Most individuals with spare funds to invest will at some time have been involved in tax planning. Without doubt, this will have been done with the view to avoiding unnecessary taxes. Nevertheless, the activity in question will have taken place with acceptance by, and even encouragement from, the authorities in the country where the investor was living at the time.
Governments take decisions about activities that they want to encourage for political or economic reasons. Then it is often the case that a tax incentive will be attached as a ‘nudge’ factor to encourage the public to take that direction of travel.
An obvious example of such a policy is the Individual Savings Account (ISA) in the UK. Successive Governments have taken the view that regular saving is an activity to be encouraged. ISAs provide all savers with an attractive environment in which to save, although the real target audience is small savers. Hence there is an annual limit on contributions to an ISA. The real target audience is unlikely to want to save regular amounts in excess of that limit. Furthermore, it was much simpler to give all savers eligibility to a limited amount of tax saving than try to create an investment vehicle that was only available to small savers
A good tax result at home is unlikely to be replicated when moving to another country
Under any such tax-favoured saving regime, all is well and good so long as the individual investor continues to reside in the ‘home’ country. However, an international move (e.g., in connection with employment) should be a trigger for the investor to take immediate advice in two respects:
- Consult a tax professional on how the investment portfolio will be taxed in the new country of residence
- Consult with an investment advisor on whether that new tax environment requires a realignment of the portfolio
A simple rule of thumb in these circumstances is that what the home country provides by way of tax incentives is unlikely to be replicated in the new host country. Even when the governments in both countries have a policy of encouraging the same type of activity, the mechanics those two countries have put in place to nudge their populations in the desired direction will differ. Someone moving from the UK to a host country which also has tax incentives to encourage small savers, is highly unlikely to find that their ISA gets any favourable treatment there. Much more likely is that all income and gains arising within the ISA will be liable to host country taxation.
It makes sense to consult an investment advisor
Consultation with an investment advisor is recommended in these ‘tax change’ situations because the economics of a particular investment may have changed fundamentally. This can be illustrated by the case of an individual who has invested in US Municipal Bonds while they were resident in the USA, as Interest on Municipal Bonds is exempt from US Federal Income Tax. However, on moving to another country, that interest income is likely to be subject to host country taxation.
Because there have been defaults in the past, interest rates on Municipal Bonds will vary according to the credit rating of the municipality which issued the bonds. Given this variation in interest rates, there is not a ‘one size fits all’ answer for the investor who moves from the US to another country.
In the case of a hypothetical AAA-rated municipality, the traditional way in which interest rates were set at the time of a bond offering followed this pattern:
- Recognition that the minimum level of investment required meant that investors would be individuals paying the highest rate of US Federal Income Tax
- Computation of the after-tax income such a top rate taxpayer would get from a AAA-rated debt instrument paying taxable interest at the current market rate
- Offer an interest rate on the ‘tax free’ Municipal Bond which delivered a better cash flow to the investor than the after-tax result at Step 2 above
- Obviously, the actual ‘premium’ offered over that after-tax amount was determined by other market forces
If the Municipal Bond interest becomes exposed to host country taxation, it is obvious that the full rationale behind the original investment decision needs to be revisited and a ‘continued fit-for-purpose’ test applied.
Another point to discuss with an investment advisor is the situation where continuing with an existing investment will give rise to statutory information reporting requirements in the host country. Some countries take a particular interest in knowing about investments which their residents have in other jurisdictions.
If that statutory information reporting is such that a third-party professional will need to be paid to assist, the associated professional fees should be looked at as being a cost of holding that investment. The extent to which such a cost tarnishes the appeal of a particular investment will vary from case to case.
Examples of the interaction of UK and US tax rules
It is beyond the scope of this short article to provide an exhaustive set of country-to-country comparisons.
- Therefore, for illustrative purposes, the issues arising from moves between the UK and the US are set out below:
Other than the fact that US citizens and ‘green card’ holders continue to be taxed by their ‘home’ country, even when living elsewhere; similar issues to those illustrated below should be considered in any country-to-country move
- The illustrations are not presented as an exhaustive list of things to consider, but merely the more obvious ones. There is no substitute for engaging a tax professional to advise on all the cross-border tax issues which will arise in relation to a particular individual’s facts and circumstances