretty severe penalty of $10,000 perform. The penalty is increased by $10,000 (up to a maximum of $50,000) foreach 30-day period that the failure continues for more than 90 days after theIRS mails you a notice of your failure to file. Additional penalties can also beimposed if you underpay your tax as a result of a transaction involving aforeign financial asset that was not disclosed on the form.

Due DateSame as due date (including extensions) of income tax return.

PenaltiesFailure to file Form 8938 comes with a pretty severe penalty of $10,000 perform. The penalty is increased by $10,000 (up to a maximum of $50,000) foreach 30-day period that the failure continues for more than 90 days after theIRS mails you a notice of your failure to file. Additional penalties can also beimposed if you underpay your tax as a result of a transaction involving aforeign financial asset that was not disclosed on the form.

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FBAR – FinCEN Form 114

BackgroundThe Bank Secrecy Act (BSA) gives the Department of Treasury the authority tocollect information from United States persons, including expats, who havefinancial interests in or signature authority over financial accounts maintainedwith financial institutions located outside of the United States.

General RuleThe BSA requires that a FinCEN Report 114, Report of Foreign Bank andFinancial Accounts (FBAR), be filed if the maximum values of the foreignfinancial accounts exceed $10,000 in the aggregate at any time during thecalendar year.

BackgroundThe Bank Secrecy Act (BSA) gives the Department of Treasury the authority tocollect information from United States persons, including expats, who havefinancial interests in or signature authority over financial accounts maintainedwith financial institutions located outside of the United States.

General RuleThe BSA requires that a FinCEN Report 114, Report of Foreign Bank andFinancial Accounts (FBAR), be filed if the maximum values of the foreignfinancial accounts exceed $10,000 in the aggregate at any time during thecalendar year.

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FBAR (cont.)

Example – US Citizen in the UK:Alan, a U.S. citizen, moved abroad in 2016 and opened a current account at aUK bank. During the same year, he opened a savings account at a separateUK bank. He first funded the current account with $5,000 and then funded thesavings account with $6,000. During he year, Alan decides to go on avacation and spends $5,000 from his savings account such that on December31, 2016, the remaining balance in his savings account is $1,000 while hiscurrent account has a balance of $3,000.

Although Alan did not have any single account with $10,000 in value andalthough the aggregate account value of his two accounts did not exceed$10,000 at year-end, Alan would be required to file a 2016 FBAR, becauseduring the 2016 year, the aggregate maximum account value of Alan’s twoaccounts was more than $10,000 (i.e., $11,000).

Example – US Citizen in the UK:Alan, a U.S. citizen, moved abroad in 2016 and opened a current account at aUK bank. During the same year, he opened a savings account at a separateUK bank. He first funded the current account with $5,000 and then funded thesavings account with $6,000. During he year, Alan decides to go on avacation and spends $5,000 from his savings account such that on December31, 2016, the remaining balance in his savings account is $1,000 while hiscurrent account has a balance of $3,000.

Although Alan did not have any single account with $10,000 in value andalthough the aggregate account value of his two accounts did not exceed$10,000 at year-end, Alan would be required to file a 2016 FBAR, becauseduring the 2016 year, the aggregate maximum account value of Alan’s twoaccounts was more than $10,000 (i.e., $11,000).

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FBAR (cont.)

Foreign Financial Account• Bank accounts such as savings accounts, checking accounts, and time

deposits

• Securities accounts such as brokerage accounts and securities derivativesor other financial instruments accounts (Example – ISA)

• Insurance policies with a cash value (such as a whole life insurance policy)

• Mutual funds or similar pooled funds (i.e., a fund that is available to thegeneral public with a regular net asset value determination and regularredemptions)

• Certain foreign pension funds

Typically, a financial account that is maintained with a bank or financialinstitution located outside of the United States is a foreign financial account.

Foreign Financial Account• Bank accounts such as savings accounts, checking accounts, and time

deposits

• Securities accounts such as brokerage accounts and securities derivativesor other financial instruments accounts (Example – ISA)

• Insurance policies with a cash value (such as a whole life insurance policy)

• Mutual funds or similar pooled funds (i.e., a fund that is available to thegeneral public with a regular net asset value determination and regularredemptions)

• Certain foreign pension funds

Typically, a financial account that is maintained with a bank or financialinstitution located outside of the United States is a foreign financial account.

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Filing the FBARThe FBAR form (FinCEN Form 114) must be filed electronically using the BSAE-Filing System maintained by the U.S. Department of the Treasury’sFinancial Crimes Enforcement Network (“FinCEN”).

Due DateFor tax years 2016 and onwards, the FBAR due date is April 15th, witha maximum extension of 6 months.

For the 2016 tax year, taxpayers are automatically granted an extension. Itremains to be seen if this continues moving forward.

FBAR (cont.)

Filing the FBARThe FBAR form (FinCEN Form 114) must be filed electronically using the BSAE-Filing System maintained by the U.S. Department of the Treasury’sFinancial Crimes Enforcement Network (“FinCEN”).

Due DateFor tax years 2016 and onwards, the FBAR due date is April 15th, witha maximum extension of 6 months.

For the 2016 tax year, taxpayers are automatically granted an extension. Itremains to be seen if this continues moving forward.

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PenaltiesA non-willful failure to report foreign bank accounts can result in a penalty ofup to $10,000 per account per year. The IRS has recently stated that thesepenalties represent maximum amounts and lower penalties may beappropriate depending on the circumstances (“mitigating circumstances”).

A willful failure to file may be subject to civil penalties equal to the greater of$100,000 or 50% of the balance in each unreported account. In addition,criminal penalties of up to $250,000 or 5 years in jail (or both) may apply in thecase of willful conduct.

Currently, the FBAR regulations do not provide guidance for distinguishing“willful” versus “non-willful” FBAR filing violations. Courts have recentlyaccepted a broader definition of being “at least recklessly indifferent to astatutory duty.”

FBAR (cont.)

PenaltiesA non-willful failure to report foreign bank accounts can result in a penalty ofup to $10,000 per account per year. The IRS has recently stated that thesepenalties represent maximum amounts and lower penalties may beappropriate depending on the circumstances (“mitigating circumstances”).

A willful failure to file may be subject to civil penalties equal to the greater of$100,000 or 50% of the balance in each unreported account. In addition,criminal penalties of up to $250,000 or 5 years in jail (or both) may apply in thecase of willful conduct.

Currently, the FBAR regulations do not provide guidance for distinguishing“willful” versus “non-willful” FBAR filing violations. Courts have recentlyaccepted a broader definition of being “at least recklessly indifferent to astatutory duty.”

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Form 3520 – Reporting Transactions with a Foreign Trust:

• Ownership of a foreign grantor trust

• The formation of a foreign trust

• The transfer of cash or other assets by a settlor or grantor to a foreigntrust

• The receipt of any distributions by U.S. beneficiaries from a foreign trust

• The loaning of money by a foreign trust to a U.S. owner/beneficiary

Form 3520-A – Return of Foreign Trust with a U.S. Owner:The foreign trust must report all of its financial activities for the year as well asfurnish each U.S. beneficiary with a statement showing their share of theactivity. The obligation to file is on the U.S. owner.

IRS Forms 3520 and 3520-A: Foreign Trusts/Pensions

Form 3520 – Reporting Transactions with a Foreign Trust:

• Ownership of a foreign grantor trust

• The formation of a foreign trust

• The transfer of cash or other assets by a settlor or grantor to a foreigntrust

• The receipt of any distributions by U.S. beneficiaries from a foreign trust

• The loaning of money by a foreign trust to a U.S. owner/beneficiary

Form 3520-A – Return of Foreign Trust with a U.S. Owner:The foreign trust must report all of its financial activities for the year as well asfurnish each U.S. beneficiary with a statement showing their share of theactivity. The obligation to file is on the U.S. owner.

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Foreign PensionsIf the plan is considered a grantor trust, it is reportable on Form 3520 and3520-A.

Examples – Self–Invested Pension Plan (SIPP), Personal Pension Plan (PPP)

If the plan is considered an employees’ trust under IRC 402(b), no reporting isrequired on Forms 3520 and 3520-A unless it is considered a grantor trust dueto employee contributions exceeding employer contributions.

Examples – Work Place Pension (WPP), Executive Pension Plan (EPP)

IRS Forms 3520 and 3520-A (cont.)

Foreign PensionsIf the plan is considered a grantor trust, it is reportable on Form 3520 and3520-A.

Examples – Self–Invested Pension Plan (SIPP), Personal Pension Plan (PPP)

If the plan is considered an employees’ trust under IRC 402(b), no reporting isrequired on Forms 3520 and 3520-A unless it is considered a grantor trust dueto employee contributions exceeding employer contributions.

Examples – Work Place Pension (WPP), Executive Pension Plan (EPP)

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Due DatesIn general, Form 3520 is due on the date that the income tax return is due,including extensions.

The Form 3520-A, in contrast, is required to be filed by the 15th day of the 3rd

month following the trust’s tax year. The difference in the filing dates is a trapfor the unwary.

An extension of time to file an income tax return will not provide an extensionof time to file Form 3520-A. Form 7004 must be filed in order to request anextension of time to file Form 3520-A.


Due DatesIn general, Form 3520 is due on the date that the income tax return is due,including extensions.

The Form 3520-A, in contrast, is required to be filed by the 15th day of the 3rd

month following the trust’s tax year. The difference in the filing dates is a trapfor the unwary.

An extension of time to file an income tax return will not provide an extensionof time to file Form 3520-A. Form 7004 must be filed in order to request anextension of time to file Form 3520-A.

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PenaltiesA penalty generally applies if Form 3520 is not timely filed or if the information isincomplete or incorrect. Generally, the initial penalty is equal to the greater of $10,000or:

• 35% of the gross value of any property transferred to a foreign trust for failure by aU.S. transferor to report the creation of or transfer to a foreign trust; or

• 35% of the gross value of the distributions received from a foreign trust for failure bya U.S. person to report receipt of the distribution; or

• 5% of the gross value of the portion of the trust’s assets treated as owned by a U.S.person for failure by the U.S. person to report the U.S. owner information.

Additional penalties will be imposed if the noncompliance continues after the IRS mailsa notice of failure to comply with the required reporting.


PenaltiesA penalty generally applies if Form 3520 is not timely filed or if the information isincomplete or incorrect. Generally, the initial penalty is equal to the greater of $10,000or:

• 35% of the gross value of any property transferred to a foreign trust for failure by aU.S. transferor to report the creation of or transfer to a foreign trust; or

• 35% of the gross value of the distributions received from a foreign trust for failure bya U.S. person to report receipt of the distribution; or

• 5% of the gross value of the portion of the trust’s assets treated as owned by a U.S.person for failure by the U.S. person to report the U.S. owner information.

Additional penalties will be imposed if the noncompliance continues after the IRS mailsa notice of failure to comply with the required reporting.

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Definition of a PFICSection 1297(a)

In general: For purposes of this part, except as otherwise provided in thissubpart, the term “passive foreign investment company” means any foreigncorporation if —

(1) 75 percent or more of the gross income of such corporation for thetaxable year is passive income (PFIC Income Test), or

(2) the average percentage of assets held by such corporation during thetaxable year which produce passive income or which are held for the productionof passive income is at least 50 percent (PFIC Asset Test).

There is no US shareholder control requirement – applies if a US person holds evena de minimis amount of PFIC shares, directly, or indirectly.

Examples – UK Mutual Funds, ISAs

IRS Form 8621 – PFIC Reporting

Definition of a PFICSection 1297(a)

In general: For purposes of this part, except as otherwise provided in thissubpart, the term “passive foreign investment company” means any foreigncorporation if —

(1) 75 percent or more of the gross income of such corporation for thetaxable year is passive income (PFIC Income Test), or

(2) the average percentage of assets held by such corporation during thetaxable year which produce passive income or which are held for the productionof passive income is at least 50 percent (PFIC Asset Test).

There is no US shareholder control requirement – applies if a US person holds evena de minimis amount of PFIC shares, directly, or indirectly.

Examples – UK Mutual Funds, ISAs

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1. Default – “1291 Fund”• Worst-case scenario for taxpayer• Designed to eliminate advantage of deferral and penalize taxpayer• Tax on excess distributions (including gain on sale of PFIC stock) at highest

ordinary income tax rate plus interest charge

2. QEF Election• US shareholder effectively elects to include in each year's income its share

of the PFIC's ordinary earnings and net capital gains.• Payment of tax can be deferred (subject to interest charge)

3. Mark-to-Market Election• Applies only to publicly-traded PFICs• US shareholder recognizes ordinary income or loss on the stock at the end

of each year that the shareholder owns the PFIC stock, equal to thedifference between the basis of the stock and its fair market value at thattime

1. Default – “1291 Fund”• Worst-case scenario for taxpayer• Designed to eliminate advantage of deferral and penalize taxpayer• Tax on excess distributions (including gain on sale of PFIC stock) at highest

ordinary income tax rate plus interest charge

2. QEF Election• US shareholder effectively elects to include in each year's income its share

of the PFIC's ordinary earnings and net capital gains.• Payment of tax can be deferred (subject to interest charge)

3. Mark-to-Market Election• Applies only to publicly-traded PFICs• US shareholder recognizes ordinary income or loss on the stock at the end

of each year that the shareholder owns the PFIC stock, equal to thedifference between the basis of the stock and its fair market value at thattime

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Who Must File• U.S. persons who are direct shareholders

• U.S. persons who are indirect shareholders, unless an exception appliesfor that particular type of indirect shareholder.

- Example: U.S. beneficiary of foreign non-grantor trust if noexcess distribution to beneficiary

Parts of the form will be required depending on ownership status anddepending on type of transaction

• Chain of Ownership: If a shareholder owns one PFIC and through thatPFIC owns one or more other PFICs, the shareholder can complete Form8621 for the first PFIC and, in an attachment, provide the informationrequired on Form 8621 for each of the other PFICs in the chain.

Who Must File• U.S. persons who are direct shareholders

• U.S. persons who are indirect shareholders, unless an exception appliesfor that particular type of indirect shareholder.

- Example: U.S. beneficiary of foreign non-grantor trust if noexcess distribution to beneficiary

Parts of the form will be required depending on ownership status anddepending on type of transaction

• Chain of Ownership: If a shareholder owns one PFIC and through thatPFIC owns one or more other PFICs, the shareholder can complete Form8621 for the first PFIC and, in an attachment, provide the informationrequired on Form 8621 for each of the other PFICs in the chain.

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Notable Exceptions to Filing – Recently Finalized RegulationsDual-resident taxpayers – The final regulations add an exception from reporting for

dual-resident taxpayers treated as residents of a foreign country under a treaty-tiebreaker rule.

Tax-exempt entities – This includes both the entity and its interest holders.

De minimis exceptions – The final regulations retain an exception to PFIC reporting if:(i) the shareholder has not made a QEF or mark-to-market election, (ii) is nottreated as receiving an excess distribution or recognizing gain treated as suchduring the shareholder’s tax year, and (iii) either (A) the aggregate value of allPFIC stock owned at year-end does not exceed $25,000 ($50,000 for a jointreturn), or (B) the PFIC stock is owned through another PFIC, and theshareholder’s proportionate share of the upper-tier PFIC’s interest in the lower-tierPFIC does not exceed $5,000 in value.

Transitory ownership – The final regulations provide an exception to PFIC reportingwith respect to PFICs owned for a short period of time (30 days or less) andduring which time no PFIC taxation was imposed on the shareholder.

Notable Exceptions to Filing – Recently Finalized RegulationsDual-resident taxpayers – The final regulations add an exception from reporting for

dual-resident taxpayers treated as residents of a foreign country under a treaty-tiebreaker rule.

Tax-exempt entities – This includes both the entity and its interest holders.

De minimis exceptions – The final regulations retain an exception to PFIC reporting if:(i) the shareholder has not made a QEF or mark-to-market election, (ii) is nottreated as receiving an excess distribution or recognizing gain treated as suchduring the shareholder’s tax year, and (iii) either (A) the aggregate value of allPFIC stock owned at year-end does not exceed $25,000 ($50,000 for a jointreturn), or (B) the PFIC stock is owned through another PFIC, and theshareholder’s proportionate share of the upper-tier PFIC’s interest in the lower-tierPFIC does not exceed $5,000 in value.

Transitory ownership – The final regulations provide an exception to PFIC reportingwith respect to PFICs owned for a short period of time (30 days or less) andduring which time no PFIC taxation was imposed on the shareholder.

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Notable Exceptions to Filing (cont.)Certain foreign pension funds – Generally, a U.S. person is exempt from PFIC

reporting with respect to PFIC stock owned through a foreign trust that is a foreignpension fund operated principally to provide pension or retirement benefits, when,pursuant to a treaty, the income earned by the pension fund may be taxed as theincome of the U.S. person only upon a distribution to the U.S. person. Theproposed regulations provided an exemption only when the foreign pension fundwas treated as a foreign trust for U.S. tax purposes. The final regulations expandthe exception to PFICs held through a foreign pension fund covered by a treaty,regardless of the pension fund’s entity classification for U.S. tax purposes.

UK Pension Plan Examples:Personal Pension Plan (PPP) , Self Invested Pension Plan (SIPP), ExecutivePension Plan (EPP), Stake Holder, Work Place Pensions (WPP), Others

Notable Exceptions to Filing (cont.)Certain foreign pension funds – Generally, a U.S. person is exempt from PFIC

reporting with respect to PFIC stock owned through a foreign trust that is a foreignpension fund operated principally to provide pension or retirement benefits, when,pursuant to a treaty, the income earned by the pension fund may be taxed as theincome of the U.S. person only upon a distribution to the U.S. person. Theproposed regulations provided an exemption only when the foreign pension fundwas treated as a foreign trust for U.S. tax purposes. The final regulations expandthe exception to PFICs held through a foreign pension fund covered by a treaty,regardless of the pension fund’s entity classification for U.S. tax purposes.

UK Pension Plan Examples:Personal Pension Plan (PPP) , Self Invested Pension Plan (SIPP), ExecutivePension Plan (EPP), Stake Holder, Work Place Pensions (WPP), Others

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Due DateForm 8621 must be attached to the shareholder’s tax return and filed by the due date,including extensions, of the return.

PenaltiesUnlike other information returns, Form 8621 does not carry a penalty for not filing theform. However, failing to file the form does leave open the statute of limitations on alltax matters for that tax year indefinitely.

Due DateForm 8621 must be attached to the shareholder’s tax return and filed by the due date,including extensions, of the return.

PenaltiesUnlike other information returns, Form 8621 does not carry a penalty for not filing theform. However, failing to file the form does leave open the statute of limitations on alltax matters for that tax year indefinitely.

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Other IRS Forms

Other potentially relevant forms include:

Form 5471, Information Return of U.S. Persons With Respect to Certain ForeignCorporations (CFCs)

Form 5472, Information Return of a 25% Foreign Owned U.S. Corporation or a ForeignCorporation Engaged in a U.S. Trade or Business

Form 926, Return by a U.S. Transferor of Property to a Foreign Corporation

Form 8865, Return of U.S .Persons with Respect to Certain Foreign Partnerships

Form 8858, Information Return of a U.S. Persons with Respect to Foreign DisregardedEntities

Other potentially relevant forms include:

Form 5471, Information Return of U.S. Persons With Respect to Certain ForeignCorporations (CFCs)

Form 5472, Information Return of a 25% Foreign Owned U.S. Corporation or a ForeignCorporation Engaged in a U.S. Trade or Business

Form 926, Return by a U.S. Transferor of Property to a Foreign Corporation

Form 8865, Return of U.S .Persons with Respect to Certain Foreign Partnerships

Form 8858, Information Return of a U.S. Persons with Respect to Foreign DisregardedEntities

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Limitation of Benefit ProvisionsLimitation of Benefit Provisions

Jeffrey M. Rosenfeld

• Only “qualified persons” can obtain benefits• Prevents interposition of entities to obtain Treaty

Benefits

Limitation on BenefitsLimitation on Benefits

Zimbabwe

67

UK

Zimbabwe

US

• Even before we get into who a qualified person is, only a“resident of a Contracting State” is eligible for Treaty benefits.

– any person who, under the laws of that State, is liable to tax therein by reason of hisdomicile, residence, citizenship, place of management, place of incorporation, or any othercriterion of a similar nature.

• RICs, REITs and REMICs are all residents of the United States for purposes of thetreaty. Although their income normally is not subject to U.S. tax in the hands of theentity, they are taxable to the extent that they do not currently distribute their profits,and therefore are regarded as “liable to tax.”

• However, does not include any person who is liable to tax in that State in respectonly of income from sources in that State or of profits attributable to a permanentestablishment in that State.

• Income earned by “Fiscally Transparent Entities” are generally deemed to be earnedby its owners. So, a U.S. owner of a U.S. partnership may claim treaty benefits if thepartnership earns U.K income.

Resident of a Contracting StateResident of a Contracting State

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• Even before we get into who a qualified person is, only a“resident of a Contracting State” is eligible for Treaty benefits.

– any person who, under the laws of that State, is liable to tax therein by reason of hisdomicile, residence, citizenship, place of management, place of incorporation, or any othercriterion of a similar nature.

• RICs, REITs and REMICs are all residents of the United States for purposes of thetreaty. Although their income normally is not subject to U.S. tax in the hands of theentity, they are taxable to the extent that they do not currently distribute their profits,and therefore are regarded as “liable to tax.”

• However, does not include any person who is liable to tax in that State in respectonly of income from sources in that State or of profits attributable to a permanentestablishment in that State.

• Income earned by “Fiscally Transparent Entities” are generally deemed to be earnedby its owners. So, a U.S. owner of a U.S. partnership may claim treaty benefits if thepartnership earns U.K income.

• An individual who is a United States citizen or an alien admitted to the UnitedStates for permanent residence (a “green card” holder) is a resident of theUnited States only if the individual has a substantial presence, permanenthome or habitual abode in the United States and if that individual is not aresident of a State other than the United Kingdom for the purposes of a doubletaxation convention between that State and the United Kingdom.

– Prevents a U.S. citizen or green card holder who is a resident of a country otherthan the United States or the United Kingdom from choosing the benefits of theConvention over those provided by the treaty between the United Kingdom andhis country of residence.

– If the U.S. citizen or green card holder's country of residence does not have atreaty with the United Kingdom, however, then he will be treated as a resident ofthe United States as long as he meets the first requirement of an economic nexus.


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• An individual who is a United States citizen or an alien admitted to the UnitedStates for permanent residence (a “green card” holder) is a resident of theUnited States only if the individual has a substantial presence, permanenthome or habitual abode in the United States and if that individual is not aresident of a State other than the United Kingdom for the purposes of a doubletaxation convention between that State and the United Kingdom.

– Prevents a U.S. citizen or green card holder who is a resident of a country otherthan the United States or the United Kingdom from choosing the benefits of theConvention over those provided by the treaty between the United Kingdom andhis country of residence.

– If the U.S. citizen or green card holder's country of residence does not have atreaty with the United Kingdom, however, then he will be treated as a resident ofthe United States as long as he meets the first requirement of an economic nexus.

• Includes:

– “pension scheme”

– a plan, scheme, fund, trust, company or other arrangement established in aContracting State that is operated exclusively to administer or provide employeebenefits and that, by reason of its nature as such, is generally exempt fromincome taxation in that State;

– an organization that is established exclusively for religious, charitable, scientific,artistic, cultural, or educational purposes and that is a resident of a ContractingState according to its laws, notwithstanding that all or part of its income or gainsmay be exempt from tax under the domestic law of that State; and

– Certain “governmental entities”


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• Includes:

– “pension scheme”

– a plan, scheme, fund, trust, company or other arrangement established in aContracting State that is operated exclusively to administer or provide employeebenefits and that, by reason of its nature as such, is generally exempt fromincome taxation in that State;

– an organization that is established exclusively for religious, charitable, scientific,artistic, cultural, or educational purposes and that is a resident of a ContractingState according to its laws, notwithstanding that all or part of its income or gainsmay be exempt from tax under the domestic law of that State; and

– Certain “governmental entities”

• One of four tests to be met

– Qualified person test

– Derivative benefits test

– Active trade or business test,

– Competent authority determination

LOB OverviewLOB Overview

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• One of four tests to be met

– Qualified person test

– Derivative benefits test

– Active trade or business test,

– Competent authority determination

• (1) Individuals

• (2) “Qualified governmental entity”• (3) Publicly traded companies and subsidiaries of publicly traded companies

– “Principal class” of its shares is listed on a recognized U.S. or U.K. stock exchange and

– is “regularly traded” on one or more “recognized stock exchanges”• (4) Publicly traded persons that are not “companies” or subsidiaries of publicly traded persons

– Company means any body corporate or any entity that is treated as a body corporate for taxpurposes

– “Principal class” of its units are listed on a recognized U.S. or U.K. stock exchange and is“regularly traded” on one or more “recognized stock exchanges”

• (5) A tax-exempt pension scheme or employee benefit arrangement (if more than fifty percent ofthe beneficiaries, members or participants of the organization are individuals resident in eitherContracting State), and tax-exempt organizations (organized excusively forreligious/charitable/scientific purposes).

Qualified PersonQualified Person

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• (1) Individuals

• (2) “Qualified governmental entity”• (3) Publicly traded companies and subsidiaries of publicly traded companies

– “Principal class” of its shares is listed on a recognized U.S. or U.K. stock exchange and

– is “regularly traded” on one or more “recognized stock exchanges”• (4) Publicly traded persons that are not “companies” or subsidiaries of publicly traded persons

– Company means any body corporate or any entity that is treated as a body corporate for taxpurposes

– “Principal class” of its units are listed on a recognized U.S. or U.K. stock exchange and is“regularly traded” on one or more “recognized stock exchanges”

• (5) A tax-exempt pension scheme or employee benefit arrangement (if more than fifty percent ofthe beneficiaries, members or participants of the organization are individuals resident in eitherContracting State), and tax-exempt organizations (organized excusively forreligious/charitable/scientific purposes).

• Any person other than an individual that meets the so-called “base erosion” test– 50 percent or more of the aggregate voting power and value of the person is

owned directly or indirectly on at least half the days of the person's taxable yearby qualified persons who are themselves individuals, qualified governmentalentities, publicly traded companies/persons, or tax-exemptpensions/organizations.

– less than 50 percent of the person's gross income for that taxable period is paid oraccrued, directly or indirectly, to persons who are not residents of eitherContracting State in the form of payments that are deductible for the purposes ofthe taxes covered by this Convention in the State of which the person is aresident (but not including arm's length payments in the ordinary course ofbusiness for services or tangible property and payments in respect of financialobligations to a bank, provided that where such a bank is not a resident of aContracting State such payment is attributable to a permanent establishment ofthat bank located in one of the Contracting States)


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• Any person other than an individual that meets the so-called “base erosion” test– 50 percent or more of the aggregate voting power and value of the person is

owned directly or indirectly on at least half the days of the person's taxable yearby qualified persons who are themselves individuals, qualified governmentalentities, publicly traded companies/persons, or tax-exemptpensions/organizations.

– less than 50 percent of the person's gross income for that taxable period is paid oraccrued, directly or indirectly, to persons who are not residents of eitherContracting State in the form of payments that are deductible for the purposes ofthe taxes covered by this Convention in the State of which the person is aresident (but not including arm's length payments in the ordinary course ofbusiness for services or tangible property and payments in respect of financialobligations to a bank, provided that where such a bank is not a resident of aContracting State such payment is attributable to a permanent establishment ofthat bank located in one of the Contracting States)

• Trying to Prevent:

Base Erosion TestBase Erosion Test

UK

74

UK ZimbabweNon Arms-Length Payments

US

• Trusts or trustees in their capacity as such if:

– 50 percent or more of the aggregate voting power and value of the person isowned directly or indirectly on at least half the days of the person's taxable yearby persons who are themselves individuals, qualified governmental entities,publicly traded companies/persons, tax-exempt pensions/ organizations or“equivalent beneficiaries” (discussed later).

– Meets the same gross income test described above under the base erosion test


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• Trusts or trustees in their capacity as such if:

– 50 percent or more of the aggregate voting power and value of the person isowned directly or indirectly on at least half the days of the person's taxable yearby persons who are themselves individuals, qualified governmental entities,publicly traded companies/persons, tax-exempt pensions/ organizations or“equivalent beneficiaries” (discussed later).

– Meets the same gross income test described above under the base erosion test

• “Principal class” of its shares is listed on a recognized U.S. or U.K. stock exchange

– Principal class is common shares of the company representing the majority of the aggregate votingpower and value of the company. If the company does not have any such stock, then the “principalclass of shares” is that class or any combination of classes of shares that represents, in the aggregate, amajority of the voting power and value of the company.

– “Shares” includes depository receipts for shares or trust certificates for shares.

• “Regularly traded”– Aggregate number of shares of that class traded on one or more recognized exchanges during the twelve

months ending on the day before the beginning of that taxable period is at least six percent of theaverage number of shares outstanding in that class during that twelve-month period.

• On one or more “recognized stock exchanges” generally encompasses– NASDAQ and any stock exchange registered with the SEC as a national securities exchange;

– London Stock Exchange;

– the Irish Stock Exchange, the Swiss Stock Exchange and the stock exchanges of Amsterdam, Brussels,Frankfurt, Hamburg, Johannesburg, Madrid, Milan, Paris, Stockholm, Sydney, Tokyo, Toronto, andVienna; and

– any other stock exchange agreed upon by the competent authorities of the Contracting States.

More on Publicly Traded EntitiesMore on Publicly Traded Entities

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• “Principal class” of its shares is listed on a recognized U.S. or U.K. stock exchange

– Principal class is common shares of the company representing the majority of the aggregate votingpower and value of the company. If the company does not have any such stock, then the “principalclass of shares” is that class or any combination of classes of shares that represents, in the aggregate, amajority of the voting power and value of the company.

– “Shares” includes depository receipts for shares or trust certificates for shares.

• “Regularly traded”– Aggregate number of shares of that class traded on one or more recognized exchanges during the twelve

months ending on the day before the beginning of that taxable period is at least six percent of theaverage number of shares outstanding in that class during that twelve-month period.

• On one or more “recognized stock exchanges” generally encompasses– NASDAQ and any stock exchange registered with the SEC as a national securities exchange;

– London Stock Exchange;

– the Irish Stock Exchange, the Swiss Stock Exchange and the stock exchanges of Amsterdam, Brussels,Frankfurt, Hamburg, Johannesburg, Madrid, Milan, Paris, Stockholm, Sydney, Tokyo, Toronto, andVienna; and

– any other stock exchange agreed upon by the competent authorities of the Contracting States.

• Subsidiaries of Publicly Traded Companies

– A company is a qualified person if five or fewer direct and indirect owners of atleast 50 percent of the aggregate vote and value of the company's shares arepublicly traded companies as previously described, provided that, in the case ofindirect ownership, each intermediate owner is a resident of either ContractingState.

• For example, a U.K. company, all the shares of which are owned by anotherU.K. company, would qualify for benefits under the Convention if theprincipal class of shares of the U.K. parent company were listed on theLondon Stock Exchange and regularly traded on the Irish stock exchange.

• However, if the U.K. parent indirectly owned the U.K. company through achain of subsidiaries, each such subsidiary in the chain, as an intermediateowner, must be a resident of the United States or the United Kingdom forthe U.K. company

More on Publicly Traded CompaniesMore on Publicly Traded Companies

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• Subsidiaries of Publicly Traded Companies

– A company is a qualified person if five or fewer direct and indirect owners of atleast 50 percent of the aggregate vote and value of the company's shares arepublicly traded companies as previously described, provided that, in the case ofindirect ownership, each intermediate owner is a resident of either ContractingState.

• For example, a U.K. company, all the shares of which are owned by anotherU.K. company, would qualify for benefits under the Convention if theprincipal class of shares of the U.K. parent company were listed on theLondon Stock Exchange and regularly traded on the Irish stock exchange.

• However, if the U.K. parent indirectly owned the U.K. company through achain of subsidiaries, each such subsidiary in the chain, as an intermediateowner, must be a resident of the United States or the United Kingdom forthe U.K. company

• Even if a resident is not a qualifying person, it still will be entitled to treaty benefits ifthe owner of the resident would have been entitled to the same benefit had the incomein question flowed directly to that owner.

Derivative Benefits TestDerivative Benefits Test

France

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UK

France

US

• Requirements:

– Seven or fewer “equivalent beneficiaries” must, directly or indirectly, own shares representing at least95 percent of the aggregate voting power and value of the company, and, an analogous 50 percent grossincome test under the base erosion test is met.

• Equivalent beneficiaries are persons meeting one of two tests:

– (1) A person may be an equivalent beneficiary if it is entitled to equivalent benefits under a treatybetween the country of source and the country in which the person is a resident. This alternative has tworequirements.

• (A) The person must be a resident of a Member State of the European Community, a EuropeanEconomic Area state, or a party to NAFTA (collectively, “qualifying States”).

• (B) the person must be entitled to equivalent benefits under an applicable treaty. In other words,the person must be entitled to all the benefits of a comprehensive treaty between the ContractingState from which benefits of the Convention are claimed and a qualifying State.

– If the treaty in question does not have a comprehensive LOB article, this requirement only ismet if the person would be a “qualified person” as an individual, qualified governmentalentity, publicly-traded company or entity, and tax-exempt organizations.

– In addition, with respect to dividends, interest, or royalties, the person must be entitled to arate of tax that is at least as low as the rate that would apply under the Convention to suchincome.


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• Requirements:

– Seven or fewer “equivalent beneficiaries” must, directly or indirectly, own shares representing at least95 percent of the aggregate voting power and value of the company, and, an analogous 50 percent grossincome test under the base erosion test is met.

• Equivalent beneficiaries are persons meeting one of two tests:

– (1) A person may be an equivalent beneficiary if it is entitled to equivalent benefits under a treatybetween the country of source and the country in which the person is a resident. This alternative has tworequirements.

• (A) The person must be a resident of a Member State of the European Community, a EuropeanEconomic Area state, or a party to NAFTA (collectively, “qualifying States”).

• (B) the person must be entitled to equivalent benefits under an applicable treaty. In other words,the person must be entitled to all the benefits of a comprehensive treaty between the ContractingState from which benefits of the Convention are claimed and a qualifying State.

– If the treaty in question does not have a comprehensive LOB article, this requirement only ismet if the person would be a “qualified person” as an individual, qualified governmentalentity, publicly-traded company or entity, and tax-exempt organizations.

– In addition, with respect to dividends, interest, or royalties, the person must be entitled to arate of tax that is at least as low as the rate that would apply under the Convention to suchincome.

• [continued from previous slide]

– (2) a qualified person under the Treaty who are individuals, qualified governmental entities, publiclytraded companies/persons, tax-exempt pensions/ organizations


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• A resident of a Contracting State engaged in the active conduct of a trade or business in that State may obtainthe benefits of the Convention with respect to an item of income, profit, or gain derived in the other ContractingState. The item of income, profit, or gain, however, must be “derived in connection with” or “incidental to”that trade or business.

Trade or Business TestTrade or Business Test

Zimbabwe

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UK(UK trade or

Business)

Zimbabwe

US incomeincidental tosuch business

• Income, profit, or gain “is derived in connection with” a trade or business if the income-producing activity inthe State of source is a line of business that “forms a part of” or is “complementary” to the trade or businessconducted in the State of residence by the income recipient.

– A business activity generally will be considered to form part of a business activity conducted in theState of source if the two activities involve the design, manufacture or sale of the same products or typeof products, or the provision of similar services.

– For two activities to be considered to be “complementary,” the activities need not relate to the sametypes of products or services, but they should be part of the same overall industry and be related in thesense that the success or failure of one activity will tend to result in success or failure for the other.

• An item of income, profit, or gain derived from the State of source is “incidental to” the trade or businesscarried on in the State of residence if production of the item facilitates the conduct of the trade or business in theState of residence

• The trade or business carried on in the State of residence, must be substantial in relation to the activity in theState of source. This determination is made based upon all the facts and circumstances and takes into accountthe comparative sizes of the trades or businesses in each Contracting State (measured by reference to assetvalues, income and payroll expenses), the nature of the activities performed in each Contracting State, and therelative contributions made to that trade or business in each Contracting State.


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• Income, profit, or gain “is derived in connection with” a trade or business if the income-producing activity inthe State of source is a line of business that “forms a part of” or is “complementary” to the trade or businessconducted in the State of residence by the income recipient.

– A business activity generally will be considered to form part of a business activity conducted in theState of source if the two activities involve the design, manufacture or sale of the same products or typeof products, or the provision of similar services.

– For two activities to be considered to be “complementary,” the activities need not relate to the sametypes of products or services, but they should be part of the same overall industry and be related in thesense that the success or failure of one activity will tend to result in success or failure for the other.

• An item of income, profit, or gain derived from the State of source is “incidental to” the trade or businesscarried on in the State of residence if production of the item facilitates the conduct of the trade or business in theState of residence



• Intended to prevent a narrow case of treaty-shopping abuses in which a company attempts to qualify for benefitsby engaging in de minimis connected business activities in the treaty country in which it is resident (i.e.,activities that have little economic cost or effect with respect to the company business as a whole).


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• Intended to prevent a narrow case of treaty-shopping abuses in which a company attempts to qualify for benefitsby engaging in de minimis connected business activities in the treaty country in which it is resident (i.e.,activities that have little economic cost or effect with respect to the company business as a whole).

UK(tiny UK trade or

Business)

Zimbabwe

US incomeincidental tosuch business

• A resident of one of the States that is neither a qualified person may be grantedbenefits under the Convention at the discretion of the competent authority ofthe State from which benefits are claimed.

• In making determinations, the competent authority will take into account as itsguideline whether the establishment, acquisition, or maintenance of the personseeking benefits under the Convention, or the conduct of such person'soperations, has or had as one of its principal purposes the obtaining of benefitsunder the Convention.

• Persons that establish operations in one of the States with a principal purposeof obtaining the benefits of the Convention ordinarily will not be granted reliefunder paragraph

Competent Authority TestCompetent Authority Test

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• A resident of one of the States that is neither a qualified person may be grantedbenefits under the Convention at the discretion of the competent authority ofthe State from which benefits are claimed.

• In making determinations, the competent authority will take into account as itsguideline whether the establishment, acquisition, or maintenance of the personseeking benefits under the Convention, or the conduct of such person'soperations, has or had as one of its principal purposes the obtaining of benefitsunder the Convention.

• Persons that establish operations in one of the States with a principal purposeof obtaining the benefits of the Convention ordinarily will not be granted reliefunder paragraph

u.s.-u.k. dual taxation pitfalls: reporting issues and planning opportunities...

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