Brexit and EU Domiciled Funds

Mr.Saver

I know there's too many Brexit topics, but I promise this is a topic that may affect many investors.

So, the funds available in the UK, especially ETFs, are often EU (specifically, Irish) domiciled. A good example of this would be the majority of (or all?) ETFs provided by Vanguard UK. Those funds are available in the UK because they are currently passported to the UK under the EU's Undertaking for Collective Investment in Transferable Securities (UCITS) rules. This is also the reason why so many funds have UCITS in their names.

Now, what's going to happen after Brexit if UCITS passporting is not a part of the deal or no deal at all? Can we still buy UCITS funds? Can we still hold UCITS funds? What's the tax position on UCITS funds inside an ISA? inside a pension? and outside tax wrappers?

Below is my opinions on this.

My feeling is those UCITS funds will still be available to buy and hold after Brexit, even in a no deal scenario. This is because UK investors are currently largely invested in those funds, and there are no UK domiciled alternatives to those funds. Plus, we can buy and hold stocks and funds from many other non-EU countries anyway.

However, the tax position may change.

After Brexit, the passporting rule will no longer apply, those funds may be treated the same as those US domiciled stocks and funds.

This means if an investor holds those funds inside an ISA, the investor doesn't need to pay tax in the UK, but may need to pay dividends tax (or whatever tax applies) in other countries, because the ISA status is not recognized in other countries.

But if anyone holds them in a pension, the dividends/interest from those funds should be tax exempted everywhere as the UK pension scheme is widely accepted.

On the other hand, if anyone is to invest in those funds outside a tax wrapper, it could become more difficult and less tax efficient. The dividends/interest from those funds are potentially treated as foreign income, and subject to the foreign income tax in the UK. The investor would also have to fill in the Self Assessment to report the foreign income on those funds.

Any other opinions on this? And how should we prepare for this?

londoninvestor

Mr.Saver wrote: »

The dividends/interest from those funds are potentially treated as foreign income, and subject to the foreign income tax in the UK. The investor would also have to fill in the Self Assessment to report the foreign income on those funds.

This is already the case today, even while we are still in the EU. From a UK tax perspective, Ireland, Luxembourg or any other EU country is already "foreign", and income from funds domiciled in those countries is treated as foreign income. If it exceeds the amounts that HMRC considers de minimis, it needs to be declared in the foreign section of your tax return. (If it's small you can just lump it in with UK income.)

Now, you can avoid double taxation by ensuring that the country you invest in has a double tax treaty with the UK. We have treaties with all the EU countries - but they are bilateral arrangements that aren't conditional on EU membership. Similarly, we have treaties with non-EU members such as the US, Australia etc.

So the tax position isn't likely to change, because the tax system even now doesn't draw a distinction between EU foreign countries and non-EU foreign countries.

The departure of the UK from the passporting regime could in principle prevent EU funds selling to UK investors. But I tend to agree with you that even without a deal, UK regulators won't be in a hurry to prevent UK investors buying EU-domiciled funds, and so will declare some kind of equivalence allowing those funds to continue selling here.

(And to be clear, passporting has nothing to do with the tax treatment of funds. You might be thinking of "UK reporting" status for funds, which does affect tax treatment - that status isn't related to passporting and nothing prevents non-EU funds having it.)

bowlhead99

Mr.Saver wrote: »

Below is my opinions on this.

My feeling is those UCITS funds will still be available to buy and hold after Brexit, even in a no deal scenario. This is because UK investors are currently largely invested in those funds, and there are no UK domiciled alternatives to those funds. Plus, we can buy and hold stocks and funds from many other non-EU countries anyway.

The fact that 'UK investors are invested in those funds and there aren't good local alternatives' does not in itself mean the UK regulator will allow the funds to continue to be made available to UK retail customers. The UK would be free to make the rules as it saw fit.

However as a practical matter, UK regulations will be equivalent to the EU regulations on day one, and the UK is keen to maintain market access and not disrupt things with as long a transition as possible, and has already made available a facility for EU funds to register to keep selling to the UK in a post EU world.

However, the tax position may change.

After Brexit, the passporting rule will no longer apply, those funds may be treated the same as those US domiciled stocks and funds.

You are confusing two completely different things.

Passporting is about being able to market a product that a financial regulator has approved in one jurisdiction, to customers who live in another financial regulator's jurisdiction, without that second regulator needing to explicitly approve the product for sale. That's allowed where the second regulator trusts that the regulations to which the product is subject in jurisdiction one is already just as good as what the second regulator would be requiring if the product was being directly regulated in jurisdiction two.

However, what the regulators think about suitability of a foreign product for a vulnerable set of investors in their country, has *nothing* to do with what HMRC think the investor should pay in tax on income or gains from that product. Nor what withholding taxes the foreign government wants to levy on distributions of interest, dividends or other income or capital proceeds to foreign investors. Such matters are covered by tax law and tax treaties, not marketing passports or financial regulators.

On the other hand, if anyone is to invest in those funds outside a tax wrapper, it could become more difficult and less tax efficient. The dividends/interest from those funds are potentially treated as foreign income, and subject to the foreign income tax in the UK. The investor would also have to fill in the Self Assessment to report the foreign income on those funds.

An Irish or Luxembourg or Guernsey or US resident investment fund is already 'foreign' to a UK investor. This doesn't change dependent on whether the UK is part of the European Union, whether or not Ireland or Luxembourg leave the EU and Guernsey or US join the EU.

Your income or gains from such investments are already foreign income and gains to you as a UK resident, and from the perspective of the foreign country of residence of the fund vehicle, you are already a foreign investor.

If the foreign countries receiving your investment into one of their collective investment schemes decide they are going to change their tax policy or renegotiate double-tax treaties with the UK to implement withholding taxes on UK investors who have put money into those vehicles, they can do so, and it could affect your investment returns if you continued to use the product, but there is no particular reason for them to do that.

HMRC doesn't withhold tax on dividend distributions to Irish residents or UK residents investing in UK funds, and likewise the Irish tax authorities don't withhold tax on dividend distributions to Irish residents or UK residents investing in Irish funds. There are no credible proposals to change that whether or not we have an exit that leaves a 'hard border' for movement of people and goods between our countries and tariffs on goods and services. Both the UK and Ireland like their funds industries which generate GDP for their respective economies, and taxing foreign investors in collective investment schemes is not a great way to attract investors to those schemes.

Any other opinions on this? And how should we prepare for this?

As londoninvestor said, any change to passporting does not have a tax effect, just a potential 'access to products' effect which the regulators are keen to avoid creating, for now.

In terms of preparation, all you can do is keep the products you want and 'watch for updates'. If at some future point the products are for some reason closed to your existing or new investment, or tax changes or tax treaty renegotiations make the investments you hold inefficient compared to rivals, then change your investments based on research you carry out at that point.

Linton

londoninvestor wrote: »

........
The departure of the UK from the passporting regime could in principle prevent EU funds selling to UK investors. But I tend to agree with you that even without a deal, UK regulators won't be in a hurry to prevent UK investors buying EU-domiciled funds, and so will declare some kind of equivalence allowing those funds to continue selling here.
,,,,,,,,

Can the regulators just do that? Will there need to be a change in legislation if we have a real no-deal BREXIT? I assume that the current passporting arrangements are at the moment just inherited from overall EU legislation. Will it depend on the EU agreeing a reciprocal arrangement?

Heedtheadvice

Does the proposed migration of European Assets Trust N.V. legal seat to the 'same' PLC (delisting on Amsterdam and and LSE and PLC application for listing on LSE) have anything to do with potential results from Brexit or are there other reasons for it?
(I hold in my ISA)


Need I be aware of any other implications for this trust or is it purely a legal change to change it's domicile and can that just be ignored?

EdSwippet

bowlhead99 wrote: »

In terms of preparation, all you can do is keep the products you want and 'watch for updates'. If at some future point ... tax changes or tax treaty renegotiations make the investments you hold inefficient compared to rivals, then change your investments based on research you carry out at that point.

Outside of ISAs and SIPPs though, doing this with a holding having a sizeable unrealised capital gain could result in a large and entirely unwanted capital gains tax liability.

bowlhead99

EdSwippet wrote: »

Outside of ISAs and SIPPs though, doing this with a holding having a sizeable unrealised capital gain could result in a large and entirely unwanted capital gains tax liability.

The 'doing this' that my post was advocating was simply to keep the investments you want, and later amend your investments if you no longer want them. The type of 'investments you want' might be coloured by potential returns, market risk, tax risk etc.

Yes, holding investments for a long time and then disposing of them at a large profit can create a gains tax liability. So if you don't want to be in a situation where the unrealised unwrapped profits are large at the point you might want to sell them, you could always sell them (or some of them) now and use up your available exemptions for this year and buy something else. The standard tactic of using up your annual exemptions each year can be a sound one, but isn't something that is a sound one just because of a potential Brexit on the horizon.

Perhaps they are not really the investments you want after all, all things considered, if their potential building in value and then you wanting to dump them at a profit creating a tax charge, is something you fear. What's the solution, buy things that don't appreciate in value so you never have to worry about paying taxes because you don't make any gain?

"If at some future point ... tax changes or tax treaty renegotiations make the investments you hold inefficient compared to rivals, then change your investments based on research you carry out at that point."

As there are no known or reliably predicted investment fund tax changes or double-tax treaty changes in the horizon, it doesn't make sense to try to plan all your investments around such changes, because you don't have any indication of what they are, or how and when they might occur. You just know that 'tax risk' is one risk among many risks associated with any investment you currently own or might buy.

EdSwippet

bowlhead99 wrote: »

Perhaps they are not really the investments you want after all, all things considered, if their potential building in value and then you wanting to dump them at a profit creating a tax charge, is something you fear.

This misses the point. Say you hold a Ireland domiciled FTSE all-world tracker fund or ETF, and an all-world tracker fund is indeed what you want to hold. And say some boneheaded rule change suddenly means that this holding is now exceedingly tax-inefficient. For example it becomes non-reporting.

Moving that investment to a UK domiciled fund or ETF holding the exact same assets, because remember that these are the assets you want to (and are happy to) hold, could generate an entirely unnecessary capital gains tax liability. One that you could have put off either for decades or perhaps indefinitely, if you die holding them, without the rule change.

Granted, this scenario is just an extension of a risk already in your holdings, specifically that reporting status can be lost. However, it seems to me that Brexit shenanigans have the potential to increase that risk. To be clear, I don't think this likely, nor that any effects would necessarily be large, but it is not unthinkable.

As it happens, entirely by luck all the tracker funds I hold outside of ISAs and SIPPs are UK domiciled. Only by good fortune, though. Before the spectre of Brexit I would not have considered this domicile difference at all significant. And I suspect hardly anyone else would either.

bowlhead99

EdSwippet wrote: »

As it happens, entirely by luck all the tracker funds I hold outside of ISAs and SIPPs are UK domiciled. Only by good fortune, though. Before the spectre of Brexit I would not have considered this domicile difference at all significant. And I suspect hardly anyone else would either.

Imagine you were one of the people holding an Irish ETF tracker - for historic reasons, the vast majority of European market ETFs are Irish or Lux domiciled even though theoretically an ETF could be UK domiciled now that the UK has accommodative regulation, tax and and stamp duty rules (which it didn't have in the early days of ETFs). And then imagine that European domiciled ETFs stopped being able to be marketed to the UK following some very unlikely Brexit scenario where financial regulators had a hissy fit.

You would not be able to buy more of the ETF. However, regulator's marketing rule wrangles post Brexit won't mean you have to sell your existing privately owned European domiciled shares. It just might make it difficult or impossible to buy more of the same ETF if it can't be marketed to you. So you could use a different (eg UK) product going forward for newly invested capital but would not really be a forced seller of the ETF. You could still put off selling, selling down at a reasonable rate to minimise tax and perhaps until you die holding them with no CGT, as you suggest.

So really the marketing passport regulations post Brexit are a red herring. They are not causing you to dump your ETF at a big profit for a tax hit. The concern is really only what happens if the tax treatment of a foreign asset changes for the worse post Brexit, causing you to want to sell it (at a big profit for a tax hit).

Such changes are unknown, because there are no known changes afoot for HMRC to change personal taxation to make owning certain foreign collective investment schemes disadvantageous and more heavily taxed than owning a UK equivalent with the same underlying assets; and there are no known changes afoot for the Irish government to make ownership of its collective investment schemes less attractive to foreign (UK) owners. So all you can say is that it could perhaps all change if all the rules are thrown up in the air to see where they land with no regard to current policy expectations.

But if you are going to say, well anything could happen... you still don't know which way it would change. The tax regimes might change so that instead of making foreign collective investment scheme inefficient compared to UK ones, UK collectives were made inefficient compared with foreign ones and then you have the opposite problem of needing to sell a UK fund when you weren't planning to do so and had an unavoidable gain built up. Then it would have been the wrong thing to avoid the EU products, you should have avoided the UK ones instead.

Granted, this scenario is just an extension of a risk already in your holdings, specifically that reporting status can be lost. However, it seems to me that Brexit shenanigans have the potential to increase that risk. To be clear, I don't think this likely, nor that any effects would necessarily be large, but it is not unthinkable.

I do see what you're saying, but there are all kinds of risks which are not unthinkable but are also not likely, with effects that would not necessarily be large, so speculating that it would be bad to own foreign domiciled assets due to unforseen tax consequences is not really a Brexit-specific conversation. As suggested already, it's just an extension of risk analysis. There is always foreign tax risk and political risk when investing overseas, but there is also domestic tax risk and political risk when investing at home. We might like to think we can see the UK policy risks coming, but governments make surprise rules which intentionally or unintentionally screw people over, all the time - we can't really see the UK tax policy risks coming any better than we can see Irish tax policy risks coming.

londoninvestor

Linton wrote: »

Can the regulators just do that? Will there need to be a change in legislation if we have a real no-deal BREXIT? I assume that the current passporting arrangements are at the moment just inherited from overall EU legislation.

While I don't know the chapter and verse of legislation, I doubt it would need new primary legislation. Funds from foreign non-EU countries can already be authorised for sale here, so I'd think EU funds could just register under the same existing framework.

Will it depend on the EU agreeing a reciprocal arrangement?

Not as a matter of law and regulation - though of course it's possible the UK government could use it as a bargaining position.