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Passive investments triggering large tax bills, warns expert

Passive investments triggering large tax bills, warns expert

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Miranda Brownlee
30 August 2017 — 1 minute read

SMSF practitioners with US expat clients have been warned that where their clients invest in foreign investment companies that are passive, they could face significant taxes, a technical expert warns.

Atlas Wealth Management managing director Brett Evans explained to SMSF Adviser that due to tax rules brought in by the IRS back in 1986, where US citizens or Australians residing in the US invest in a passive foreign investment company (PFIC), they may have to pay additional taxes.

A PFIC, he explained is a non-US company or trust that either generates gross income that is mostly passive, at least 75 per cent, or the majority of the assets are passive.


According to Mr Evans, the rules were brought in originally to address some of the investment products that were being marketed to people in the US such as foreign managed funds, listed investments companies and mutual funds that were avoiding paying the correct taxes to the US.

“The way the tax works is that the IRS will consider the time that an individual has held an asset and they’ll go back and tax a portion of that capital gain each and every year that the investor has held it, and they’ll tax it at the top marginal tax rate.

As the IRS taxes the asset retrospectively, the investor may also be hit with interest charges as well, Mr Evans warned.

“The other problem also is that it's treated as income and because it's treated as income and not as a capital gain, you can't use any losses to offset against that,” he said.

“Last of all, if you are domiciled as an Australian expat in the US, then you also have state taxes to contend with as well too, because each one of the states treats PFIC taxes in a different way so it's layer upon layer.”

Mr Evans said a lot of clients are not even aware of this trap and that it’s a significant problem for US expats based in Australia.

“While the legislation has been around for a couple of years, it's taken a while for the data matching to occur between the ATO and the IRS, and unfortunately, if someone were to hold a managed fund for a number of years and then sell it down the track, they could certainly be up for a big tax bill,” he said.

Passive investments triggering large tax bills, warns expert
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