Where Is Your ETF Domiciled? This Is Important

A lot of very knowledgeable UK investors find the UK tax regime quite confusing and this often leads them to invest in inappropriate ETFs that can ultimately lead to unexpected and unwelcome tax bills.

Without taking a political stance, while I would never condone tax evasion, I would equally strongly advise against paying too much tax. All investors should seek professional advice, but here is my understanding of why it is preferable to invest in UK listed ETFs rather than go overseas.

Are You Being Over-Taxed?

Many ETFs listed in the U.S. or the Far East can look very attractive because they are bigger, more liquid or have lower total expense ratios (TERs) than those available in the UK. This may be superficially correct, but there are good tax reasons for not investing in the biggest or cheapest ETFs. As a general rule, a UK taxpayer should be very careful investing in any U.S.-listed ETFs or any vehicle listed outside the UK.

UK taxpayers be aware: if you buy a U.S.-listed ETF, the dividends paid by that ETF will be subject to 30 percent U.S. withholding tax before hitting your account, whether that account is a self-invested personal pension (SIPP), individual savings account (ISA) or a General Investment Account. If you fill in form W-8 from the Internal Revenue Service you can reclaim 50 percent of this tax under the double tax treaty that exists between the U.S. and the UK, and reduce the withholding tax you pay to 15 percent of dividends.

And if you do not reclaim the tax, bills will add up – consider that if dividend yields are about 2 percent for U.S. equities and the extra tax you pay is 15 percent, the loss is only 0.3 percent a year – not a huge amount, but sufficient to wipe out any advantage of buying such a fund in the first place.

Ireland Has Double Tax Treaty

However, if you buy an ETF listed in the UK, but domiciled in Dublin, the ETF does all the hard work for you and reclaims the withholding tax on your behalf under the double tax treaty between the U.S. and Ireland.

Interestingly, Luxembourg-listed ETFs do not have a double tax treaty with the U.S. and do not claim that tax back on your behalf, so be careful of the domicile.

Watch Your Wrapper – It’s Not Always Tax Free

Some investors have said to me that they invest though a SIPP or an ISA, which come with certain tax benefits, and they assume that they do not pay withholding tax on their U.S.-listed ETFs. I am afraid that this is not the case and I would suggest you look at a London-listed, Dublin-domiciled ETFs, unless you like paperwork.

UK Reporting Status

There is another reason to be cautious of ETFs listed outside the UK. That is the complex issue of UK Reporting Status (UKRS). Nearly all ETFs are domiciled offshore even though they may be listed on the London Stock Exchange and it is essential for UK tax payers to ensure that their ETFs have UKRS, granted by HMRC. Virtually all London-listed ETFs have UKRS. It is possible that some ETFs listed on European exchanges have UKRS, but you should always check.

The issue of UKRS is not important for investors who invest via their SIPP or ISA, but it is very important for the 50 percent of investors who invest outside of these tax wrappers. If your ETF does not have UKRS and you are lucky enough to make a capital gain, you will not be able to use your Capital Gains Tax annual tax free allowance of £11,100 and you will be taxed at your highest marginal rate of income tax. That could mean transforming your tax rate from zero to 45 percent.

Always, Always Check

In summary, it is best to invest in UK-listed ETFs and to check that your chosen ETF has UKRS status, something that should be clearly marked on the ETF factsheet and on the ETF provider’s website.

Any saving you may make on the fund’s TER can easily be lost in unwelcome tax bills. If you are not sure, seek professional tax advice. This is not an easy arena to navigate.