Written by Jonathan Laws, ACA, Ch.FCSI, Senior Financial Adviser, Cameron James.
Key Takeaways
- • A PFIC is, broadly, any non-US pooled fund. Most UK and EU funds, including index funds, OEICs and investment trusts, are PFICs for US tax purposes.
- • The default PFIC regime taxes gains at the highest ordinary income rates, adds an interest charge, and requires a separate Form 8621 for each fund every year.
- • PFIC rules do not apply inside a pension. A SIPP, a UK workplace pension, an IRA or a 401(k) lets a US person hold diversified funds without PFIC exposure.
- • An ISA gives no PFIC shield. The IRS does not recognise it, so pooled funds held in an ISA still create PFIC exposure.
Few acronyms cause as much anxiety for a US person living in the UK as PFIC. You open a UK investment account, buy a sensible low-cost index fund, and later discover you may have walked into one of the most punitive corners of the US tax code. The fear is understandable. The reassuring part is that PFIC exposure is largely structural, which means it is also largely avoidable once you understand where the rules reach and, just as importantly, where they do not.
This article explains what a PFIC is, why ordinary UK and EU funds fall into the trap, and the one structural place the PFIC rules do not apply at all.
What Is a PFIC?
PFIC stands for Passive Foreign Investment Company. From the perspective of the US Internal Revenue Service (IRS), “foreign” simply means non-US. A PFIC is, broadly, any pooled investment vehicle domiciled outside the United States that earns most of its income from passive sources such as dividends, interest and capital gains. In practice, a fund is caught if it meets either a 75% passive income test or a 50% passive asset test.
That definition captures almost every fund a UK investor would naturally buy:
• UK domiciled open-ended investment companies (OEICs) and unit trusts
• UCITS funds, including UK and EU domiciled index funds and ETFs
• UK investment trusts
In other words, the standard building blocks of a sensible UK portfolio are, in the eyes of the IRS, PFICs.
A short conversation can tell you exactly where you stand.
We review your US and UK accounts together, authorised on both sides of the Atlantic, so nothing falls through the gap between two tax systems.
Why PFICs Are So Punitive
The default PFIC regime is designed to remove any benefit from deferring income in a non-US fund, and it does so aggressively.
Under the default regime (the Section 1291 “excess distribution” rules), gains and certain distributions are taxed at the highest ordinary income rates rather than the lower long-term capital gains rates, and an interest charge is layered on top to claw back the perceived benefit of deferral. An excess distribution is, broadly, the part of a distribution that is greater than 125% of the average of the previous three years, and any gain on sale is treated the same way. On top of the tax cost, each PFIC must generally be reported on a separate IRS Form 8621 every year, which is time-consuming and, when prepared professionally, expensive.
There are elections that can soften this (the Qualified Electing Fund election and the mark to market election), but they depend on the fund providing the right information, and most non-US funds simply do not produce a PFIC annual information statement. The Form 8621 instructions set out how each method works. For the great majority of US persons, the practical answer is to avoid holding PFICs in the first place.
The Catch-22 for US Persons in the UK
Here is where it becomes frustrating. The obvious fix would be to buy US domiciled funds instead, because a US domiciled fund is not a PFIC. But a separate set of UK rules, the PRIIPs Key Information Document (KID) requirements, makes it very difficult for a UK retail investor to buy US domiciled funds in the first place.
So the US person in the UK is caught between two regimes:
• Buy a UK or EU fund and you have a PFIC problem.
• Try to buy a US fund and the UK KID rules block you.
The One Place PFIC Rules Do Not Apply: Inside a Pension
PFIC rules do not apply to investments held inside a pension. This is the single most important point in this article.
Under the US-UK Double Taxation Agreement (DTA), the following accounts are recognised as pension schemes by both countries:
• UK workplace pensions
• UK Self-Invested Personal Pensions (SIPPs)
• US 401(k) plans and other US employer plans
• US Individual Retirement Accounts (IRAs), both Traditional and Roth
Because these wrappers are treated as pensions, PFIC rules do not apply to the investments held inside them. Inside a SIPP or a workplace pension, a US person can hold diversified, pooled funds without creating PFIC exposure. Inside an IRA or a rolled over 401(k), the same is true.
This changes the entire planning picture. The asset that would be radioactive in a taxable account is perfectly acceptable inside the pension wrapper. It is why, for most US persons in the UK, pensions sit right at the top of the investment priority list.
If you have an old US employer plan, our guide to 401(k) to IRA rollovers for Americans living in the UK explains how to consolidate it without triggering an unnecessary tax event.
Where PFIC Rules Still Bite
Outside the pension wrapper, the PFIC rules are very much alive. The accounts to watch are set out below.
| Account | PFIC shield? | What this means in practice |
| UK SIPP / workplace pension | Yes | Pooled funds are fine inside the wrapper |
| US IRA / 401(k) | Yes | Pooled funds are fine inside the wrapper |
| Stocks and shares ISA | No | Not recognised by the IRS, so no PFIC protection. Pooled UK and EU funds create PFIC exposure |
| General Investment Account | No | PFIC rules apply in full to non-US pooled funds |
| US HSA | No | Treated by HMRC as taxable; PFIC applies to any non-US funds held in it |
| US 529 plan | No | Treated by HMRC as taxable; PFIC applies to any non-US funds held in it |
The ISA is the one that catches people out. It looks like a tax-free wrapper, and for UK purposes it is, but the IRS does not recognise it, so it offers no PFIC shield. That is why a US person, without the assistance of an adviser, generally cannot hold funds in an ISA and is pushed towards individual stocks instead. We cover this in detail in our dedicated ISA article.
Investing in PFIC Free Portfolios
As alluded to above, the perfect solution to the PFIC issue is to simply purchase US domiciled ETFs, but that is easier said than done, as most platforms don’t accept US persons, and those that do cannot provide US domiciled funds due to regulatory restrictions. So, what do you do?
Well, what you do is work with a dual authorised financial adviser, US advisers can purchase US domiciled ETFs, even inside UK-based accounts like ISAs and GIAs. Non US advisers are limited like you to purchasing individual stocks.
A Note on Form 3520 and Foreign Grantor Trusts
Separate from PFIC, there is a long-running grey area about whether UK pensions and SIPPs should be reported to the IRS as foreign grantor trusts on Forms 3520 and 3520-A. This is a genuinely unsettled area with several schools of thought. It does not change the PFIC position, because PFIC still does not apply inside the pension, but it is something to take advice on, and we treat it as a separate topic.
How Cameron James Helps
Getting this right is mostly about asset location: making sure your growth assets sit in the wrappers where PFIC cannot reach them, and that you are not unintentionally holding PFICs in an ISA or GIA.
About Cameron James and how we are regulated
Cameron James Ltd is a financial planning firm authorised and regulated in the United Kingdom by the Financial Conduct Authority (FCA). Many of our advisers hold individual SEC authorisation in the US, and individual EU/EEA authorisations where applicable. This adviser level authorisation across both sides of the Atlantic is what allows us to advise on your US accounts and your UK accounts within a single coordinated plan, rather than leaving you to stitch together UK only and US only advice that does not join up.
In practice, that means we can:
• Structure your portfolio so equity and other growth assets sit inside PFIC safe pension wrappers.
• Build globally diversified portfolios using US listed, non-PFIC, HMRC reporting ETFs where appropriate.
• Coordinate your US and UK tax reporting, so the two systems work together rather than against each other.
Speak to a Cameron James Adviser
PFIC exposure is almost always a question of where your assets sit, not what you are allowed to own. If you are a US person in the UK and you are not certain whether your funds are working for you or against you, a short conversation can give you clarity. Our advisers are authorised on both sides of the Atlantic and can review your full picture within a single coordinated plan.
Frequently Asked Questions
No. A SIPP is recognised as a pension under the US-UK tax treaty, and PFIC rules do not apply to investments held inside it. The same is true of UK workplace pensions, IRAs and 401(k)s.
Yes. An ISA is tax-free for UK purposes but is not recognised by the IRS, so it provides no PFIC protection. Holding pooled UK or EU funds in an ISA creates PFIC exposure, which is why US persons generally cannot use index funds inside an ISA.
No. PFIC rules apply only to funds domiciled outside the US, so a US domiciled ETF is not a PFIC. The challenge with US ETFs is access through UK platforms, not their PFIC status.
Almost certainly yes. UK and EU domiciled funds, including index funds, ETFs and investment trusts, are generally PFICs for US tax purposes.
It is the IRS form used to report a holding in a PFIC. A separate form is generally required for each PFIC, each year, which is one of the reasons holding PFICs is so burdensome.
These accounts do not benefit from the pension PFIC shield. HMRC does not recognise a US HSA or 529 plan as tax-free, so it treats them as taxable. If either account holds non-US pooled funds, PFIC rules can apply to those holdings, and the account is also exposed to UK tax. Most US persons in the UK should take specific advice on how best to hold or unwind these accounts.
The most reliable route is asset location. Hold growth assets such as pooled funds inside pension wrappers, where PFIC rules do not apply, and avoid holding UK or EU domiciled funds in an ISA or General Investment Account. Where diversified exposure is needed outside a pension, US listed, non-PFIC, HMRC reporting ETFs can be used where appropriate. A cross-border adviser can map this to your own circumstances.
Important information
This article is for general information only and does not constitute financial, tax or legal advice, nor a personal recommendation. Tax treatment depends on your individual circumstances and may change. The value of investments can fall as well as rise and you may get back less than you invested.
Jonathan Laws, ACA Ch.FCSI, Senior Independent Financial Adviser, Cameron James
“In my experience, the PFIC problem frightens people far more than it needs to. Once you understand that it is a structural issue, the path forward becomes clear. The single most important move for most US persons in the UK is to make full use of pension wrappers, because that is where PFIC rules simply do not apply. What I always say to clients is this. Do not let the fear of PFIC push you into a worse decision. Get your asset location right first, and much of the anxiety disappears.”