Repurcussions of PRIIPs on US listed ETFs/CEFs

[hiriskpaul]

Some new european legislation, coming into force on 1 Jan 2018, is going to negatively impact anyone holding non-european collective investments, such as US listed ETFs or closed ended funds. The new regulation requires that issuers of certain types of investments, known as "Packaged Retail Investment and Insurance Products" ("PRIIPs), must publish a Key Information Document (KID) if they are available to private investors. US listed ETFs and CEFs will not be producing compliant KIDs, which means trading in these will be off limits to UK private investors from the end of this year.

This is a pain for me and many other investors. For one thing, tax savings will be lost if private investors will no longer be allowed to hold US collectives. For example, if you hold a US listed S&P 500 ETF, you will pay 15% dividend withholding tax (assuming a W-8BEN has been filled in). But this can be used to offset UK income tax on those dividends, so if you are due to pay 7.5% dividend tax, you will pay nothing and if you are due to pay 32.5%, you will only have to pay 17.5%. Had you bought a european listed S&P 500 ETF, the ETF itself would be subject to 15% US dividend withholding tax and the dividends paid out will be subject to the full HMRC dividend tax without any deductions. That means the effective tax on US S&P 500 dividends will rise to 21.375% for basic rate tax payers (instead of 7.5%) and 57.375% (instead of 17.5%) for higher rate tax payers. Note that ITs/UTs and OEICs will also suffer these same losses.

ISA investors will not be affected as they cannot hold non-european listed funds, but SIPP holders are given a special status in paying zero dividend withholding tax on US listed ETFs and CEFs, so following the introduction of the new PRIIP KID rules, SIPP holders will lose this withholding tax saving.

I have received a message from Hargreaves Lansdown which explains how they are going to handle the new legislation. They have said that existing holdings of US listed ETFs and CEFs can be held and sold beyond 1 Jan 2018, but no new purchases made. With HL then, we have until the end of the year to still take advantage of the tax savings available. I have not yet heard how other brokers will be handling the new PRIIPs rules, which is somewhat surprising as I hold US listed ETFs at IG and DEGIRO.

[TedSwippet]

Thanks for the note. Ironically -- and for assorted sad and complicated reasons -- after Jan 1 next year will be the first time in a decade that I would personally be able to easily hold US domiciled ETFs. :-(

One other note... you did lose me in the maths here:

That means the effective tax on US S&P 500 dividends will rise to 21.375% for basic rate tax payers (instead of 7.5%) and 57.375% (instead of 17.5%) for higher rate tax payers.

I make this 42.625% (instead of 32.5%) for higher rate tax payers. That is, 32.5% of the 85% of dividends received, plus the 15% leakage to US tax internal to the fund or ETF.

[Lootman]

Some new european legislation, coming into force on 1 Jan 2018, is going to negatively impact anyone holding non-european collective investments, such as US listed ETFs or closed ended funds. The new regulation requires that issuers of certain types of investments, known as "Packaged Retail Investment and Insurance Products" ("PRIIPs), must publish a Key Information Document (KID) if they are available to private investors. US listed ETFs and CEFs will not be producing compliant KIDs, which means trading in these will be off limits to UK private investors from the end of this year.

I haven't seen these new rules but when you say a KID is necessary "if they are available to private investors", what does that really mean?

It might mean that a EU-domiciled broker cannot make a market in any security that doesn't have a KID. But I don't think it can mean that you as an individual cannot hold one, as HL appears to have told you. And I don't see how the rule can stop you buying one either, except insofar as you might need to buy through a broker outside of the EU (e.g. Switzerland, the UK (soon) or various non-European offshore centres). Or for that matter you might buy through a US broker if one will open an account for you.

In other words, isn't this restriction really for EU brokers and not EU individuals?

This mirrors a provision which the US has that forbids US residents from buying non-US funds. In that case, such funds are not allowed to market themselves in the US, and US brokers cannot make a market in them. But Americans still manage to buy and hold them via third party intermediaries.

There are also exceptions for so-called HNWI, "sophisticated" or "accredited" investors who self-certify as "understanding the risks":

"UK Sophisticated Investor – Qualified Investor – High Net Worth Investor. As a UK Sophisticated, High Net Worth, Qualified Investor,within the UK definitions of a sophisticated investor, the register is extremely important, especially for Unregulated Collective Investment Schemes where by the company can’t both market and sell to a sophisticated investor that they the fund certified. Having the persons go to a third party first for certification, such as the http://www.sophisticatedinvestorregister.com allows for the promoters of a UCIS to send their investors to register first through the “third party” and return with the certification to invest within the collective investment scheme. Therefore all firms working with UCIS projects should send their investors to the register to ensure they don’t fall foul of Artcile 23 PCIS Order. It is the responsibility of the provider and distributor to send them to this third party register to return to the investment scheme and make a placement."

https://www.isin.net/sophisticated-inve ... investors/

[hiriskpaul]

Thanks for the note. Ironically -- and for assorted sad and complicated reasons -- after Jan 1 next year will be the first time in a decade that I would personally be able to easily hold US domiciled ETFs.

One other note... you did lose me in the maths here:

That means the effective tax on US S&P 500 dividends will rise to 21.375% for basic rate tax payers (instead of 7.5%) and 57.375% (instead of 17.5%) for higher rate tax payers.

I make this 42.625% (instead of 32.5%) for higher rate tax payers. That is, 32.5% of the 85% of dividends received, plus the 15% leakage to US tax internal to the fund or ETF.

Yes quite right. 15% + 85%*32.5% = 42.625%. That's the sort of thing that happens with tax calculations after not sleeping on an economy night flight back from the Caribbean!

Big difference over the total 17.5% on holding a US listed ETF anyway.

[hiriskpaul]

Some new european legislation, coming into force on 1 Jan 2018, is going to negatively impact anyone holding non-european collective investments, such as US listed ETFs or closed ended funds. The new regulation requires that issuers of certain types of investments, known as "Packaged Retail Investment and Insurance Products" ("PRIIPs), must publish a Key Information Document (KID) if they are available to private investors. US listed ETFs and CEFs will not be producing compliant KIDs, which means trading in these will be off limits to UK private investors from the end of this year.

I haven't seen these new rules but when you say a KID is necessary "if they are available to private investors", what does that really mean?

It might mean that a EU-domiciled broker cannot make a market in any security that doesn't have a KID. But I don't think it can mean that you as an individual cannot hold one, as HL appears to have told you. And I don't see how the rule can stop you buying one either, except insofar as you might need to buy through a broker outside of the EU (e.g. Switzerland, the UK (soon) or various non-European offshore centres). Or for that matter you might buy through a US broker if one will open an account for you.

In other words, isn't this restriction really for EU brokers and not EU individuals?

This mirrors a provision which the US has that forbids US residents from buying non-US funds. In that case, such funds are not allowed to market themselves in the US, and US brokers cannot make a market in them. But Americans still manage to buy and hold them via third party intermediaries.

There are also exceptions for so-called HNWI, "sophisticated" or "accredited" investors who self-certify as "understanding the risks":

"UK Sophisticated Investor – Qualified Investor – High Net Worth Investor. As a UK Sophisticated, High Net Worth, Qualified Investor,within the UK definitions of a sophisticated investor, the register is extremely important, especially for Unregulated Collective Investment Schemes where by the company can’t both market and sell to a sophisticated investor that they the fund certified. Having the persons go to a third party first for certification, such as the http://www.sophisticatedinvestorregister.com allows for the promoters of a UCIS to send their investors to register first through the “third party” and return with the certification to invest within the collective investment scheme. Therefore all firms working with UCIS projects should send their investors to the register to ensure they don’t fall foul of Artcile 23 PCIS Order. It is the responsibility of the provider and distributor to send them to this third party register to return to the investment scheme and make a placement."

https://www.isin.net/sophisticated-inve ... investors/

Yes, the restriction is on EU brokers and possibly not all EU brokers. IG classify me as a professional investor rather than retail, so it may be possible for me to sidestep the restriction that way. I emailed them today to find out. I don't know yet whether HL cater for other types of investors other than normal retail, or if they do, whether they charge them more! The cheap retail brokers may not have the systems to cope with anything other than retail investors. I have checked with DEGIRO as well. DEGIRO offer futures and options trading, unusual for a European retail broker, so may allow some flexibility. I have my SIPP at HL, which is going to be a problem if they do not allow retail opt-out.

[TedSwippet]

Yes quite right. 15% + 85%*32.5% = 42.625% ... Big difference over the total 17.5% on holding a US listed ETF anyway.

If you are comparing the total 42.625% tax loss to the 17.5% previously paid to HMRC then this isn't a valid comparison. The former includes the US tax paid but the latter excludes it and so isn't really 'total'.

The total tax for a higher rate taxpayer on dividends paid through a US domiciled ETF is 32.5%, comprising 15% to the US and 32.5% - 15% = 17.5% to HMRC. On a non-US domiciled ETF the total tax for the same taxpayer is 42.625%. The payment to HMRC would come out to 27.625% of the gross dividend (that is, 32.5% of 85%). The net tax increase is 10.125%.

So worse, definitely. But the overall increase is not as bad as 42.625% - 17.5% = 25.125%.

[hiriskpaul]

You are of course quite right TedSwippet! And a basic rate taxpayer pays 15% TOTAL tax. I think I had better get some sleep.

[TedSwippet]

This mirrors a provision which the US has that forbids US residents from buying non-US funds. In that case, such funds are not allowed to market themselves in the US, and US brokers cannot make a market in them. But Americans still manage to buy and hold them via third party intermediaries.

Any that do will find themselves envying the dead when tax reckoning time comes around, thanks to horrific protectionist US tax provisions aimed squarely at US investors who hold non-US domiciled funds.

This sort of nonsense from the US makes the worst of the UK's tax rules for 'non-reporting' offshore funds look positively benign by comparison.

[Alaric]

How far are US ETFs prepared to go to meet European or British rules to enable their funds to be sold to non-US investors? I was thinking more about the tax rules surrounding distribution status. If you actually receive an income, as opposed to having it accumulated in the price, does that mean it's a distribution regardless?

[hiriskpaul]

How far are US ETFs prepared to go to meet European or British rules to enable their funds to be sold to non-US investors? I was thinking more about the tax rules surrounding distribution status. If you actually receive an income, as opposed to having it accumulated in the price, does that mean it's a distribution regardless?

The US ETF providers don't offer accumulation units. Some, e.g. Vanguard, do have HMRC reporting status, so UK holders don't end up paying income tax on capital gains.

[hiriskpaul]

iWeb/HSDL appear to have stopped offering US listed ETFs and closed ended funds now, apparently due to new regulations, but the person I was in contact with was not too clear on which regulations. Getting a straight and reliable answer out of iWeb/HSDL about something even slightly complicated is usually impossible anyway. I spoke to IG and they have said they will continue to offer US ETFs to retail investors. IG's interpretation is that US listed ETFs do not require KIDs! Be interesting to see how long that lasts. DEGIRO asked me to send in an email as this was too complicated for them to deal with over the phone - not heard back yet.

Anyway, I acted today to boost my US ETFs in my SIPP as I doubt HL will relent, except perhaps sometime after Brexit. I sold the remaining UK bank prefs I hold in my SIPP and doubled my holding of the Vanguard US REITs ETF (VNQ) - something I was intending to do in the new year. I also increased my position in the total US market ETF (VTI) after reducing it a couple of weeks ago and buying at IG. Would ideally like to buy more and reduce my unsheltered position, but there is nothing else I want to sell in my SIPP before the end of the year. Now have to LTBH them as I cannot buy back if I sell!

I can now really understand many people's frustrations over European regulations when faced with such mind numbing stupidity. No ban on brokers offering individual US shares, even though that is potentially far more risky than buying an ETF!

[Alaric]

No ban on brokers offering individual US shares, even though that is potentially far more risky than buying an ETF!

You might suspect there are those in the EU decision making process who would like to ban or severely restrict individual share ownership. That would, you might hope, be politically impossible. Instead they creep round the edges by putting up barriers, supposedly in the interests of investor protection. Investment Trusts of in the UK form have it seems escaped, perhaps for the time being.

I think I am right that a Dublin based ETF tracking a US Index would be available without quibble, subject to it dotting the i's and crossing the t's of a Key Features Document. If the same is demanded of the identically risky US offering, that's a protectionist barrier protecting the EU version.

[hiriskpaul]

No ban on brokers offering individual US shares, even though that is potentially far more risky than buying an ETF!

You might suspect there are those in the EU decision making process who would like to ban or severely restrict individual share ownership. That would, you might hope, be politically impossible. Instead they creep round the edges by putting up barriers, supposedly in the interests of investor protection. Investment Trusts of in the UK form have it seems escaped, perhaps for the time being.

I think I am right that a Dublin based ETF tracking a US Index would be available without quibble, subject to it dotting the i's and crossing the t's of a Key Features Document. If the same is demanded of the identically risky US offering, that's a protectionist barrier protecting the EU version.

Investment trusts have not escaped, they have to produce KIDs as well. I think I read somewhere that Irish UCITS ETFs do not have to produce KIDs for another 5 years, but that may have just been an early proposal. The investor protection regulations are nonsensical and do look a little protectionist to me as well, but there is nothing to stop US ETF providers from producing KIDs should they choose to. However, I suspect most are uninclined to do that as they can direct investors instead to their Irish domiciled ETFs which come with higher management fees! Vanguard US listed S&P 500 ETF 0.04%, Irish domiciled 0.07%.

[TedSwippet]

Vanguard US listed S&P 500 ETF 0.04%, Irish domiciled 0.07%.

While the Ireland version of this fund charges nearly TWICE what the US one charges(!), this would be £3/year on a £10,000 holding. I can't think of a single investing goal that could be derailed by that differential.

The people who look to me most likely to take a bath here are US citizens living in the UK. This would include any dual US/UK citizens, perhaps even US citizens who gained citizenship through a parent and perhaps have never even set foot in the US themselves. The US (and Eritrea) tax on citizenship as well as residency.

For Americans living in the UK, holding non-US domiciled funds or ETFs invites US tax treatment that can potentially consume 100% of their gains, a sort of US tax 'death sentence'. Up to now their primary way to sidestep this while staying within the UK's 'reporting funds' regime has been to invest using Vanguard's US domiciled yet UK 'reporting status' ETF range.

Now that EU brokerages will no longer carry US domiciled ETFs, and with US brokerages now starting to restrict or refuse service to individuals resident outside the US, these folks' options just got a whole lot narrower and more unpleasant.

[TedSwippet]

States bailed out banks, but the fundamental problems remain ... distancing the UK from explosive Euro risk.

Non-sequitur. None of these has any connection to the increasing US tax problems faced by Americans living abroad, nor visibly to PRIIP in general.

[ModernMicawber]

With HL then, we have until the end of the year to still take advantage of the tax savings available. I have not yet heard how other brokers will be handling the new PRIIPs rules, which is somewhat surprising as I hold US listed ETFs at IG and DEGIRO.

I hold US-listed ETFs in an AJ Bell SIPP; in fact they account for ~70% of portfolio by value, the single largest being VTI.

I intend to adopt an "ostrich" response for the time being; this change, if AJ Bell end up imposing it in the same way, is certainly rather an annoyance.

In my "defense", I have definitely filled in a "Complex Financial Instruments" form in the past, hopefully this will be enough to get me off the hook!

EDIT: Having thought about it, the SIPP will definitely be spending Christmas week looking down the back of the sofa for spare change to invest in VTI, "just in case"!

[hiriskpaul]

I had replies from HL and DEGIRO. HL currently do not support MIFID professional classification, so all their clients are retail. Shame as that would be an easy way out. They did hint that they might review this policy. DEGIRO have interpreted the new regulations in a strange way, linked to the language used in the ETF's documentation. If English language documentation is available, they will allow UK customers to trade the ETF, wherever it happens to be listed. If not, UK customers are barred from trading. I will have a play tomorrow to see what has actually been implemented.

What a mess. I don't know which broker is right, but I have found that HL are often very conservative when it comes to regulations. Any slightly grey areas and you cannot trade. For example, they insist on a W8-BEN if you trade US securities in a SIPP, but other brokers such as AJ Bell say this is not necessary. They have never let me trade certain US preferred shares (bank preferreds) in a SIPP either because they are unhappy about some obscure detail/ambiguity in the prospectuses.

[JMN2]

...DEGIRO have interpreted the new regulations in a strange way, linked to the language used in the ETF's documentation. If English language documentation is available, they will allow UK customers to trade the ETF, wherever it happens to be listed. If not, UK customers are barred from trading. I will have a play tomorrow to see what has actually been implemented...

In Finland (and possibly in Sweden too) both the brokers and the local regulator have interpreted similarly - if the documentation is translated into Finnish then all is OK.

[Alaric]

DEGIRO have interpreted the new regulations in a strange way, linked to the language used in the ETF's documentation. If English language documentation is available, they will allow UK customers to trade the ETF, wherever it happens to be listed.

Are they saying that if essentially the same ETF is listed in both Dublin and New York, that you can buy the New York version on the basis of the Dublin Key Features? That's very pragmatic if true.

[hiriskpaul]

DEGIRO have interpreted the new regulations in a strange way, linked to the language used in the ETF's documentation. If English language documentation is available, they will allow UK customers to trade the ETF, wherever it happens to be listed.

Are they saying that if essentially the same ETF is listed in both Dublin and New York, that you can buy the New York version on the basis of the Dublin Key Features? That's very pragmatic if true.

No, that would be a different product. Curiously I cannot locate any US listed ETFs on DEGIRO now, even if I use the ISIN. However, I have a few in my Favourites list and they are still tradeable! Undoubtedly a loophole.

True to their word, HL will not allow me to buy more US listed ETFs and output this message on the trade screen:

By law certain stocks must have a Key Investor Information Document / Key Information Document available before investors can purchase them. The party responsible for publishing the documents have not made them available to Hargreaves Lansdown for this stock and so it cannot be purchased. We apologise for any inconvenience caused.

Trading seems to be business as usual at IG.