Form 1116: No foreign capital gains for U.S.-based mutual funds?


F

frenchguynyc

For my 2013 Form 1040 (U.S. Individual Income Tax Return) to be filed by October 15, I am currently preparing my Form 1116 (Foreign Tax Credit), specifically Line 1a (Foreign Gross Income) in Part I.

After reading the instructions for Form 1116, I know I may be required to make certain adjustments to my foreign source qualified dividends and foreign source capital gains (including any foreign source capital gain distributions) or losses, if I have any.

Since I own shares of Vanguard Total International Stock Index Fund, Vanguard sent me a tax document clearly stating the amount of my foreign qualified dividends, but there is no mention of foreign capital gains.

Out of curiosity, I look at the websites of other U.S.-based mutual fund companies and never found any mention of foreign capital gains (and associated foreign taxes), whereas the topic of foreign qualified dividends (and associated foreign taxes) comes up regularly for funds investing in foreign securities.

Hence my question:
Why do U.S.-based mutual funds investing in foreign securities never report foreign capital gains to their shareholders (whereas they typically report foreign qualified dividends)?

Thank you in advance for your responses.
 
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A

Alan

For my 2013 Form 1040 (U.S. Individual Income Tax Return) to be filed by October 15, I am currently preparing my Form 1116 (Foreign Tax Credit), specifically Line 1a (Foreign Gross Income) in Part I.

After reading the instructions for Form 1116, I know I may be required to make certain adjustments to my foreign source qualified dividends and foreign source capital gains (including any foreign source capital gain distributions) or losses, if I have any.

Since I own shares of Vanguard Total International Stock Index Fund, Vanguard sent me a tax document clearly stating the amount of my foreign qualified dividends, but there is no mention of foreign capital gains.

Out of curiosity, I look at the websites of other U.S.-based mutual fund companies and never found any mention of foreign capital gains (and associated foreign taxes), whereas the topic of foreign qualified dividends (and associated foreign taxes) comes up regularly for funds investing in foreign securities.

Hence my question:
Why do U.S.-based mutual funds investing in foreign securities never report foreign capital gains to their shareholders (whereas they typically report foreign qualified dividends)?

Thank you in advance for your responses.
It's not foreign source income. When the mutual fund you invested in
buys and sells foreign stocks at a gain or loss, it is US source income.
When a foreign stock pays a dividend, that is foreign source income.
Typically, a mutual fund makes the "certain adjustments" so that you
need only report the foreign source income
 
F

frenchguynyc

It's not foreign source income. When the mutual fund you invested in

buys and sells foreign stocks at a gain or loss, it is US source income.

When a foreign stock pays a dividend, that is foreign source income.

Typically, a mutual fund makes the "certain adjustments" so that you

need only report the foreign source income



--

Alan

http://taxtopics.net
Alan,

Thank you very much for your response.

I agree with your answer. It's the only one that could explain why U.S.-based mutual funds investing in foreign securities never report foreign capital gains. Something is still puzzling me though...

When U.S.-based mutual funds invest in foreign stocks, I believe they have 3 options:
1) American Depository Receipts (ADRs), which trade in the U.S.
2) Foreign stocks that trade in the U.S. like in their local market, such as Canadian stocks.
3) Stocks that only trade on a foreign stock market.

In the 3rd case, these mutual funds - that often tout their global presence in key world financial markets - don't go through foreign brokers (which, I assume, would eventually generate foreign capital gains)?
 
J

John Levine

In the 3rd case, these mutual funds - that often tout their global presence in key
world financial markets - don't go through foreign brokers (which, I assume, would
eventually generate foreign capital gains)?
The fund is in the US, it owns the shares in the US, so it's US gain when they sell it.

Here's a thought experiment: you, a US resident, go down to your local
Travelex in the US one day and buy a thousand euros for $1200. You
put them in a drawer for a while, exchange rates change, and later go
back and sell them back for $1300. Euros are issued by the ECB in
Frankfurt. Is that $100 a US gain or a German gain? If you did these
transactions in Canada, would the answer be different?
 
F

frenchguynyc

The fund is in the US, it owns the shares in the US, so it's US gain when they sell it.



Here's a thought experiment: you, a US resident, go down to your local

Travelex in the US one day and buy a thousand euros for $1200. You

put them in a drawer for a while, exchange rates change, and later go

back and sell them back for $1300. Euros are issued by the ECB in

Frankfurt. Is that $100 a US gain or a German gain? If you did these

transactions in Canada, would the answer be different?
John,

Thank you very much for your response.

So you're saying that if U.S.-based mutual funds own the shares of foreign stocks, they always own them in the U.S. Therefore, I gather that if these funds own stocks that only trade on a foreign stock market (different from ADRs), they must systematically do it through U.S. brokers (and never through foreign brokers). Maybe there's even a regulation that requires them to do so.

Regarding your thought experiment:
- if a U.S. resident buys euros and later sells them at a gain in the U.S., I would say it's a U.S. gain because the U.S. Travelex office is a U.S. payer;
- if a U.S. resident buys euros and later sells them at a gain in Canada, I would say it's a Canadian gain - that is a foreign gain - because the Travelex office in Canada is a foreign payer (from a U.S. tax perspective).
Did I get the right answers?
 
J

John Levine

So you're saying that if U.S.-based mutual funds own the shares of foreign stocks, they always own
them in the U.S. Therefore, I gather that if these funds own stocks that only trade on a foreign
stock market (different from ADRs), they must systematically do it through U.S. brokers (and never
through foreign brokers). Maybe there's even a regulation that requires them to do so.
I don't see why the location of the broker would matter. When you or
your fund sell a share of stock, the money comes from a buyer, who
could be anywhere, to the seller, minus a sliver for the broker. The only
thing that goes to the underlying company is a note telling them where
to send the proxies and annual report. But when that stock pays a
dividend, the money originates at the company, and they send you your
share.

That's why the former is not foreign income, and the latter is.
 
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F

frenchguynyc

I don't see why the location of the broker would matter. When you or

your fund sell a share of stock, the money comes from a buyer, who

could be anywhere, to the seller, minus a sliver for the broker. The only

thing that goes to the underlying company is a note telling them where

to send the proxies and annual report. But when that stock pays a

dividend, the money originates at the company, and they send you your

share.



That's why the former is not foreign income, and the latter is.
John,

I think I get it now. When a U.S.-based mutual fund realizes a capital gain, it's a U.S. gain because the fund is a U.S. entity and it owns the shares in the U.S., as you said. It doesn't matter whether the capital gain is realized on U.S. securities or foreign securities.

Conversely, I assume a foreign mutual fund generates foreign capital gains.

Regarding your thought experiment, I still have the same answers as before but based on a revised justification:
- if a U.S. resident buys euros and later sells them at a gain in the U.S., I would say it's a U.S. gain because the gain is realized in the U.S.;
- if a U.S. resident buys euros and later sells them at a gain in Canada, I would say it's a Canadian gain - that is a foreign gain (from a U.S. tax perspective) - because the gain is realized outside the U.S.
Did I get the right answers?
 
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A

Alan

John,

I think I get it now. When a U.S.-based mutual fund realizes a capital gain, it's a U.S. gain because the fund is a U.S. entity and it owns the shares in the U.S., as you said. It doesn't matter whether the capital gain is realized on U.S. securities or foreign securities.

Conversely, I assume a foreign mutual fund generates foreign capital gains.

Regarding your thought experiment, I still have the same answers as before but based on a revised justification:
- if a U.S. resident buys euros and later sells them at a gain in the U.S., I would say it's a U.S. gain because the gain is realized in the U.S.;
- if a U.S. resident buys euros and later sells them at a gain in Canada, I would say it's a Canadian gain - that is a foreign gain (from a U.S. tax perspective) - because the gain is realized outside the U.S.
Did I get the right answers?
Bad example using coins that are personal property. The sale of personal
property by a US resident in Canada where the property does not belong
to a permanent establishment in Canada is not taxable by Canada and any
gain/loss is not foreign source income. This is the general rule in
most tax treaties I am familiar with.
If the coins were sold in a country that did not have a tax treaty with
the US, one would have to look to the tax laws of that country to see if
the gain was taxable. Most likely, the sale of personal property would
not be taxed and would not be foreign source income.

When it comes to property the general rules are that real property
located on foreign soil will generate foreign source income. Personal
property that is not part of a fixed base used by the US person for
generating income nor belongs to a permanent establishment on foreign
soil will not generate foreign source income.
 

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