Investing in Mutual Funds for US Citizens under FATCA
Updated September 2022
First a message from my compliance department; I am not allowed to give tax advice and this paper must not be construed as giving advice on taxation for either German or US private citizens.
Now that part is behind us, we must consider what is practical, possible, and legal for those wishing to invest in a portfolio of managed funds while resident in Europe.
European financial institutions are deeply conscious of the costs of falling foul of the US Internal Revenue Service because the penalties for even an inadvertent breach of regulations are draconian. Many (but not all) such institutions refuse even to allow a bank account for US Persons. We have access to those financial institutions of good repute that will still take US National as clients and are happy to make the necessary introductions. There are of course also those we are not happy to recommend, and our clients are steered only toward the most useful organizations.
US Persons receive advice from many US tax advisors to the effect that any investments in PFICS (Passive Foreign Investment Companies) are fraught with the high costs of completing the many-sided forms per fund. This is the official and a somewhat unimaginative approach, especially for the retail investor whose assets do not extend into the millions.
Working on the basis that FATCA is targeted at Fat Cats, there has to be a pragmatic alternative for smaller investors.
Firstly, one should be aware that most mutual funds have sales clauses specifically stating that these funds must not be sold, amongst others, to citizens of the United States of America, wherever they may reside. ‘Most mutual funds’ does not however mean ALL mutual funds and the skill is finding, from the 46,000 funds available to investors on the German market, those where this blockage does not apply. There are no published lists of such funds, indeed if there were, steps would probably be taken to close this loophole; but the funds exist and can be found with diligent research and checking each individual prospectus.
Another hurdle is the ever-shrinking list of platform banks willing to accept the investments of US clients, assuming they are willing to accept US persons as clients in the first place.
There is also the potential problem of reporting the investments in mutual funds to the tax authorities in Germany (in our case) and to the US. An efficient and professional platform bank where clients’ assets are held securely, will prepare tax reports showing the profits and losses of a portfolio for the preceding year normally in February or March of the following year. These satisfy the needs of the local tax authorities. A pragmatic US tax adviser then will know at which point the FATCA reports require detail and below which a portfolio as a whole can be reported. Here it is essential that the US Tax adviser is well versed in the detail of the IRS level of tolerance. This is a pragmatic solution, relying on the fact that there are a limited number of staff within the IRS available to pore over the details of every report and the fact that a well-known and reliable US tax adviser will normally be trusted to deliver accurate data.
More recently we have found that a number of insurance companies now offer a life insurance wrapper that meets the requirements of the IRS as a pension product without falling foul of the PFIC reporting quagmire. This can be used to great effect and complies with the needs of both the German and US tax reporting requirements.
Investors with existing mutual fund portfolios should be aware that when using this insurance wrapper, the structure will mean that all holdings of funds will be deemed to have been sold and re-bought at the same price on the same day. The fund portfolio will then fall under the ownership of the insurance company and the investor, as the policy holder, will have a mirror investment in a private retirement plan of the same value.
The investment therefore becomes a retirement plan under German law, the value of which can be reported to the tax authorities on an annual basis.
Article contributed by John Townsend. John Townsend advises clients on their investment portfolios for Matz-Townsend Finanzplanung. He is a Fellow of the Chartered Institute for Securities and Investment in London.>