Taxation of Foreign Stock Gains/Losses By Vernon K. Jacobs, CPA  & J. Richard Duke, J.D., LLM

If U.S. taxpayers make a direct purchase of the stock of a foreign corporation, the stock is subject to tax on any gains or losses and on any dividends the same as with a domestic stock purchase. The problem is that it's very difficult for a U.S. taxpayer to do that because the U.S. Securities and Exchange commission regulates the sale of securities to U.S. persons. Thus, the U.S. taxpayer has to leave the U.S. and go to another country in order to make these purchases. Even then, most non-U.S. institutions won't sell a foreign security directly to a U.S. person. In some cases, a non-U.S. bank will agree to function as an agent to make such transactions, but usually only for investors with substantial accounts.

Therefore, the U.S. investor who wishes to have direct access to foreign stocks or bonds must form an intermediate entity such as a trust or corporation domciled outside the U.S. The problem is that a foreign trust is subject to some information reporting that adds substantially to the expense both in terms of setting up the entity and in the annual fees to maintain it.

If the U.S. investor resorts to the use of a foreign corporation (or IBC), the investor will incur some formation costs and some annual fees as well as annual accounting services. The U.S. investor in a foreign corporation that is used to purchase investments is likely to be subject to the onerous controlled foreign corporation rules, the foreign personal holding company rules and the passive foreign investment company rules. All of these entail substantial expense and adverse tax consequences.

Another option is to form a foreign partnership or a limited liability company that elects to be taxed like a partnership. However, to do this, the investor usually needs to be willing to have a partner - although a spouse or adult child could be the partner. While the foreign partnership is subject to less onerous reporting requirements than a foreign corporation or foreign trust, it does add a layer of extra cost and complexity on the simple process of buying foreign stocks.

In some cases, it might be possible to structure a foreign (non U.S.) LLC as a single owner LLC that elects to be taxed as a proprietorship (referred to as a "disregarded entity). This would provide the least amount of cost and added complexity to the process of developing an international portfolio.

The U.S. investor who buys a U.S. mutual fund is conditioned to pay taxes each year on the gains and the income of the fund - in proportion to his shares of the fund. Doing this with an offshore fund is not nearly as simple. Generally, a U.S. investor with a modest portfolio should either buy foreign stocks through a U.S. mutual fund or should seek to find some way to purchase foreign stocks directly rather than through a foreign mutual fund, investment company or unit investment trust. Another option is to buy shares of U.S. companies with extensive business interests outside the U.S., or to buy shares of foreign companies that are listed on one of the U.S. stock exchanges.

 A non-U.S. investor who buys shares of a U.S. domestic corporation enjoys tax free gains on the sale of the stock. Such gains are not subject to U.S. income taxes. However, dividends paid by U.S. companies on debt obbligations is subject to a withholding tax, which is usually 30% unless modified by a treaty with the investor's own country.
 
 

About the authors: Vernon Jacobs is a CPA who provides tax accounting and consulting services for clients with international interests.   J. Richard Duke, JD, LLM is an attorney who specializes in international tax law and is an Adjunct Professor of international tax law. Sponsored by Offshore Press, Inc. Copyright, 2006, All rights reserved. Offshore Press, Inc., Box 8194, Prairie Village, KS 66208. (913) 362-9667. Email to Offshore Press  Vernon K. Jacobs, Webauthor