Navigating PFIC rules for US-based clients with Australian investments
In any given year, tens of thousands of Australian expats reside and work in the US and are required to register as US taxpayers. At the same time, many high-net-worth US investors look to invest directly in overseas markets, including Australia.
Both groups need to be familiar with Passive Foreign Investment Company (PFIC) rules, which can significantly impact US taxpayers investing in Australia and other jurisdictions.
What is a PFIC?
A PFIC is a non-US based company that meets at least one of two criteria: either 75 per cent or more of its gross income is passive (such as interest, dividends, or capital gains), or 50 per cent or more of its assets produce or are held to produce passive income.
The PFIC rules were established to prevent US taxpayers from using foreign investments to defer or avoid paying US taxes. If a US taxpayer holds investments in a PFIC, they are subject to strict reporting requirements and potential tax consequences, including the need to file IRS Form 8621.
Popular investments captured by the PFIC rules
Investing in some types of Australian securities can expose US taxpayers to PFIC rules, especially when dealing with certain types of unitised investment vehicles like managed funds, listed investment companies, and exchange-traded funds (ETFs). These investment vehicles often generate passive income, making them potential PFICs under US tax law
The consequences of owning PFICs can be severe, including:
Excessive taxation: PFICs are subject to higher tax rates on gains and distributions.
Complex reporting requirements: US taxpayers must file IRS Form 8621 for each PFIC they own, which can be time-consuming and complicated.
Interest charges: If the PFIC rules are not followed correctly, taxpayers may face interest charges on deferred tax liabilities.
Direct indexing can provide a solution
One way for US taxpayers to avoid the complications of PFIC rules while still investing in the Australian market is through a direct indexing strategy. This approach involves purchasing individual shares of Australian companies directly, rather than investing in managed funds or ETFs that may be classified as PFICs.
There are several benefits to direct indexing, including:
Efficient and cost-effective: Just like an ETF, direct indexing portfolios can provide equivalent exposure to the performance of an index with great efficiency, while keeping costs low.
Customisation: Investors can enjoy additional benefits with the ability to tailor their portfolios to match their specific values and circumstances.
Tax optimisation: Direct indexing allows for more precise tax management, not available within the constraints of a unit trust.
Where to from here?
While investing in Australian stocks can offer diversification and growth opportunities, US taxpayers must be mindful of the PFIC rules and their potential tax implications. By considering a direct indexing strategy, investors can participate in the Australian market while avoiding the complexities and higher taxes associated with PFICs.
The good news is that direct indexing – the fastest growing investment strategy in the US – is now available in Australia. Thanks to Briefcase’s innovative technology platform, advisers can design, manage, and implement index-aware portfolios efficiently, and at low cost, via a range of leading investment and stockbroking platforms.
Get in contact with us today to learn more.
Disclaimer:
The information provided in this article is for general informational purposes only and does not constitute tax advice. While we strive to ensure the accuracy and reliability of the information presented, it may not be applicable to your specific circumstances. Tax laws and regulations are subject to change, and their application can vary based on individual situations.
We strongly recommend that you seek professional advice from a qualified tax advisor or financial professional before making any investment decisions or taking any action based on the information provided. The author and publisher are not responsible for any errors or omissions, or for any actions taken based on this information.