Financial adviser: how to deal with US clients

  • |
  • 31 mins 23 secs

Tutors:

  • Richard Gould, Business Development, Cazenove Capital
  • Martin Heale, Director, Schroders US Wealth Management

Learning outcomes:

  1. How to establish if your client counts as an American when it comes to tax
  2. The responsibilities of a financial adviser to establish if a client counts as an American
  3. How US tax authorities treat SIPP and ISA investments

Channel

DFM
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Mark: Investment and tax planning are bread and butter issues for UK financial advisors. But if the client turns out to be an American, and that's not as simple to work out as you might think, it can get to be a whole lot more complicated. To discuss why the rewards are worth the extra work and what the key issues are, I caught up with Martin Heale, director at Schroders US Wealth Management and with Richard Gould, private client director at Cazenove Capital. But before that, let's have a look at the learning outcomes from this Akademia session. First, how to establish if your client counts as an American when it comes to tax. Second, the responsibilities of a financial adviser to establish if a client counts as an American. And finally, how U.S. tax authorities treat SIPP and ISA investments. And now here's Richard Gould and Martin Heale.
Mark: Well, Richard, first of all, how many Americans are there living in the UK?
Richard: Yeah, I mean, it's a very topical subject of discussion at the moment. It’s caused a lot of problems and a lot of headaches over the last few years in terms of, can they offer financial advice to US citizens residing outside of the U.S., but more importantly to some extent, is there an investor management capability solution available to these U.S. Citizens, and you know, coming back to original question, to put numbers into the frame, the numbers vary substantially, depending on which source that you look at. But if we were to look at the end of 2017, the U.S. State Department alluded to the fact that they're around 9.4 million U.S. citizens residing outside of the U.S., now that is clearly a very high number, but when we try and dig deeper into how many of those are living here within the UK, the UK census essentially estimated that at the end of 2001, bearing in mind, that’s almost 20 years ago. There are approximately 158,500 Americans living here in the UK, 10 years forward from that, the number jumped by 40,000 to just under 200,000. So, bearing in mind, we're in 2020 now, it's pretty safe to assume that there are now well over 200,000 if not more than 250,000 Americans living here in the UK. Now, clearly, that in itself is quite a high number, but what, and this is kind of where it gets interesting, what the statistics do not take into account is the notion of the accidental American. And this is, to cut a long story short, a person who is completely unaware that they are actually deemed a U.S. person for many reasons. It's grabbing headlines, a phrase that's something Martin's gonna be talking about in a lot more detail today. But what many believe, actually, when you factor this into the equation, the number of U.S. Citizens living here in the UK is gonna be significantly higher than what I quoted previously and that is incredibly important for a number of reasons and one of the main ones being the citizenship based tax regime of the U.S. which, to cut a long story short, basically, dictates and requires that every U.S. person, and this is whether they are an accidental American or not, has to file reports to the U.S. tax authorities regardless of where they live. Failure to do so can lead to pretty heavy penalty fees or penalty fines or create a lot of headaches for these clients and U.S. citizens. So, it's incredibly important to get this right.
Mark: And we'll come onto the strict definition of accidental American a little later. But fundamentally, you could be in American without having an American passport.
Richard: Yeah, and it's caused a lot of people quite a few headaches because they were blissfully unaware of that.
Mark: Um, Martin, how are U.S. citizens treated differently to UK taxpayers. A lot of people think, well, we're too big countries, there's probably double taxation treaties, pay tax in one or pay tax on the other.
Martin: Absolutely, and we speak the same language, we're very similar. How different can it be? Well, as Richard said, U.S. citizens are taxed on a citizenship basis, and to repeat what Richard was saying, that means that wherever a U.S. citizen is in the world, they still have to declare and file their taxes to uncle Sam, whereas most other countries will tax on a residency basis. So, if there's a UK person living in a resident in a different country, they may only be paying tax in that country and not still have an income tax obligation to the UK, so that's the critical difference. Therefore, an American living in the UK still has to be cognisant of the tax impact of any financial transactions or decisions they make in the UK They may not only just be paying UK tax, they have to be aware of the U.S.. tax as well. Therefore, their advisers have to be aware of their dual status and appreciate that an investment that may work or a structure that may work in the UK may not work in the U. S. That's the key difference as far as tax is concerned. The other main difference when it comes to investments and investment advice is that U.S. persons are governed by the SEC when it comes to investment regulation, and again, that is different to how a UK investor is governed.
Mark: And how likely is it? Bit of devil’s advocate, that the U.S. tax authorities or that the SEC is going to realise that somebody was, you know, didn't quite get all their paperwork right for two or three years?
Martin: Well, for a very long time it's been a legal requirement for all U.S. Citizens to declare and file their taxes, but a new law was passed starting back in about 2008, running through to 2011/2012/2013. It came in stages, called FATCA. This is the Foreign Account Tax Compliance Act. We refer to it sometimes jokingly, as the fear and total confusion act. Now the interesting thing about this act is that it was passed on foreign financial institutions, FFI’s. It's actually a law that was passed on foreign companies, foreign banks, foreign financial institutions, not U S citizens. And it basically asked for those foreign financial institutions to discover if any of their clients are U.S persons, and if they are to then report on them to uncle Sam. And to begin with, this caused some confusion because it's unusual for one country's government to pass a law on other countries. Uh, but as a result of this, what it means is that foreign financial institutions have an obligation to report on their clients, who are U.S. persons and so that puts quite a significant responsibility and onus on those institutions to, to adhere to that law.
Mark: Richard, when you’re out and about talking to advisers, do you find this means that they're quite reluctant to what this means for their clients?
Richard: Yeah. I mean, the amount of times I've heard the same story where an IFA has been introduced to a client and then has found out from their fact finding, from their due diligence said they have U.S. connections or affiliations to the U.S. It's been so many examples of that where they have actually just been turning clients away because they actually weren't even aware that they could provide financial advice to them and you know what we want to say to them is that is not the case at all. You know, we have a very specialised US wealth management arm here at Cazenove capital within Scroders that tailors exclusively to U.S. clients and we can help with.
Mark: So, what are some of the problems, that, from the sounds of it, aren't insurmountable, that it throws up if you're a UK adviser.
Martin: So, if you are a UK advisor. First of all, you have to be aware that your client is a U.S. person and once you've established that, the responsibility is for their investments to be efficient from a U.S. tax perspective and also allowable under an SEC regime as well. The U.S. client will also want their financial affairs reported, you know, in a way that is helpful and compliant to fill in their U.S. tax filings as well. So, all of these issues together make it a little more complicated for a UK advisor to advise a U.S. person.
Mark: But in a sense, you have to be master of two completely different tax systems and regimes and know how to bridge them. I mean, that sounds nigh on impossible.
Martin: It's hard and it's complicated, and this is why in the U.S./UK financial community, professional community in the UK. This is what people do full time. So, you come across UK/U.S. specialist lawyers, accountants, investment managers and bankers like ourselves, and we only look after U.S. clients, you have to do that as a full time job in order to keep up to date and keep up to speed with changes in tax laws or legal requirements in order to do your job properly. It requires a lot of ongoing learning and development.
Mark: So, if an American comes over here, they're looking at, thinking about their retirement options, they get themselves a SIPP. It seems very sensible, lots of people have got them, are they able to do so?
Martin: That's a very good question. We come across a lot of Americans with SIPP’s. Usually, it's a Brit that has built up quite a good pension fund, opted out and taken his SIPP and then moved to work in the U.S. and has become a U.S. taxpayer, but SIPP’s are very interesting because SIPP’s are specifically a UK structure. However, the investments within that SIPP are owned by the beneficial owner that is the U.S. person. So, this is where the conflict arises, should those investments be managed in accordance with the regulations governing a U.S. taxpayer or not? And time and time again, we come across the fact that a lot of people don't know how to deal with SIPP’s. So, if the clients accountant submits the form 35 20 annually, then the U.S. tax authorities can view that SIPP as a foreign pension and not tax it in a punitive way. However, if that submission isn't made, then as far as the U.S. tax authorities are concerned, they don't recognize the SIPP as a tax beneficial RAPA, which is obviously what the UK authorities see it as they would look through, and that's a very common term in U.S. tax law. They would look through the SIPP RAPA, look at the underlying investments and treat them as if they were held in the client's own name. And of course, that means that the client may well be receiving the tax benefits in the UK but losing them in the U.S. So, what's the solution? Now, if we take our Brit that is living in the U.S., His UK manager may then discover that he's U.S. resident and may decide I can no longer act for you. So, the client then has to find another manager. He'll go to an investment manager in the U.S. who will say I'm not familiar with SIPP’s, So the solution is to find a manager, an investment manager in the UK who is cognisant of how a UK SIPP works. But also, how investments are affected for a U.S. person and crucially, they're accountant should be aware of how to treat both. That leads me onto one other point in that, as I said before, the U.S. professional community serving Americans is really quite small and we come across a great deal of advisors who think, as you were saying earlier, how hard can it be? How different is it, and, critically, they can miss an odd point. My advice to everybody would be always get a specialist US/UK adviser. Be it an accountant, lawyer or investment manager if you have dual citizenship.
Mark: Richard, have you come across cases where there's been a problem or actually there’s been an elegant solution to it?
Richard: Yeah, absolutely. I mean, the beauty of my job is I've hosted countless seminars and presentations across the country over the last few years and it’s interesting, every time I introduce the concept that we have a U.S. wealth management solution for U.S. clients, it's incredibly interesting for a lot of the IFA’s in attendance, and inevitably they come up to me after the event and coincidently there was one several months ago where an IFA I've never had any business dealings with in the past. He had been introduced to a client who had U.S. affiliations and he was reluctantly gonna have to pass the client away because he didn't think he could advise on it. And this particular client had substantial assets for investment. We had a chat. I introduced him to Martin and his team. We went into depth about what this client was and all the different structures. Set up a meeting with the clients at his offices with the IFA there and was able to not only talk about the general investment companies, But to uncover the SIPP that this particular client had and, they were completely unaware that this was something that we could help manage. And, you know, two weeks later, the client had, uh, completed all the forms. We were able to introduce him to a cross border UK/U.S. tax specialist tax accountants who were able to go through everything to make sure everything is U.S. compliant. So it’s a great example of a collaborative approach that benefits both the IFA and allow them to maintain that relationship and for us to grow that relationship with them.
Mark: Now Martin, you were talking earlier about SIPP’s, but obviously there's lots of other pensions in the UK, some are trust based, some are contract based, but in broad terms. How does how does the U.S. authorities look at those If you're an American or an accidental American, that's playing into one?
Martin: I'm not a pension advisor, but if a U.S. person joins a company pension scheme, in my experience, the company pension schemes are usually aware of that U.S. person’s status and there is a section and a part of their corporate pension scheme that is appropriate, suitable for an American.
Mark: Right. Okay. Thank you for that. I guess that also that brings the other great savings vehicle or RAPA, is the ISA. How do the tax authorities look at that?
Martin: Yes, well, again, ISA’s are an interesting one, on this side of the pond in the UK, we're well aware of their beneficial tax status for an ISA holder, but in the USA, they are a classic look through. They're not recognized by the U.S. tax authorities as a beneficial tax RAPA. So, the holder of the ISA is taxed as if he were holding those investments in his own name. So, this brings us to an interesting point. So, an American resident in the UK aged over 18 can subscribe to an ISA and can receive the tax benefits under the UK tax regime. But they are still paying tax in the U.S. tax regime. So is an ISA worthwhile and, it's interesting because I think the opinion on this is pretty equally divided. I find a lot of people say an ISA is worthwhile for an American because it's a disciplined form of savings. Others say, what's the point? Because you're paying tax in one jurisdiction, so you you're losing the benefits. It becomes more interesting if you have a UK taxpayer who then moves to the USA. He loses the tax benefits as far as the U.S. tax authorities are concerned on his ISA investments but if he plans to return to the UK, then maybe it is worth retaining those ISA’s. However, that is just a simple mathematical calculation that one can make over a period of years to say, I'll be a U.S. person for this length of time. I plan to be a UK person again for that length of time. Is it worth me retaining them, and usually one could get a good outcome.
Mark: So, how difficult, when you mention this concept of look through, how far through do they look? So, you had an ISA portfolio, and it had four oeic funds in each, of which had 60 underlying holdings. How far do you do you look into each of those 60? Do you go through the fund or do your calculations of how much you've gained loss where the income comes from stop at the level of those six underlying funds?
Martin: So, this is capturing a term called PFIC. This is PFIC. It stands for passive foreign investment company, now classically in many SIPPs, in many pensions and in many ISAs. It's the normal choice for the investment manager to acquire a fund. It might be a mutual fund. It might be a unit trust. It might be an ETF an exchange traded fund, and the benefits of these funds is they are a broad spread of investments across a market or many markets. However, in the UK, they're treated as an investment very similar to a non-ordinary stock or share, in the U.S. The term PFIC has a different tax status, which is where we're going to with oeics and so on without going into too much detail. Essentially, they're taxed on a punitive basis in the U.S., so they're taxed. The tax treatment and return is broadly based on the underlying investments rather than the RAPA of itself. So, what it can mean in effect is that a U.S. person holding a PFIC in the UK they can hold it for two years, not sell it, but still receive a tax bill. It's quite bizarre, and in addition to that, they could receive quite a hefty accountant or CPA bill for the work involved. So, this is where I was saying that investment managers have to be aware of the dual tax status of the US/UK client and in many cases, PFIC’s are not appropriate for those clients, and the manager needs to be aware it's a very easy mistake to make.
Mark: Just so I’ve got this right, I was giving my example of six underlying funds, lets say each has got 40 underlying holdings to sort out the tax, you'd have to employ somebody to go into each of those underlying six oeics. Look at every single holding that was in them, when it got bought, when it got sold, what your little bit of gain or loss was in each of that, pull it all together and then say to the U.S. Tax authorities, we owe you $48 or 22 50?
Martin: Broadly speaking, that's correct, and that's exactly where the hefty CPA or accountants bill comes in to play.
Mark: The one fund you didn't mention, was an investment trust. How's that treated? Is that counted as an individual share or as a PFIC?
Martin: In many cases, that would be a PFIC, now the rules on PFIC’s are very clear, but really there's no handbook that says these are PFIC’s and these or not. It really takes an expert investment manager or accountant to look at each specific investment to determine whether something is a PFIC or not. But in essence, if you're dealing with the U.S. Person and they're holding a fund. That would be a red flag to say I should look at this in more detail.
Mark: Richard. We talked a little bit about why financial advisers might be reluctant to take on U.S. clients. But in your experience, are UK financial institutions that providers reluctant to do so as well?
Richard: Potentially I mean, for example, a lot of SIPP providers Yeah, we have. We come up against them and then some of them have turned, turned the business away, you know? But then we have a select few SIPP providers that we work with are very happy to take these on because they’ve done their due diligence. We worked with them and so on and so forth. So, the answer's yes. But again, this is a very niche area of the market. So, having our specialist knowledge and having the contacts that Martin and his team have is incredible because we can fit the right people to the rights clients.
Mark: Have you ever met a SIPP provider who's been reluctant to deal with the U.S. client that you've got the expertise that will hold their hand and as a result, that’s where their business should be?
Richard: Absolutely. But then you're working with Martin. We have those providers that we do want to work with that are happy to work with us for these clients and they get a lot of businesses resulting.
Mark: Now, the big topic, because you've both alluded to, what is an accidental American? How easy is it to be an American and not know?
Martin: Well, it's a very interesting area, but essentially an accidental American is someone who is an American, but they don't know they're an America. Now, this may come about because they were born in America, but they may have left at a very early age and not really taken on board that they were born in America but under the U.S. laws. If you're born in America, you are an American, and you have a duty to submit and file and and pay your taxes?
Mark: There's Boris Johnson’s paying taxes,
Martin: And I believe he was once called an accidental American some years ago, and I think he has now renounced his U.S. citizenship. But that's a classic example. Yes, other situations when somebody may become an accidental American is that they may be born in, say the UK. But both their parents are U.S. persons and as a result of that, they are a U.S. person themselves. Now this is interesting because there's a notion that because the child was born on UK soil and perhaps the parents didn't register them with the U.S. Embassy, they're not a U.S person, they don't have to pay U.S. tax. That would be a big mistake. They should take professional advice and decide what to do with that, what to do. Slightly more complex is when a child is born of a one U.S. parent, and broadly speaking if that U.S. parent had been resident in the U.S. for more than five years, two of which were after the age of 14 then there's a very high chance that their child is a U.S. person as well. So, if you’re an advisor and you talk to a client who explains that one of their parents is in America, that's an immediate cue to dig a little deeper.
Mark: And what about Brits who go and work in the states? We hear a lot about people wanting to get their green card. Does that bring them into the U.S. Tax system?
Martin: Well, in many cases, yes. People move to the USA for many reasons, marriage, to study, but mainly to work. And they’ll be employed using a U.S. visa. And there are many different types of VISA, far too many to go into detail for, but essentially if their residents unemployed and working in the U.S. and paying US tax. They're captured as a U.S. taxpayer and their financial affairs have to be advised accordingly. Now the green card is more serious. It's a permanent leave to remain, and essentially when somebody applies for a green card, they're saying I want to become an American. This is my home and whereas a normal work employment visa will expire, and they could move back to the UK. A green card is more permanent than that. And whilst a green card has an expiry date on it, it doesn't just expire, and you can forget about it. You actually formally have to renounce it using a form I407 So once something has a green card. You should treat them as a fully-fledged American forever, really, unless they can prove to you that they did renounce, and they have shown you their certified I407.
Mark: Presumably, if you could renounce your green card can an American renounce their American citizenship as well?
Martin: Yes, they can. It's not a straightforward process. Its lengthy. It may involve paying some back taxes it will involve an interview at an embassy. My advice would be to anybody thinking of renouncing their citizenship is to seek a good immigration U.S. lawyer to help them through the process.
Mark: And, in your experience, Richard, how do people react? How do advisers react if they discover they've got a client who is an accidental American?
Richard: With trepidation. A lot of the time they that they think everything is fine. It's a normal kind of process. They find out there's an affiliation to the U.S and as I said earlier, they instantly thing they can’t provide financial advice and that is completely inaccurate. You know, they can in the majority of cases, and we can help them through that, and it's a great relationship tool, revenue generator for them.
Mark: But how easy is it to unpick it? So, you're an adviser. You've done everything you think that's right and you genuinely have. And then you discover somebody's got one U.S. parent. They were in the States for three years or, you know, five or six years at some point in their life after the age of 14. How do you go about unpicking? How sympathetic are the U.S. authorities if you've made an error.
Martin: Well, I think as an advisor, you have a duty of care to your client, and you have a duty to get to know your client and to understand their circumstances. So, in my opinion, really is the responsibility of that advisor to discover that that person is an American. Even if the client doesn't know they're an American themselves, it's still your duty to discover it for them because also, your firm will have a duty to under FATCA to report on that U S person to the U.S. tax authorities. So how do you do that? I think there are three critical questions you can ask to capture most American clients, be they accidental or otherwise. The first question is, do you have a U.S. passport, because many advisors asked for proof of ID and a client will produce a UK passport. They may have a U.S. Passport as well. The next question is, where were you born? And if they were born on U.S. territory again, that's an indication they may well be a U.S. person.
Mark: How easy is it to discover what U.S. territory, is it one of the 50 states, or are there other dependent territories?
Martin: There are some dependent territories as well. If in doubt, speak to a lawyer or accountant. You can even google U.S. territories. But my point is, the second you're getting this clue…
Mark: Yeah.
Martin: That's when you should be alert and take more professional advice. Now, the third category, or third question really is to ask, where were your parents born? If the answer is that, were either parent born in the U.S. again, that's a good indication that your client may be a U.S. Person.
Mark: But, taking all of that on board, you have responsibilities, but you made a genuine mistake. How easy is it to unpick what it is creating? Does it create fines for you as the adviser? Does it mean you're telling your client, I'm sorry we messed up a bit. You have to write a big cheque to sort it out. What's the sort of response you get back from the U.S. Authorities?
Martin: Uh, well, first and foremost I would say. Have you done your job correctly as a UK adviser? And have you breached any of your internal company policies and your regulatory rules by not discovering whether this client was a U.S. person or not? I think it would be case by case, very specific. Sometimes you should have spotted it, sometimes, perhaps it was a lot harder. In my experience, the IRS would really have an issue with the underlying client, the citizen who they're taxing and I think they're less likely to be concerned that their chosen advisor made the mistake. They're more inclined to say to their taxpayer, you owe us this much tax. Then that may, in turn, caused the client to seek a claim against the adviser who they may feel didn't give them appropriate advice.
Mark: But is it a rule of thumb that the IRS is interested in is the money rather than going any further than that.
Mark: Yes, that's right. Equally, if you have a SEC license in the UK and perhaps you haven't conducted your role properly, then I'm sure the SEC would take an interest in that as well.
Mark: Richard, from your point of view, any other red flags, sorts of things to be aware of if you're if you're an adviser dealing with clients?
Richard: To be perfectly honest, I think those three questions are absolutely imperative to ask and it gives you the grounding to ascertain whether they are an accidental American or not. And if they are, then the IFA needs to really get the advice and the support that they need, which we can help to introduce them to, because if they’re doing as Martin quite rightly alluded to, the headaches that causes is gonna be pretty steep.
Martin: Can I add in there as well, those three questions are great, but I think a good advisor would also be alert to what we call U.S. (inaudible). So, when a client is filling in a form, what address of it? What correspondence address are they putting down. What phone number are they putting down? Is there any reference to any time spent in the U.S. So, if there's any hint or a clue anywhere that they've spent some time in the U.S, or have some U.S. involvement, then that should be followed up.
Mark: Do you get to point with U.S. clients where actually is just easier if you channel all their investments and all their savings via U.S. vehicles in the U.S. It just keeps it much, much cleaner?
Martin: No, not really. There are very many UK investments that are entirely suited and attractive for U.S. clients. I think the key thing in investment management is that we like to be able to invest on a global basis because there can be good opportunities at any one time, anywhere in the world, so we do not restrict our global investment offering for U.S. clients. It gives us the opportunity to diversify, and it gives us the opportunity to overweight those areas we think are gonna be best. I can well understand why an investment manager may want to restrict their investment offering to easy, simple areas. But if you have sufficient resource of capability, then yes, certainly should you should be looking to invest as wide as possible. And with the right expertise there's nothing stopping you doing that for an American.
Mark: Well Richard, if somebody has dual citizenship or is an accidental American and you think about it. I mean, I suppose part of this depends on where you long term, you plan to end up, to what extent do people have to have a clear view of, being blunt, where they want to retire before they know whether it's worth it? Brit, American, French, whatever it happens to be.
Richard: I think they need to have an idea of where they’re gonna be ending up. But I'll be perfectly honest with you the majority of the time. These clients actually don't. They might have a five-year plan rather than 15 or 20 year plan. So, it is kind of the IFA’s job and then our job working collaboratively with the IFA to try and ascertain where they see their future with their long term future, and then come up with a strategy accordingly.
Mark: We talked through a lot in the last half hour. I want to get a final thought from each of you. Richard, if you're a financial advisor, this is potentially topic for you. What should you do next?
Richard: I mean, as I said, this is a very topical subject of discussion of the moment. It has caused a lot of clients, and in turn, IFA’s a lot of headaches, as far from our research, we are one of a very few numbers of DFM’s that can actually manage U.S. client's assets. And there's a raft of information on our website, as Martin alluded to, if IFA’s and clients can’t ascertain this information from their fact-finding due diligence, there's gonna be a lot of headaches to come. So, we want them to have a look at everything that we have. There's a lot of information there, and we would be delighted to help with them.
Mark: Martin.
Martin: I think to repeat those three critical questions. Do you have a U.S. passport? Where were you born? Where were your parents born.
Martin: We have to leave it there. Martin Heale, Richard Gould. Thank you both very much.
Richard: Thank you.
Martin: Thank you.
Mark: In order to consider the viewing of this akademia video as structured learning, you must complete a reflective statement in order to demonstrate what you've learned on its relevance to you. By the end of this session, you should be able to understand and to describe how to establish if your client counts as an American when it comes to tax the responsibilities of a financial adviser to establish if a client counts as an American and how the U.S. tax authorities treat SIPP and ISA Investments. Please complete your reflective statement to validate your CPD.