JacobsReport
on International Financial Planning

The JacobsReport is a free email newsletter that will discuss investment, business, tax and financial planning in an international context. Reports will be issued as the author's work schedule permits, but will usually be issued on a weekly schedule.

Offshore Variable Annuities and
Foreign Mutual Funds

The following is an extensive question about offshore variable annuties and passive foreign investment companies (i.e., mutual funds) with a fairly extensive response. Instead of posting this entire discussion in the Jacobs Report, I have referred interested members of the group to this web page.  Vern Jacobs

QUESTION:  I am a Finnish asset manager and at the moment I am running the retirement fund of Finnish ice hockey players.
 
A while ago I started to collect information to decide if establishing an asset manager service to small niche segment of Finnish NHL-players would make sense. Now I  face some tax challenges because the players are considered as US persons and are taxed in U.S.
 
As you probably already know, almost all the European mutual funds, ETFs, and other similar structures have added disclaimers to their products such as the following:
 
1.        The Company has not been and will not be registered under the Investment Company Act of 1940 of the United States and the Participating Shares have not been and will not be registered under the Securities Act of 1933 of the United States (as amended) (the 1933 Act) or the securities laws of any State of the United States.
 
The Participating Shares may not be directly or indirectly offered, sold or delivered to any person in the United States or to or for the account or benefit of any US Person (as defined herein) except pursuant to an exemption from, or in a transaction not subject to, the registration requirements of the 1933 Act and any applicable State laws. Applicants for Participating Shares will be required to declare that they are not a US Person and are not applying for Shares on behalf of any US Person.
 
On the tax side I have faced PFIC problem which would make investing to European listed products heavily taxed (and those who haven’t added U.S person disclaimers to their products either don’t know yet or they will do it in the near future):
 
2.       Passive Foreign Investment Companies legislation
 
It seems that offshore variable annuities could be one choice to solve both problems. It would allow me much better freedom of choice with the instruments with which I am familiar. I read your advertisement from http://www.offshorepress.com/osva-info.htm and your guide seemed interesting and an efficient way for me to get additional information regarding offshore variable annuities.
 
Although I have couple questions regarding your guide:
 
1.       As you mention below, U.S legislation is under constant change and your guide is approximately 6 years old. I wonder if you have updated your guide or how valid is the information in your guide at the moment (and if not do you know where could I get updated general information easily and assuredly)? 

The U.S. tax laws are in a constant state of change due to new laws enacted by Congress, new or revised regulations or rulings issued by the IRS, and new court cases. The information in this report was current -- to the author's knowledge -- as of December 31, 2000.
 
One of the most common incentives to invest in a variable annuity was to be able to invest the annuity assets into stocks rather than fixed income investments. Until the 2003 tax law, that was a pretty good reason.

But the 2003 tax law reduced the top tax rate on qualified dividend income and long term capital gains to 15%. Income distributions from an annuity will be taxed as ordinary income and subject to tax rates of up to 35%. Investing annuity assets in stocks or other long term gain assets may result in having to pay a higher tax rate because of the annuity.

My report on offshore variable annuities was written before the 2003 tax law and does not discuss this issue.

 
2.       Is it possible to purchase your guide online as an e-book without becoming a subscriber?
3.       Or how much does the shipping of paper version cost and how long will it approximately take?
4.       Does the Offshore annuity guide include to Offshore Tax Strategies e-book edition?

 
REPLY:  I’ll respond first to the 4 questions at the end of your memo.

1. The Guide to Offshore Variable Annuities has not been updated because I’ve been working on updating the Controlled Foreign Corporation Tax Guide, the book on Legal Ways to Save Taxes Offshore and Onshore and the book on Offshore Tax Strategies. And, because of the reduced tax rates on long term gains and qualified dividend income, annuities have lost their appeal as a way to defer taxes. Except for the implications of the reduced tax rates on long term gains and dividends and the fact that I have not attempted to verify whether the list of vendors is current, the information in the guide is still accurate. As for whether there are any other more current guides available, I doubt it, but I have not made an intensive search for a competing product.
2. The offshore annuity tax guide is not currently available as an e-book except for our subscribers. But if you want to purchase an e-book version, place an order for the discounted printed version ($33.00) for subscribers and I will send you a copy via email even though you are not a subscriber. (See http://offshorepress.stores.yahoo.net/guidtoofan.html )
3. The price of the printed copy includes shipping in the U.S. but I recommend getting an e-book version as described above for international orders.
4. The book on Offshore Tax Strategies is a comprehensive over-view of how the U.S. tax law affects U.S. companies and individuals who have offshore investments or businesses. It includes a brief description of the tax treatment of foreign annuities.  The Offshore Annuity Guide is 56 pages and provides a lot more detail and background. However, the Offshore Tax Strategies book includes information about PFICs, whereas the annuity guide does not.

Your question about using a variable annuity as a way to avoid the onerous tax treatment of gains from passive foreign investment companies (PFICs) is one that I should have included in the variable annuity guide. It’s a good idea and it gives me a reason to consider spending the time to update that guide. So long as the investments are being managed by someone other than the policyholder, it seems like a reasonable way to deal with foreign mutual funds.  

You state at the beginning of your letter that you are “running the retirement fund” of Finnish hockey players who are U.S. citizens. If it is a tax qualified retirement fund (under U.S. tax law), it should not be necessary to use an offshore annuity to invest in foreign mutual funds. As far as I can tell, the PFIC tax on excess distributions does not apply to tax exempt entities like tax qualified retirement plans. 

You also mention that you would be investing in “European listed products”. By listed, I presume you mean being listed on a securities market. If foreign mutual funds are listed on a national securities market similar to the NYSE and ASE or NASDAQ, the fund owners may be eligible to elect to use the mark-to-market method of reporting income from PFICs. Any increase in value from year to year is simply reported as ordinary income. 

The disclaimer you quoted by one of the foreign mutual funds appears to be over-kill with respect to the purchase of shares “on behalf of any U.S. person”. The U.S. tax rules do not prohibit the purchase of foreign fund shares by U.S. persons. The SEC prohibits the sale of unregistered securities to U.S. persons in the U.S.. But their regulations include an exception (Regulation S) for the purchase of unregistered foreign securities by U.S. persons who are physically outside the U.S. at the time of the transaction.  A number of foreign security vendors have taken the position that they will not sell directly to a U.S. person (individual or entity) but they will sell foreign unregistered securities to a non U.S. corporation. This can cause tax problems for the U.S. owners of that foreign corporation unless they make an election to have the corporation taxed as a foreign disregarded entity. 

Please note that the information in this web page is not intended to constitute advice on what you should do. It is intended to serve as a public discussion of the issues you have raised, but you will need to consult with a qualified tax professional for any advice.