How foreign ETFs can double your tax bill on returns

If you’re tempted to invest in some of the trendy ETFs sprouting up from across the Atlantic that support, say, the backers of the Republican Party or profits from the obesity epidemic, beware the tax treatment on gains first. 

It could cost you more than double compared to backing a UK-based fund.

This is because not all ETFs listed in the US and in other overseas territories are HMRC approved.

Thematic ETFs that profit from the obesity epidemic are listed in the US but UK investors can pile into the propositions if they so choose

This means they can’t be held in the tax-efficient Isa wrapper and gains might not be taxed as capital growth but as income – which applies a greater levy that could potentially nullify investment returns when fund fees are factored in.

There are other considerations too. 

Investment in ETFs that aren’t listed in the UK could be subject other taxes imposed by the country where the product is domiciled.

What’s more, currency risk – the potential risk of loss from fluctuating foreign exchange rates – applies as ETFs are seldom denominated in sterling. 

However, in recent history, the fall in the value of the pound against the dollar post Brexit has propped up the returns of US listed ETFs for UK investors.  

Of course for some investors, buying an ETF aligned with their personal beliefs and convictions is worth paying a pretty penny for. But investing in ETFs listed overseas is a technical minefield, and you should do your research before doing so.

We asked Oliver Smith, portfolio manager at IG, to shed some more light on the main considerations. Here’s what he had to say. 

For an ETF to qualify for regular UK tax treatment it must be HMRC approved. Your investment platform should only allow you to buy HMRC approved investments in your Isa and Sipp but if you are in doubt, HMRC keeps an updated list here.

Oliver Smith of IG says UK investors should buy UK-listed ETFs where possible

Oliver Smith of IG says UK investors should buy UK-listed ETFs where possible

If an offshore fund has obtained UK reporting status from HMRC, any gains will be taxed at your applicable Capital Gains Tax (CGT) rate. 

If the ETF is not authorised, your realised gains face the prospect of being taxed at your prevailing income tax rate. With UK income tax rates as high as 45 per cent, compared to existing CGT of just 20 per cent, this can make a significant dent in your returns.

Investors in overseas ETFs also open themselves up to paying local taxes. For example, under US tax rules a 30 per cent withholding tax is applied to dividends made to foreign persons. 

Ordinarily you will not be able to claim this back, meaning you should always consult a tax specialist if you are considering making a large investment that is not UK listed. 

It’s important to remember that overseas investments do carry additional risk. The most important of those is currency risk.

Over the past three years, UK holders of overseas equities have benefited from currency appreciation – with the pound losing 20 per cent against the Euro since the summer of 2015.

Even if an ETF is denominated in pounds sterling, you will still have exposure to foreign currency fluctuations. The only way to reduce this is to buy currency hedged vehicles. For example, the iShares MSCI Europe ex UK GBP Hedged ETF (EUXS) will protect against a strengthening pound.

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We all focus on the costs of trading, but foreign exchange charges to buy stocks and ETFs from overseas are often forgotten. 

With some of the most popular platforms charging up to 1.5 per cent to convert pounds into euros or dollars, it is worth looking around for a lower-cost provider.

Overall, UK investors are very well catered for by the ETF providers, and only in very niche areas is there no overlap with overseas listed products. Consequently, we advise UK investors to buy UK listed ETFs where possible.

The majority of UK listed ETFs are actually domiciled in Dublin, which is important as Ireland has a dual tax treaty with the US. This means ETFs that invest in the US can slightly outperform the index they follow. 

Vanguard, iShares and SPDR, to name just three providers, all offer ETFs tracking the S&P 500 that perform better than the net return index. 


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