Maybe your initial reaction is that there is no impact on investors in the GCC because, thankfully, we live in countries where the personal income tax code is zero (for now!). However, this does not insulate us from taxes in other countries, like the US, where the tax code is very different. Unfortunately, as with any of tax snippets, this is unlikely to be a pleasant read but if you can stick with it, there is a silver lining.
The US remains a very popular destination for investment opportunities for GCC investors since it is home to some of the largest organisations in the world. It hosts the biggest and most exciting stock market dominating our news headlines every day. Even global passive investors with a portfolio tracking the world index would have, staggeringly, in excess of 50% exposure to US equities. Whether you are an online trader or use the services of a Private Bank, it is essential to understand how the US treats GCC investors from a tax perspective.
If you are American, you will be all too familiar, nay afraid of the complex IRS tax code. However, if you are a foreign national – referred to in US tax parlance as an ‘alien’ – you need to determine if you are classified as a “resident” or “non-resident.” An ‘alien’ is an individual who is not a US citizen, green card holder, or US tax resident. Your tax residency and domicile status, as in most countries, is crucial in the estate and income tax computation, and for those who are ‘non-resident,’ it can provide some tax benefits or advantages. Regardless of which category you fall under, your ownership of US situs assets will definitely give rise to income and estate tax implications.
A ‘resident alien’ is a foreign national who has either a lawful permanent residence green card or a substantial presence in the US. These are the two objective tests that the IRS uses when making an assessment as to whether you are exposed to US income and estate tax.
A ‘non-resident alien,’ that is most of us in the GCC, is someone who meets neither tests above and is a non-resident alien for federal income tax purposes. Non-resident aliens, in general, are only taxed on income derived from US sources or activities. The IRS states that US source income that is considered “effectively connected” with a US trade or business, such as salary, rental income, and other forms of compensation, is taxable. US investment income such as dividends from stocks, rental income, private debt are generally taxed up to 30%.
Plus, US equities/assets/deposit accounts (property) owned by a ‘non-resident alien’ will be subject to US Federal Estate Tax of up to 40% on the individual’s death. To reiterate, your US stock portfolio loses 30% withholding tax per annum, and should you pass, your estate is liable to 40% in estate and gift tax. It may come as a shock since withholding tax is taken at source, so many investors do not realise they are paying it, and estate tax is frequently overlooked anyway. Americans command a generous $13 million allowance before they pay any estate tax but if you are a ‘non-resident alien,’ that allowance plummets to $60,000.
Note that this is a collective figure and not ‘per asset’ or ‘per holding’, and anything above this will be subject to a top rate of estate tax of 40%. More crucially, any tax due must be paid before the asset(s) can pass to the next generation or beneficiaries. The US has no more than 16 double tax treaties for Estate Duty, and not in every case will these be fully protective; and alas the UAE is not one of them either. The Executor of the estate is personally liable to pay the estate taxes if assets are passed before the estate tax is settled. This Executor has a legal duty to complete and file Form No. 706-NA within nine months of the deceased’s death where there are US assets valued at $60,000 or more. Failure to file can lead to interest and penalties. Therefore, it is important to know who your Executor is for your US assets.
Other than cutting all financial links with the US, one potential solution could be the use of Private Placement Life Insurance (PPLI) sometimes referred to as “wrappers”. This is a specialised solution that has been an effective planning tool for nearly 40 years. It allows for the transfer of ownership from the individual directly into a major insurance company, bringing with it the traditional benefits of owning insurance, such as tax efficiencies, tax deferral, simpler estate handling upon death, avoidance of probate or Shariah, absolute privacy, and ease of reporting (CRS). A wrapper legally mitigates individuals with their US income tax and estate tax whilst retaining control thereby offering a tailored solution that is globally mobile and compliant.
Since the assets are held legally and beneficially by the wrapper, there is no transfer of the shares on the death of the insured. Instead, it is the benefits arising under the insurance policy that are transferred to the deceased policyholder’s estate or beneficiaries – not the investments linked to the policy. This means that, for US Federal Estate tax purposes, there is no transfer of value, and therefore no Estate Tax is due. Wrappers use existing US/IRS legislation to effectively mitigate tax in a compliant manner.
If a wrapper is structured correctly and takes full advantage of the benefits and network of dual taxation treaties, a GCC investor can mitigate the annual 30% withholding tax and eradicate their 40% estate tax completely. Even though wrapper solutions have been in existence for decades, they have been overshadowed by less robust alternatives of complex trusts and offshore company combinations pitched by law firms/fiduciary which for the most part do not protect the investor, only their fees. As with other governments around the world, a raft of legislation has been passed to unravel the opacity these offshore structures portray and so the insurance wrapper cannot be overlooked any longer.
GCC member states' introduction of corporate tax can affect those investors who use blockers to mitigate their US taxes. And the IRS is deploying $8 billion over the next 10 years, increasing its headcount (even in the GCC), deploying bots and AI to enhance its ability to collect tax on a global scale. Failure to plan effectively could find you wearing some orange pyjamas sooner than you think.
In summary and from a tax perspective, I would normally advocate ignoring the espouses of a rapper from the US, unless it is one preceded with the letter W. So, if you have any exposure to the US, directly or otherwise, appreciate you are likely to have tax liabilities that you may be unaware. With the fiscal world in constant change, it is essential to review, since tax complexity is itself a kind of tax.
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