Investing in European Mutual Funds for US Citizens under FATCA.
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 while resident in Europe.
European financial institutions are deeply conscious 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 Nationals. 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 toward the most useful organizations.
US Nationals receive advice from many US tax advisors to the effect that any Mutual Fund investments are fraught with the high costs of completing the many sided forms per fund. This is the official and 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 is 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.
Be warned, the list of available mutual funds is relatively short and building a balanced portfolio is therefore more complex than it would be for non- US investors. One should not consider a targeted portfolio, for instance for sustainability and ethical funds. For a thoughtfully constructed portfolio however, where the factors of risk, market cycles and manager quality are important, there is just sufficient room for maneuver.
Then there is the 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.
The system is subtle and needs gentle handling, but it works.
Investors with existing mutual fund portfolios should be aware that the changes in German tax laws due to come into effect at the end of 2017, will mean that all holdings of funds will be deemed to have been sold at their value on 31st December 2017 and rebought at the same price on 1st January 2018 then to be taxed under the new system which will then prevail. Many of the existing fund portfolios will partly or wholly consist of funds which under current laws are not open to US investors. Each of these will need to be considered carefully.
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.