PFIC Reporting for US Expats: UK Funds, ISAs, and Investment Trusts

For US citizens and green card holders living in the UK, Passive Foreign Investment Company (PFIC) rules represent one of the most punishing and least understood areas of US international tax law. UK-based investment funds, ISA investments, unit trusts, OEICs, and investment trusts are frequently classified as PFICs — triggering a complex US tax regime that can result in effective tax rates far exceeding those on equivalent US investments.

This guide explains what PFICs are, how UK investment vehicles are affected, the three tax regimes available, and how to make elections that may significantly reduce your US tax exposure.

What Is a PFIC?

A Passive Foreign Investment Company is any foreign corporation that meets either of two tests:

• Income test: 75% or more of the corporation’s gross income for the taxable year consists of passive income (dividends, interest, rents, royalties, capital gains)
• Asset test: 50% or more of the average value of the corporation’s assets are assets that produce or are held for the production of passive income

Almost all UK collective investment vehicles — unit trusts, OEICs (Open-Ended Investment Companies), investment trusts, ETFs domiciled outside the US, and many ISA holdings — are PFICs under these definitions. Unlike US mutual funds, UK funds lack the tax treatment under US law that would prevent PFIC classification.

Which UK Investments Are Typically PFICs?

The following UK investment vehicles are generally classified as PFICs:

• UK unit trusts (e.g., Vanguard UK funds, Fundsmith, Liontrust)
• OEICs (most major UK fund ranges)
• Investment trusts (e.g., Scottish Mortgage Investment Trust, City of London Investment Trust)
• UK-listed ETFs (even those tracking US indices)
• Stocks and shares ISA holdings (where the underlying investments are PFICs)
• SIPP investments held in non-US funds
• NS&I Premium Bonds may not be PFICs but carry other reporting implications

Individual shares in UK companies (e.g., buying BP or Barclays shares directly) are generally not PFICs, because operating companies that fail the income test are excluded. The PFIC rules target collective investment vehicles and holding companies whose income is primarily passive.

The Default PFIC Tax Regime: Section 1291

If no election is made, PFIC investments are taxed under the punitive Section 1291 excess distribution regime. Under this regime:

• Any distribution from the PFIC in excess of 125% of the average distributions over the prior three years is an excess distribution
• Any gain recognised on the sale of PFIC shares is treated as an excess distribution
• Excess distributions are allocated back over the holding period of the PFIC shares, with the portion allocated to prior years taxed at the highest marginal income tax rate for each of those years (currently 37% for US federal purposes), plus interest on the deferred tax
• This means capital gains receive no preferential treatment — they are taxed at ordinary income rates plus interest, regardless of how long the investment was held

The effective tax rate on PFIC gains under the default regime can easily exceed 40–50% once the interest charge is factored in. This makes holding UK funds without making an election extremely costly for long-term investors.

PFIC Election Option 1: Qualified Electing Fund (QEF)

A Qualified Electing Fund (QEF) election under IRC Section 1295 allows the US investor to include their pro-rata share of the PFIC’s ordinary income and net capital gains in US taxable income each year — much like a US mutual fund pass-through. Under the QEF regime:

• Ordinary income from the PFIC is taxed at ordinary income rates annually
• Net capital gains from the PFIC are taxed at preferential capital gains rates annually
• When shares are eventually sold, no additional US tax is owed (since income was already taxed each year)
• The QEF election must be made in the first year the investment is held, or there are complex “purging election” procedures required to start fresh

The critical limitation: to make a QEF election, the fund must provide a PFIC Annual Information Statement — a document showing the fund’s ordinary earnings and net capital gain per share for the year. Most UK unit trusts and OEICs do not issue these statements, making the QEF election practically unavailable for most UK funds.

PFIC Election Option 2: Mark-to-Market (MTM)

The Mark-to-Market (MTM) election under IRC Section 1296 is available for PFICs whose shares are regularly traded on a qualified exchange. Under MTM:

• At the end of each year, the US investor marks the PFIC shares to market (compares year-end fair market value to adjusted basis)
• Any increase in value (unrealised gain) is included in ordinary income for that year
• Any decrease in value (unrealised loss) is deductible, but only to the extent of previously included MTM gains
• When shares are sold, any additional gain is ordinary income; losses are ordinary to the extent of prior MTM gains

The MTM election requires the PFIC shares to be traded on a “qualified exchange.” The London Stock Exchange (LSE) is a qualified exchange for this purpose. This means UK investment trusts listed on the LSE (e.g., Scottish Mortgage, Pershing Square Holdings) may be eligible for the MTM election — even though OEICs and unit trusts typically are not, as they are not listed on a stock exchange in the traditional sense.

Form 8621: Reporting Each PFIC

Form 8621 (Information Return by a Shareholder of a Passive Foreign Investment Company or Qualified Electing Fund) must be filed for each PFIC in which the US person holds shares during the year. Key rules:

• A separate Form 8621 must be filed for each PFIC — if you hold ten UK funds, you file ten Forms 8621
• Under the QEF or MTM regimes, Form 8621 is required every year, even if no elections or distributions occur
• Under the default Section 1291 regime, Form 8621 is required in any year there is an excess distribution, recognised gain on sale, or if the total value of all PFIC shares exceeds $25,000 (married filers: $50,000)
• Failure to file Form 8621 causes the statute of limitations on the entire tax return to remain open — meaning the IRS can audit any part of the return indefinitely until Form 8621 is filed for all PFICs

PFIC and ISAs

ISAs add a layer of complexity because the IRS does not recognise the tax-exempt status of ISAs. Gains and income within an ISA are taxable for US purposes as earned, regardless of UK tax treatment. If the ISA holds UK funds that are PFICs, those PFIC investments must be reported on Form 8621, and elections must be made separately for each underlying fund held within the ISA.

Furthermore, depending on the ISA structure, it may itself be classified as a foreign grantor trust — requiring additional reporting on Form 3520 and Form 3520-A. Our guide on Form 3520 covers the ISA trust question in more detail.

PFIC and SIPPs

Self-Invested Personal Pensions (SIPPs) face a different set of challenges. Under the US-UK Tax Treaty (Article 17), UK pension income is generally taxable only in the country of residence at the time of distribution. However, the treaty does not provide a blanket US tax exemption for pension growth during the accumulation phase.

If SIPP funds are invested in UK collective investment vehicles (unit trusts, OEICs), those underlying investments are PFICs. Whether treaty protections extend to suppress PFIC reporting obligations during the accumulation phase is a contested area. Some practitioners take the position that the SIPP trust itself is not a PFIC (it is not a corporation), but the underlying fund investments may be PFICs held by the trust. Our SIPP and US Tax guide covers these issues in detail.

Practical Planning for US Expats

The most important practical action for US expats in the UK is to understand what investments are PFICs before purchasing them. After-the-fact compliance is significantly more complex and expensive than proactive planning. Key planning points:

• Consider US-domiciled ETFs if you want index fund exposure. US ETFs (e.g., those listed on NYSE Arca or NASDAQ) are US corporations and are not PFICs. They can be held by UK residents in a general investment account (not an ISA).
• Hold individual UK shares rather than funds. Individual shares in operating UK companies are generally not PFICs.
• Make MTM elections promptly on any LSE-listed investment trusts you hold, before the first year of holding passes.
• Request PFIC Annual Information Statements from fund managers — some larger fund groups (particularly those with US investor client bases) may be able to provide them.
• Avoid accumulation units where possible in existing UK fund holdings — these generate notional income that requires US reporting even without a cash distribution.

Frequently Asked Questions

Are all UK investments PFICs?

No. Individual shares in UK operating companies (e.g., HSBC, Unilever, AstraZeneca) are not PFICs. UK government gilts and corporate bonds are not PFICs. Premium Bonds are not PFICs. The PFIC rules primarily target collective investment vehicles — unit trusts, OEICs, investment trusts, and ETFs — whose income is predominantly passive.

Can I get the lower capital gains tax rate on my UK fund gains?

Not under the default Section 1291 regime — all excess distributions (including realised gains on sale) are taxed at ordinary income rates plus interest. Under a QEF election, the fund’s net capital gains are passed through to you at preferential capital gains rates, but QEF requires a PFIC Annual Information Statement from the fund manager which most UK funds do not provide. Under MTM, all income is ordinary. In short, preferential capital gains treatment for UK funds is difficult to achieve.

I have held UK funds for many years without reporting. What do I do?

This is a common situation. Options include catching up through the IRS Streamlined Filing Compliance Procedures (if the failure was non-wilful), the Delinquent International Information Return Submission Procedures (if no income was unreported), or — if you plan to sell the funds — calculating the Section 1291 excess distribution tax on the accrued gains. Each route requires professional assessment of your specific facts.

Do I need to file Form 8621 even if my UK fund made a loss?

If the total value of all your PFIC holdings exceeds $25,000 ($50,000 for married couples), Form 8621 must be filed annually even without distributions or sales. If your total PFIC holdings are below this threshold and you made no distributions or disposals, a limited exception may apply — but the statue of limitations issue means professional advice is strongly recommended before relying on any exception.

Get Expert Help with PFIC Compliance

PFIC compliance is one of the most technically demanding areas of US expat tax. The stakes are high — excessive tax rates on investment gains, open-ended audit exposure, and significant penalties for missed Forms 8621. Our cross-border tax specialists regularly assist US expats in the UK with PFIC analysis, Form 8621 preparation, QEF and MTM elections, and catch-up procedures.

Contact us today to discuss your PFIC situation. We can help you understand your exposure, make the right elections, and bring your US tax reporting into full compliance.