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Jul 16

ISA Tax Complications as an Expat in the UK

Reading Time: 4 mins

Expats are allowed to open ISAs in the UK; however, the tax complications and additional reporting requirements make the process inconvenient and tax disadvantageous in most cases.


ISA for UK Citizens

ISA or Individual Savings Account is a tax-efficient savings account in the UK. It was introduced by the UK government to help people save and grow their money tax-free. The account is open to all residents of the UK, including UK citizens and expats.

ISA is a flexible savings account that allows investors to deposit or withdraw money anytime, without any lock-in period. You can access your money anytime without losing on the tax benefits on the remainder of the funds and cater to your short-term and medium-term financial needs. Additionally, there is no tax on withdrawal of the money or profits earned by investing through ISAs. They are highly tax-efficient with no tax on dividend income and interest earned on bonds. However, contributions made towards ISAs are not tax-free. The annual allowance of £20,000 for 2019/20, which means that the total contributions made to an ISA account cannot exceed £20,000 each year.

There are four types of ISAs, including cash ISAs, stocks and shares ISAs, innovative finance ISAs, and Lifetime ISAs. The minimum age requirement is 16 years for opening a cash ISA and 18 years for other types of ISAs. There is also a maximum age limit of 40 years for opening a Lifetime ISA.


ISA Rules for US Residents in the UK

All the UK residents that fulfil the minimum age criteria are eligible to open an ISA, including the UK citizens and expats. Thus, US residents can open an ISA in the UK. However, the tax treatments and other benefits vary for the UK citizens, the UK citizens, and other expats. Therefore, the US residents may suffer various pitfalls by opening ISAs in the UK owing to the differential treatment of ISAs by the UK and US financial regulators.


US Taxation Rules on the UK ISAs

ISAs are highly tax-effective for UK citizens as they allow them to save and grow their money, without getting taxed on withdrawals. They can save £20,000 per year in their ISAs and withdraw the funds at any time without paying tax on cash withdrawals or capital gains.

However, the Internal Revenue Service (IRS), the US federal agency, does not recognize ISA as an investment product. As a result, any investment made by US residents in UK ISAs is not eligible for any tax benefits and is considered as any other investment account. Such investments are labelled as a Passive Foreign Investment Company (PFIC) by the IRS and may prove to be more tax disadvantageous than any other form of savings.


Treatment of Cash ISAs and Stocks and Shares ISAs

The cash ISAs opened by the US residents in the UK are considered as standard foreign bank accounts by the IRS. The interest earned on the cash is subject to ordinary rates of tax. On the other hand, the treatment of stocks and shares ISAs depends on the underlying investments.

If the underlying investment is in individual shares or bonds, the capital gains are treated as interest earned from cash ISAs and the income earned flows to Schedule B, D or others depending on the nature of the earned income. On the contrary, if the underlying investment is made in pooled assets like mutual funds, ETFs, or unit trusts, the IRS Code 6048 becomes applicable. Under the code 6048, ISA is treated as foreign trust for tax purposes, and the investors are treated as beneficiaries.

Such a treatment requires US expats to report their earnings from foreign trusts on Form 3520, making it increasingly cumbersome for them.

Additionally, if the investments through the shares and stocks ISAs are in investment trusts, OEICs, and exchange-traded funds, the rules pertaining to PFICs apply and need to be reported on Form 8621. The filing requirements of the Form 8621 vary with the tax treatment of the PFIC under the mark-to-market, qualified electing fund, or the default method.


Benefits and Drawbacks of ISA Opening by the US Residents in the UK

Opening the ISAs in the UK can prove to be advantageous to US residents in terms of fees. ISA platforms, including AJ Bell Youinvest, and Cavendish Online, charge low fees for cash, shares and stocks, and Lifetime ISAs. However, any amount saved in fees or gained in profits on investments may get completely wiped out due to the tax disadvantages. The complexities of the US tax system, the tax treatments, and other rules and regulations may make the process inconvenient and highly unproductive.


UK Citizens in the US Who Own an ISA Account

If a UK citizen opens an ISA in his country and then moves to the US, he can continue to keep his account open, depending on the service provider. The tax benefits on the cash and investments held in his ISA will also continue to accrue.

However, once the UK citizens move abroad, they cannot continue to add money to their ISAs after the tax year they move. The rule is exempted for Crown employees employed in foreign countries along with their spouses or civil partners. When the UK residents return to their country, they can start paying into their ISA again as before.

As a bottom line, US residents can open ISA in the UK, but the savings and investments made through ISAs may not turn out to be as productive as for the UK residents. It is due to the differential tax treatment of ISAs in the US and the UK and the resulting tax disadvantages.


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