Are UK investment trusts PFICs?

Why is a UK investment trust usually a PFIC

Because a trust is built to fail the PFIC tests. A foreign corporation is a PFIC if at least three quarters of its gross income is passive, or if at least half of its assets, on average, produce or are held to produce passive income. An investment trust's income and assets are mostly portfolio holdings, so one or both tests are usually met.

Passive income is defined by reference to the foreign personal holding company rules, so it broadly covers dividends, interest, rents and royalties outside an active business, and gains on assets of that kind. The Form 8621 instructions (opens the official IRS page in a new tab) add a look-through rule: where the company owns at least a quarter of another corporation by value, it is treated as holding its share of that corporation's assets and receiving its share of that corporation's income. For a publicly traded company the asset test is generally measured by value rather than book cost.

The tests run each year, and the result is not fixed by the word trust in a company's name. Some trusts hold large stakes in unlisted businesses, and the look-through rule can then change the picture, so the answer depends on the trust's structure, not on the label.

• Dividends and interest from the portfolio count as passive income
• Gains on selling portfolio shares and bonds generally count as passive income
• Listed shares and bonds held for return generally count as passive assets
• Stakes of at least a quarter in another company are looked through
• Cash held for investment usually counts towards the passive side

How do REITs and London-listed trading companies compare

A trading company listed in London is usually not a PFIC, because most of its income comes from selling goods or services and most of its assets are used in that business. A UK REIT sits between the two: rental income can be passive, so whether a property company is a PFIC depends on how its rents are earned.

The foreign personal holding company rules that define passive income exclude rents derived in the active conduct of a trade or business, but only where detailed conditions are met, broadly that the lessor itself manages and operates the property through its own staff. A REIT that lets property through external managers may struggle to show that, while one with an in-house operating platform may be able to.

Some listed operating companies also need checking. A company that has sold its main business and holds the cash, or a holding company whose value sits mostly in minority investments, can meet the asset test for a time. Our article on why a stocks and shares ISA worries the IRS makes the same point for direct shareholdings generally, and our PFIC reporting service reviews holdings company by company.

Which PFIC tax regime applies to investment trust shares

The excess distribution regime applies unless an election is in place. Two elections can replace it: a qualified electing fund election, which needs an annual information statement from the company, and a mark-to-market election, which needs the shares to be marketable stock. Listed trusts often meet the second condition, while the first depends on each company.

Under the default regime, gain on a sale is treated as an excess distribution, as is any part of a year's dividends above a set multiple of the average of the previous three years. Each excess distribution is spread over the holding period, and the part allocated to earlier PFIC years carries tax at the highest rate for each year plus an interest charge. Ordinary trust dividends within the limit are taxed in the year received.

A qualified electing fund election taxes the holder each year on a share of the company's ordinary earnings and net capital gain, which keeps capital gain character for that part. It is only available where the company provides a PFIC Annual Information Statement. Whether a particular investment trust provides one is company-specific: some UK-listed companies with US investors publish one, and many do not, so the investor relations pages or the company secretary need to be checked.

The mark-to-market election is the one most often open to a listed trust. Marketable stock includes PFIC shares regularly traded on a foreign exchange regulated by a government authority with the characteristics set out in the regulations, and regularly traded means trading in more than minimal quantities on a set minimum number of days in each calendar quarter. Each year's rise in value is taxed as ordinary income, and a fall is deductible only to the extent of earlier inclusions not yet reversed.

When do investment trust shares need a Form 8621

Generally each year, for each PFIC, unless an exception applies. The main exception is the de minimis rule: where no election has been made and there is no excess distribution or gain on the shares in the year, the annual report is not needed if all PFIC holdings total $25,000 or less at year end, or $50,000 on a joint return.

The exception is narrower than it first looks. The threshold is an aggregate across every PFIC held, not a limit per company, so a few modest trusts alongside a fund or two can pass it. A sale of any shares in the trust, or a dividend large enough to be an excess distribution, means a form is needed for that year whatever the value. A holding under a mark-to-market or qualified electing fund election also needs a form, because the election itself is reported.

Values can be taken from periodic account statements unless there is reason to think they are wrong. Where a form is needed, Form 8621 is filed for each company with the Form 1040, and the IRS page for Form 8621 (opens the official IRS page in a new tab) holds the current version. The same shares also count towards the FBAR through the account that holds them and, where its thresholds are met, Form 8938.

Consider a US citizen working in Leeds who holds four investment trusts in a general investment account and sells one during the year. The sale makes that trust reportable regardless of the aggregate value. For the three still held, the de minimis test depends on the year-end value of all PFIC holdings together against $25,000, if no election applies and no excess distribution arises on them. Our individual tax returns service runs that test before deciding which forms to file.

• Any sale or other disposal of shares in the trust during the year
• A dividend that exceeds the excess distribution limit
• A mark-to-market or qualified electing fund election in force
• Total PFIC holdings above the de minimis threshold at year end

Does an ISA or a UK pension change the answer

An ISA does not. It gives no US tax protection, so investment trust shares inside it are treated as held directly, with the same tests, regimes and reporting. A UK pension can be different: a reporting exception applies to PFICs held through a scheme that a US income tax treaty treats as a pension fund, where the treaty defers tax on the scheme's income.

The ISA (opens the official GOV.UK page in a new tab) rules are a UK concept, and switching between trusts inside the wrapper is a sale for US purposes. Our article on the stocks and shares ISA covers the mechanics, so this post does not repeat them.

For pensions, Treasury Regulation section 1.1298-1(c)(4) removes the Form 8621 requirement for a member of an arrangement treated as a foreign pension fund under a treaty, where under that treaty the fund's income may be taxed as the member's income only when and to the extent it is paid out. Article 18(1) of the US-UK tax treaty (opens the official IRS page in a new tab) contains a deferral of that kind for a member resident in one country of a pension scheme established in the other, and the treaty's saving clause does not override it.

Whether a particular SIPP or workplace scheme, and a particular member, fall within the article depends on the scheme's status and the member's residence, so the exception should be confirmed rather than assumed. Our US-UK pensions service reviews how the treaty applies to each scheme, and the US-UK tax treaty page sets out where a Form 8833 disclosure fits.

What should a US holder of investment trusts check

Start with a list of every holding and the account it sits in, then decide company by company whether it is likely to be a PFIC, which regime applies and whether a form is due. Trusts bought years ago without a timely election need the most care, because the default regime follows the shares.

The default treatment also does not end simply because a company stops meeting the tests. The Form 8621 instructions provide a deemed sale election for a former PFIC, under which the shares are treated as sold at the end of the company's last PFIC year, with any gain taxed under the default rules. Without it, the earlier PFIC years continue to affect later distributions and sales.

Missing forms matter even though Form 8621 has no standalone monetary penalty, because the statute of limitations for the whole return stays open until the form is supplied. Our PFIC reporting service and the guide to US-UK tax for founders, fund managers and executives cover the wider position, and the Instructions for Form 8621 (opens the official IRS page in a new tab) set out each election in full.

• Each trust's income and asset mix, using its annual report
• Whether the company publishes a PFIC Annual Information Statement
• Whether the shares meet the regular trading test for marketable stock
• Purchase dates, costs and exchange rates for each lot of shares
• Which account holds each trust: ISA, pension or general account