Are the rules for tax any different if I use Contract for Difference to invest in US shares/EFTs?

w00519773

I am a UK investor.  This is a follow on from this question: https://forums.moneysavingexpert.com/discussion/comment/78069701#Comment_78069701
Are the rules for tax any different if I use Contract for Difference to invest in US shares/EFTs instead of dealing in the shares directly?
If I use CFDs then I assume I would not have to fill in a IRS W8-BEN form (though I don't know) and I would pay UK taxes only?
I understand the risks of CFDs - I am just trying to understand my options at this stage.

underground99

You don't have it quite right.

The US IRS does levy a withholding tax on US-source income paid to foreign investors, and since the last rule change a few years ago this doesn't just apply to receiving an actual dividend directly from the company but also to those receiving a 'dividend equivalent payment' via a derivative such as a contract for difference or spread bet when you hold an open long position at the point a share starts to trade ex-dividend.

So, your broker will generally ask you to fill out a W-8BEN to confirm you are UK resident and can take advantage of the US-UK tax treaty to reduce the amount of withholding on dividend payments (and dividend-equivalent CFD payments) to 15% instead of 30%. If you don't, you'll simply pay more income tax to the IRS than you need to - and if you pay more US tax than you need to, there's no mechanism for you to claim that back from HMRC or anyone else other than the IRS itself.

If you are not US resident or citizen you won't pay any 'capital gains' tax to the US on share or CFD transactions, the IRS is are only concerned with they US 'income' side.

From the UK tax perspective, CFDs work a little differently from direct shares holding, in that your total profit on the contract is within the scope of CGT and the cash payout when something goes ex-div is not seen as income subject to income tax..  but just as something that affects the total profit you made on the contract which is subject to CGT.

This is somewhat logical because the underlying company isn't actually paying you an income; the company only pays the income to the owners of the real shares. The overall net profit or loss on the contract is simply a net amount being paid from one participant in the contract to the person on the other side of it (ie the person who's long paying to or receiving from the person who's short, or vice versa, depending on overall movement).

So CG56101 within the HMRC CGT manual at gov uk hmrc-internal-manuals/capital-gains-manual/cg56101 will tell you that you calculate your overall gain on the contract based on all costs and payouts involved whatever direction they are (price movement, dividend adjustment, broker commission, margin/gearing interest etc).

Long story short, there's a difference in treatment of the CFD dividend between UK and US taxes where the US sees a payout to a long CFD holder as being just the same as if you'd held the underlying share and levies withholding taxes while the UK just sees it as an adjustment to the taxable gain.  The US one appears a little lopsided to a UK taxpayer as if you are long on the contract you only get 85% of the dividend (due to 15% WHT) while if you're short on the contract you still pay 100% of the amount, with no tax refund.

w00519773

underground99 said:

You don't have it quite right.

The US IRS does levy a withholding tax on US-source income paid to foreign investors, and since the last rule change a few years ago this doesn't just apply to receiving an actual dividend directly from the company but also to those receiving a 'dividend equivalent payment' via a derivative such as a contract for difference or spread bet when you hold an open long position at the point a share starts to trade ex-dividend.

So, your broker will generally ask you to fill out a W-8BEN to confirm you are UK resident and can take advantage of the US-UK tax treaty to reduce the amount of withholding on dividend payments (and dividend-equivalent CFD payments) to 15% instead of 30%. If you don't, you'll simply pay more income tax to the IRS than you need to - and if you pay more US tax than you need to, there's no mechanism for you to claim that back from HMRC or anyone else other than the IRS itself.

If you are not US resident or citizen you won't pay any 'capital gains' tax to the US on share or CFD transactions, the IRS is are only concerned with they US 'income' side.

From the UK tax perspective, CFDs work a little differently from direct shares holding, in that your total profit on the contract is within the scope of CGT and the cash payout when something goes ex-div is not seen as income subject to income tax..  but just as something that affects the total profit you made on the contract which is subject to CGT.

This is somewhat logical because the underlying company isn't actually paying you an income; the company only pays the income to the owners of the real shares. The overall net profit or loss on the contract is simply a net amount being paid from one participant in the contract to the person on the other side of it (ie the person who's long paying to or receiving from the person who's short, or vice versa, depending on overall movement).

So CG56101 within the HMRC CGT manual at gov uk hmrc-internal-manuals/capital-gains-manual/cg56101 will tell you that you calculate your overall gain on the contract based on all costs and payouts involved whatever direction they are (price movement, dividend adjustment, broker commission, margin/gearing interest etc).

Long story short, there's a difference in treatment of the CFD dividend between UK and US taxes where the US sees a payout to a long CFD holder as being just the same as if you'd held the underlying share and levies withholding taxes while the UK just sees it as an adjustment to the taxable gain.  The US one appears a little lopsided to a UK taxpayer as if you are long on the contract you only get 85% of the dividend (due to 15% WHT) while if you're short on the contract you still pay 100% of the amount, with no tax refund.

Thanks - so in summary:
1) A W8-BEN is needed for US CFDs
2) No US tax to pay for capital gains US CFDs
3) 100% tax to pay for US CFDs when shorting with no refund?
4) 15% tax to pay for US CFDs when longing with a refund from HMRC possible?

underground99

w00519773 said
Thanks - so in summary:

1) A W8-BEN is needed for US CFDs
2) No US tax to pay for capital gains US CFDs
3) 100% tax to pay for US CFDs when shorting with no refund?
4) 15% tax to pay for US CFDs when longing with a refund from HMRC possible?

not quite:
1) Yes. Strictly speaking it is probably not needed, but then you would suffer US withholding at 30% on the income piece instead of 15%, so makes sense to do it - and the broker may be reluctant to let you trade US CFDs without it.

2) Yes

3) not quite right. What I was saying is that when you're 'long' on a $100 dividend, you'll only get $85 of the dividend in cash, due to withholding... whereas if you are short, you pay the full $100 amount of the dividend in cash, and the other $15 isn't subtracted from the amount they want you to pay.  That's not really a '100% tax to pay'; it just means that when short, the dividend costs you the full gross amount without regard to whether the person on the other side of the trade is going to suffer withholding tax or not. But correct, no refund for any taxes. You just pay your CGT on your overall profit.

4) When you're long, you'll lose 15% on the dividend-equivalent amount, just like you would do if you held the actual shares and suffered withholding tax on the real dividend. But foreign income taxes withheld on dividends can only be offset against UK dividend tax paid on the same source income.  Due to the way that the 'notional dividend' receipt is treated by the UK taxman (as a capital amount rather than an income amount), you won't have any 'UK dividend tax paid on the same source income', so you can't reduce your UK income tax bill by your foreign income tax paid, because you don't have a UK income tax bill from that investment.

  I don't know if HMRC would accept you knocking the US tax off your gross proceeds as an allowable cost when doing your CGT calculation (thus saving CGT on the $15 that you never actually received), but it is not a cost of acquisition or disposal in the traditional sense (like a broker fee, stamp duty, accounting or valuation cost, etc), so that foreign income tax withheld (which can't be reclaimed against your UK income tax bill) is probably just 'lost'. It's not something that has ever materially affected me so haven't taken any tax advice on it.

maxsteam

imho you should worry about finding an instrument that you can make a profit with before worrying about paying taxes on a profit that you have not yet made. If you want to keep things simple, as a UK investor, you should stick to UK shares and derivatives.