Withholding tax on US Mutual Funds for UAE investor

For residents of the United Arab Emirates.
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Topic Author
chrismues
Posts: 17
Joined: Mon Nov 05, 2018 11:56 pm

Withholding tax on US Mutual Funds for UAE investor

Post by chrismues »

Hi, I read through a number of posts but didn't find any that addressed the same question - so apologies if I missed that.

I am German citizen, living in the UAE and am considering opening an account with Interactive Brokers in the US. I am only interested in investing in Mutual Funds, and potentially ETFs. I would like to understand the tax implications, as I have found conflicting information.

Assuming I invest in an US mutual fund, I understand that for UAE investors, since there is no treaty with the US, 30% withholding tax applies on distributions from the MF, which may be due to dividends received from the underlyings in the fund, or from the MF selling an underlying (source: https://www.gsam.com/content/dam/gsam/p ... ?sa=n&rd=n - section B4). However, I found a presentation from IB saying that (a) "Long – term and short term capital gain distributions from mutual funds – also reportable but not subject to withholding", and (b) "Gains (losses) on securities trading – not reportable" (source: https://www.interactivebrokers.com/webi ... tomers.pdf - p15). My questions are:

1) As long as I hold a stake in a US based MF, would distributions received from the fund be subject to withholding tax?
2) Once I sell my stake in the US based fund, say 5-10 years down the line, will the sales proceeds be subject to withholding tax?
3) If I buy, through my account with Interactive Brokers in the US, a stake in a non-US based MF, will the outcome of 1) and 2) above change?

Many thanks
TedSwippet
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Joined: Mon Jun 04, 2007 4:19 pm
Location: UK

Re: Withholding tax on US Mutual Funds for UAE investor

Post by TedSwippet »

chrismues wrote: Tue Nov 06, 2018 12:59 am1) As long as I hold a stake in a US based MF, would distributions received from the fund be subject to withholding tax?
If you do this -- and it will be better for you if you do not -- 30% withholding and US tax liability on dividends. No withholding on capital gains or interest. Be aware, though, that the US can apply an estate tax of up to 40% of your total holdings above $60k if you die while holding 'US situs' assets. US domiciled funds and ETFs are 'US situs'.

You can effectively reduce this 30% US tax rate on dividends to between 15% and 0% (depending on the underlying assets) and entirely escape the threat of conficatory US estate tax if you use non-US domiciled funds or ETFs instead of the ones most commonly discussed by US investors on this site. US domiciled funds and ETFs can be horrible US tax traps for US nonresidents.
chrismues wrote: Tue Nov 06, 2018 12:59 am2) Once I sell my stake in the US based fund, say 5-10 years down the line, will the sales proceeds be subject to withholding tax?
Generally, no. There is a potential FATCA withholding of 30% of 'gross sale proceeds', but the IRS has been pushing implementation of that out for over eight years now, so it probably won't be an issue. In any case, unlike the 30% of dividends which is both your withholding and your actual US tax liability, any FATCA withholding should be recoverable with the right paperwork (this one is withholding but not actual US tax liability).
chrismues wrote: Tue Nov 06, 2018 12:59 am3) If I buy, through my account with Interactive Brokers in the US, a stake in a non-US based MF, will the outcome of 1) and 2) above change?
Yes. As already mentioned, you significantly reduce your US tax bill and you also escape the threat of US estate tax and any future FATCA withholding nonsense. Win, win, win. For you, this is the better way forwards.

A slight US estate tax threat remains. Any cash holding above $60k in a US broker is at risk of US estate taxes. The simplest solution here is to not hold large cash balances in a US broker (and be sure not to die just before purchase, just after sale, or when rebalancing).

See also: answers posted to your other thread.
ICH
Posts: 244
Joined: Wed Jun 13, 2018 3:08 am

Re: Withholding tax on US Mutual Funds for UAE investor

Post by ICH »

chrismues,

With regards to taxes, you will always find conflicting information, because it is generally a complicated matter and tax laws change. But for what you are asking, things are clear:
- Do not buy US domiciled funds (Mutual Funds or ETFs).
- As an expat in the UAE, you are limited to ETFs. Buying into Mutual Funds is possible but carries excessive brokerage costs and not all brokers provide them.

Apart from the estate tax, you can see the effect of tax withholding here: https://www.bogleheads.org/wiki/Nonresi ... Irish_ETFs

Vanguard Total World Stock ETF (VT) domiciled in the US is having an Expense Ratio of 0.17% (currently it is 0.10%).
Vanguard FTSE All-World UCITS ETF (VWRL) which is for all practical purposes the same fund but domiciled in Ireland is having an Expense Ratio of 0.25%
Seems like a no-brainer to go for VT and actually lots of people fall for it.

But if you add the effect of tax withholding, the actual total cost becomes:
VT-> 0.77%
VWRL-> 0.46%

What is confusing as an expat in the UAE, where you don't have income tax, is what happens after you leave and go back home or to any other country.
How will the new country tax your investments?
Can you keep the same ETFs or will you need to liquidate before going there and buy again once you are there (to rest your basis)?
Above depend on the country you will be going to and you don't need to overthink it at the moment. As soon as you take the decision to move, you can decide then.
Topic Author
chrismues
Posts: 17
Joined: Mon Nov 05, 2018 11:56 pm

Re: Withholding tax on US Mutual Funds for UAE investor

Post by chrismues »

Thanks all,

Understood, and I set up a excel calculator in line with the thread you pointed out (NRA w/o US tax treaty) to calculate the actual TWR, so that's super helpful.

Few more questions if I may:
- I have not spent much time one ETFs, but thought that in terms of performance they also mainly track the indices, ie they may have a long term return of 8-9%, but they do generally not have much higher returns (vs some of the well performing MFs that manage to achieve 13-15%). Is that correct?
- I have zoned in on a few MFs through research on Morningstar. Do you know if the annualized returns over say a 10yr period that being stated there, do they include the dividend yield, i.e. if the 10yr ann. return is 13% and dividend yield is 2%, would the ann. return purely on price appreciation be 11%?
- How do I find MFs/ETFs base din Ireland? If I look on Morningstar UK, you can only look for UK based, or offshore - but offshore may include non-Ireland based funds? Same issue on Morningstar US.
- On the platforms you mentioned) IB, Internaxx, Swissquote (I am also considering currently Schwab International, any views?), are you aware if I can specifically search for Ireland based funds, or do I need to go through the prospectus everytime I am interested in a fund?

Many thanks
TedSwippet
Posts: 5166
Joined: Mon Jun 04, 2007 4:19 pm
Location: UK

Re: Withholding tax on US Mutual Funds for UAE investor

Post by TedSwippet »

chrismues wrote: Wed Nov 07, 2018 2:12 am- I have not spent much time one ETFs, but thought that in terms of performance they also mainly track the indices, ie they may have a long term return of 8-9%, but they do generally not have much higher returns (vs some of the well performing MFs that manage to achieve 13-15%). Is that correct?
A passive tracker mutual fund and a passive tracker ETF that both track the same index will produce the same investor returns, because they contain the same underlying assets. (So much so that Vanguard US treats its ETFs as just another 'share class' of its mutual funds, and US investors can switch seamlessly from mutual fund holdings to equivalent ETF holdings.)

An actively managed mutual fund can beat its index benchmark. However, for each that beats its benchmark there will be one that under-performs by the same amount. And it will be difficult, likely impossible, to identify the winners ahead of time. Active fund management is not what this site focuses on.
chrismues wrote: Wed Nov 07, 2018 2:12 am- How do I find MFs/ETFs base din Ireland? If I look on Morningstar UK, you can only look for UK based, or offshore - but offshore may include non-Ireland based funds? Same issue on Morningstar US.
This ETF screener allows you to search for ETFs by selected criteria, one of which is 'Fund Domicile'.
ICH
Posts: 244
Joined: Wed Jun 13, 2018 3:08 am

Re: Withholding tax on US Mutual Funds for UAE investor

Post by ICH »

I don't get it.
How do you intend to buy Mutual Funds from the UAE?
I know some ways:
1. Through the banks: stay away - bad fund selection and charges are horrible.
2. Through the whole life insurance thing and its variations, sold widely in the UAE: stay away - it's the best way to lose money
3. Through some of the discount brokers: fund selection is limited and charges are also horrible.
4. Through the very-very few solid investment companies: fund selection is also limited - charges are horrible (there is a new robo-advisor based in the UAE which seems legit, but still charges are high).
5. Through open architecture online broker platforms: selection is OK - charges are way too horrible.

DO NOT USE THESE VEHICLES! THEY ARE EXPENSIVE. That's why we buy ETFs through online discount brokers.

For the rest of your questions:
- An ETF tracking an index will have substantially the same performance with an index mutual fund that tracks the same index, before costs.
- I assume you are looking at active mutual funds on Morningstar. You are looking at past returns. Guess what: they are not guaranteed to continue into the future. If nothing else, if an active fund has outperformed the index for a number of years, it is quite possible that it will underperform during the coming years. It is better to compare costs, instead of returns, because you will be paying these for sure.
- To find ETFs domiciled in Ireland use justETF.com. Once you finish searching (take your time and make an investing plan first), I suggest to buy one world stock and one world bond ETF. You don't need to buy a bunch.
- Schwab International has high fees for me. Did you compare the fees you 'll be paying? I forgot to mention Saxo, which is a good option also.
- If you plan to invest, you need to go through the prospectus of the 2-3 ETFs you want to invest in. If nothing else, to understand what you 're investing in.
- If you 're planning to buy-sell as a game, no need to waste your time with the prospectus. If you were a professional that could have some chances (although very limited chances) of buying the funds that will outperform in the future, you wouldn't be asking these questions.
Topic Author
chrismues
Posts: 17
Joined: Mon Nov 05, 2018 11:56 pm

Re: Withholding tax on US Mutual Funds for UAE investor

Post by chrismues »

Thanks for the link to justETF.com, that is very helpful.

I have a decent view of the drivers that influence markets: macros, liquidity flows, credits, risks (business, sector, political, geographical, others), sentiment, etc. I also have a fairly good view of how funds and ETF s operate, my question was more to ensure that there is nothing I have missed. And there isn't, which I am glad about. What I did not know much about is the tax implications (you guys helped a lot, thanks), and indeed the cost structure (doing my research).

You are right that past returns do not guarantee future returns. But in absence of a crystal ball, past performance is certainly one aspect in how you select an instrument you want to invest in (I don't know anyone who disregards past performance, even pure algo-based hedge funds use past performance, even if it is only to calculate correlation to certain other drivers). But in the end you are right - your best guess on future performance is as good as mine, or anyone's. But as long as you have a decent grip on what your cost base is going to be (your sunk costs once you have invested; which I am establishing with the help of you guys), you can then find out what returns your MF/ETF needs to make for you to get your target return. You are right that ETFs reduce the risk of underperformance vs the respective index, but it also reduces the chance to outperform. So in the end, it is just for you to find the right instrument that matches your risk/return profile

Re Saxo - after a certain min. account value, other platforms are cheaper than Saxo. I will not do many trades, I am planning to buy/hold. Schwab has no custody/account management fees for the amount I am looking at. Neither has IB.

Re Bogleheads® investment philosophy - I completely agree.
TedSwippet
Posts: 5166
Joined: Mon Jun 04, 2007 4:19 pm
Location: UK

Re: Withholding tax on US Mutual Funds for UAE investor

Post by TedSwippet »

chrismues wrote: Wed Nov 07, 2018 5:41 amThanks for the link to justETF.com, that is very helpful.
If you haven't already stumbled onto them, these model portfolios might be a decent starting point for you to work from. Simple, clean, cheap, efficient, and free of unwelcome and expensive US tax entanglements:

EU investing - Accumulating/capitalizing vs. distributing ETF share classes

Although listed in the 'EU investing' part of the wiki, they are equally applicable to anyone living in a country without any US tax treaties. And because they are composed of UCITS ETFs, they should also be little or no trouble for you if you were to return to Germany or Europe but continue holding them. As a resident of a country with no income tax, the accumulating/distributing distinction currently comes down to just preference and convenience.
ICH
Posts: 244
Joined: Wed Jun 13, 2018 3:08 am

Re: Withholding tax on US Mutual Funds for UAE investor

Post by ICH »

Fair enough, but again:
How do you intend to buy Mutual Funds from the UAE?

I did some research some time back on buying (index) MFs instead of ETFs, but the sunk cost was excessive. And you're not going to find Vanguard MFs easily (or anything with ER less than 1.5% for that matter :happy ) If you find anything interesting feel free to inform.

By the way, there is a range of factor ETFs for the active players. Have a look.

Good Luck
Topic Author
chrismues
Posts: 17
Joined: Mon Nov 05, 2018 11:56 pm

Re: Withholding tax on US Mutual Funds for UAE investor

Post by chrismues »

Schwab International - their account for NRAs - offers access to 106 offshore MFs.
Internaxx provides access to 600+ MFs and about 350 or so have a ER of 1.1% or less (as low as 0.15%)
Swissquote offers around 3,000 funds at ER of 1% or less

Now, not all of these may be offshore/non-US, so you may not be able to invest in all of them (@ICH - I believe you are right that I cannot invest into US registered/based MFs), but unless I am missing something, generally investing in MFs from the UAE I don't see a problem in.

OK, so I may change my mind and sway towards the broad based ETFs. Reading an interesting book: single female investors beat single males, married males beat single males, but even married males don't beat single females... because males just think they know it all... so I may succumb and just let the market do its magic.

Question 1: if I buy, say a S&P 500 ETF, traded on LSE or in Ireland, I guess I the only additional costs I have on top of the ER is the 15% withholding tax when the underlying shares pay dividends to the ETF (plus brokerage costs, lets leave that our for now)?

Question 2: assume I set up an account with Interactive Brokers - which is an US registered broker and the account will be in the US in USD, but they have an amazing access to 28 markets and a wide array of ETFs and offshore MFs: if I invest $100k with such IB broker account in the US in the same S&P 500 ETF that is traded on LSE or in Ireland, and I die, will the investment be subject to US estate tax > $60k because the account is in the US, or will it not be, because the ETF is traded in LSE/Ireland?

Many thanks
ICH
Posts: 244
Joined: Wed Jun 13, 2018 3:08 am

Re: Withholding tax on US Mutual Funds for UAE investor

Post by ICH »

chrismues wrote: Thu Nov 15, 2018 11:02 am Schwab International - their account for NRAs - offers access to 106 offshore MFs.
Internaxx provides access to 600+ MFs and about 350 or so have a ER of 1.1% or less (as low as 0.15%)
Swissquote offers around 3,000 funds at ER of 1% or less

Now, not all of these may be offshore/non-US, so you may not be able to invest in all of them (@ICH - I believe you are right that I cannot invest into US registered/based MFs), but unless I am missing something, generally investing in MFs from the UAE I don't see a problem in.
As I wrote already, you can invest in MF from the UAE. I gave 5 options that I know off. The problem with all of them is that you 're not investing directly to the MF; you're doing it through an intermediary, thus adding one more layer of costs (and of course risk). If we were leaving in the UK for example, we would not go to a broker to buy Vanguard MFs; we would go to Vanguard directly!

You can give it a shot with the online brokers if you wish. For me, I checked the costs and variety some time back, and they 're simply not for my style.

Note that there are some serious investment companies with offices in the UAE (Fidelity, State Street, etc), but they give access to their MFs only to institutional investments at the moment.
chrismues wrote: Thu Nov 15, 2018 11:02 am Question 1: if I buy, say a S&P 500 ETF, traded on LSE or in Ireland, I guess I the only additional costs I have on top of the ER is the 15% withholding tax when the underlying shares pay dividends to the ETF (plus brokerage costs, lets leave that our for now)?
If you buy an S&P500 ETF domiciled in the US, everytime the fund distributed a dividend, you will receive the dividend minus 30% withholding tax. You will see this in your broker's statement. Say dividend was 100USD, you will see something like this:
- Dividend = 100USD
- Withholding tax = 30USD
- Amount received in the account = 70USD

If you buy an S&P500 ETF domiciled outside US (typically Ireland), everytime the fund distributed a dividend, there will be withholding tax of 15%, but you will not see it separately, because it is internal between fund and US government. So for the same example as above, you will see only:
- Amount received in the account = 85USD

Check the wiki: https://www.bogleheads.org/wiki/Nonresi ... Irish_ETFs

chrismues wrote: Thu Nov 15, 2018 11:02 am Question 2: assume I set up an account with Interactive Brokers - which is an US registered broker and the account will be in the US in USD, but they have an amazing access to 28 markets and a wide array of ETFs and offshore MFs: if I invest $100k with such IB broker account in the US in the same S&P 500 ETF that is traded on LSE or in Ireland, and I die, will the investment be subject to US estate tax > $60k because the account is in the US, or will it not be, because the ETF is traded in LSE/Ireland?
Estate tax applies for funds domiciled in the US and cash in your brokerage account. If you hold non-US domiciled funds, no issue. If you keep less than 60k USD cash in your account, no issue. Why do you think everybody invests in Ireland domiciled ETFs? The other popular option is Luxembourg domiciled funds, but they are not tax efficient if they are holding US domiciled securities.

P.S. Have a chat with AES and Sarwa to see what they 're offering. These are the only 2 serious investment companies that I know off in the UAE and they will not push you into money losing practices at least. Join the local bogleheads group to see different opinions and practices: https://www.simplyfi.org/
ICH
Posts: 244
Joined: Wed Jun 13, 2018 3:08 am

Re: Withholding tax on US Mutual Funds for UAE investor

Post by ICH »

chrismues wrote: Thu Nov 15, 2018 11:02 am Schwab International - their account for NRAs - offers access to 106 offshore MFs.
Internaxx provides access to 600+ MFs and about 350 or so have a ER of 1.1% or less (as low as 0.15%)
Swissquote offers around 3,000 funds at ER of 1% or less

Now, not all of these may be offshore/non-US, so you may not be able to invest in all of them (@ICH - I believe you are right that I cannot invest into US registered/based MFs), but unless I am missing something, generally investing in MFs from the UAE I don't see a problem in.
As I wrote already, you can invest in MF from the UAE. I gave 5 options that I know off. The problem with all of them is that you 're not investing directly to the MF; you're doing it through an intermediary, thus adding one more layer of costs (and of course risk). If we were leaving in the UK for example, we would not go to a broker to buy Vanguard MFs; we would go to Vanguard directly!

You can give it a shot with the online brokers if you wish. For me, I checked the costs and variety some time back, and they 're simply not for my style.

Note that there are some serious investment companies with offices in the UAE (Fidelity, State Street, etc), but they give access to their MFs only to institutional investors at the moment.
chrismues wrote: Thu Nov 15, 2018 11:02 am Question 1: if I buy, say a S&P 500 ETF, traded on LSE or in Ireland, I guess I the only additional costs I have on top of the ER is the 15% withholding tax when the underlying shares pay dividends to the ETF (plus brokerage costs, lets leave that our for now)?
If you buy an S&P500 ETF domiciled in the US, everytime the fund distributed a dividend, you will receive the dividend minus 30% withholding tax. You will see this in your broker's statement. Say dividend was 100USD, you will see something like this:
- Dividend = 100USD
- Withholding tax = 30USD
- Amount received in the account = 70USD

If you buy an S&P500 ETF domiciled outside US (typically Ireland), everytime the fund distributed a dividend, there will be withholding tax of 15%, but you will not see it separately, because it is internal between fund and US government. So for the same example as above, you will see only:
- Amount received in the account = 85USD

Check the wiki: https://www.bogleheads.org/wiki/Nonresi ... Irish_ETFs

chrismues wrote: Thu Nov 15, 2018 11:02 am Question 2: assume I set up an account with Interactive Brokers - which is an US registered broker and the account will be in the US in USD, but they have an amazing access to 28 markets and a wide array of ETFs and offshore MFs: if I invest $100k with such IB broker account in the US in the same S&P 500 ETF that is traded on LSE or in Ireland, and I die, will the investment be subject to US estate tax > $60k because the account is in the US, or will it not be, because the ETF is traded in LSE/Ireland?
Estate tax applies for funds domiciled in the US and cash in your brokerage account. If you hold non-US domiciled funds, no issue. If you keep less than 60k USD cash in your account, no issue. Why do you think everybody invests in Ireland domiciled ETFs? The other popular option is Luxembourg domiciled funds, but they are not tax efficient if they are holding US domiciled securities.

P.S. Have a chat with AES and Sarwa to see what they 're offering. These are the only 2 serious investment companies that I know off in the UAE and they will not push you into money losing practices at least. Join the local bogleheads group to see different opinions and practices: https://www.simplyfi.org/
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