Tax Considerations for US Expatriate Investors in Scottish Startups

15/10/2024
Image by Alexander Mils

By David Baptiste

Navigating tax regulations can be tricky. Especially for US expats interested in investing in Scottish startups. While the excitement of backing a promising Scottish company is undeniable, you need to keep an eye on the tax side of things too. It’s not just about your investment; it’s about how you manage your tax obligations both in the US and abroad.

First, let’s get one thing clear: As a US citizen, you are taxed on your worldwide income. So, whether you’re living in the US or outside of it, Uncle Sam expects you to report everything. This also means your investments abroad—including in Scotland—are subject to scrutiny by the IRS. Sounds tough, right? But don’t worry, there are ways to navigate these complexities, including seeking expat tax services that specialize in cross-border tax matters.

FATCA and FBAR: What You Need to Know

One of the first hurdles for expat investors is complying with the Foreign Account Tax Compliance Act (FATCA) and Foreign Bank Account Reporting (FBAR) rules. These sound complicated, but essentially, they require you to report any foreign financial accounts you hold over certain thresholds.

FBAR applies if you have more than $10,000 in foreign bank accounts at any point during the year. FATCA is similar but has different thresholds: $200,000 for single filers living abroad and $400,000 for joint filers. If you’re investing in a Scottish startup through a local bank or investment firm, you’ll likely have to file these forms. Failing to report this can lead to harsh penalties, so it’s crucial to stay on top of it.

Passive Foreign Investment Company (PFIC) Rules

If you’re investing in a Scottish company, you need to be aware of the Passive Foreign Investment Company (PFIC) rules. These rules apply if you own shares in a foreign corporation that earns mostly passive income, such as dividends or interest. Many foreign startups, especially in tech, might meet this definition.

Why does this matter? Because PFICs come with some of the most punitive tax treatments in the US tax code. Instead of favorable capital gains rates, income from PFICs may be taxed at the highest ordinary income rates, along with an interest charge. This makes tracking your investment gains extremely important, and you may want to consult with a tax advisor to avoid nasty surprises.

Double Taxation: US and UK

A big concern for US expat investors is double taxation. Luckily, the US and UK have a tax treaty in place that helps prevent paying taxes twice on the same income. If you’re earning dividends, interest, or capital gains from a Scottish startup, the treaty can offer some relief by reducing the withholding tax on dividends and other income types.

But here’s the tricky part: The US still requires you to report this income, even if you’ve already paid UK taxes. You can claim a Foreign Tax Credit (FTC) to offset your US tax liability, which helps prevent you from being taxed twice. Keep in mind that the FTC only offsets US taxes on the same type of income, so you’ll need to ensure your filings are correct to maximize this benefit.

Startups and Foreign Earned Income Exclusion (FEIE)

You might be wondering if the Foreign Earned Income Exclusion (FEIE) applies to your investments. The short answer? No. FEIE allows you to exclude up to $120,000 of earned income (for 2023) from US taxation, but it doesn’t apply to passive investment income like dividends or capital gains from startups. So, while you may be able to exclude your salary if you’re working abroad, you can’t shield your investment income under this provision.

Understanding Self-Employment Tax

If you are not only investing but also involved in the startup’s operations, self-employment tax could come into play. The US requires you to pay self-employment tax if you own more than 10% of a foreign corporation and are actively involved in the business. While the UK has its own national insurance contributions, these typically don’t cover your US self-employment tax obligations. You’ll need to keep an eye on both systems, which makes working with a tax advisor even more important.

Timing Matters: Tax Deferral and Gains

Another point to consider is the timing of when you sell your shares or take distributions. If the startup grows and you sell your stake at a profit, the IRS will tax those capital gains. However, when you sell those shares matters—if you wait for at least one year after your investment, the US provides lower tax rates on long-term capital gains compared to short-term ones.

But, depending on UK law, you might owe UK capital gains taxes first. Since the US allows you to use foreign tax credits, planning your timing could reduce your overall tax bill. Again, this is an area where detailed planning can make a huge difference.

GILTI and CFC Rules

For larger investors, the Global Intangible Low-Taxed Income (GILTI) and Controlled Foreign Corporation (CFC) rules are another concern. If you own more than 10% of a foreign startup, the US might consider the company a CFC, which triggers additional reporting and potential taxation under GILTI. Essentially, GILTI taxes a portion of the foreign company’s profits, even if they are not distributed to you.

If the startup does well but doesn’t pay dividends, you could still owe US taxes on the earnings, which is obviously frustrating. However, there are planning strategies to mitigate the impact of GILTI, such as the Section 962 election, which can help reduce the tax burden by allowing you to claim a lower corporate tax rate.

Conclusion

Investing in Scottish startups as a US expat has great potential, but the tax side of things is far from simple. Between FBAR, FATCA, PFIC, and the risk of double taxation, there are multiple layers to manage. Seeking expat tax services that specialize in US and UK tax laws can help ensure you’re making smart decisions for both your wallet and your peace of mind. With the right planning and advice, you can minimize your tax obligations and maximize the potential of your investments in Scottish startups.

The latest stories

UK Government Confirms £1.4bn Investment for Local Growth Projects Across Scotland
Sand Management Network to hold major industry conference in Aberdeen
North Sea Energy transition taskforce launched to safeguard jobs and future
Education Secretary launches academy.scot to upskill Scotland’s workforce