Introduction: Why AT1 Bonds Are Taxed as Two Different Assets
AT1 bonds are perpetual, loss-absorbing securities that banks issue to count towards their Additional Tier 1 capital, and for an American living in London they are among the most mismatched investments you can own. Britain taxes the coupon as interest and, for sterling issues, exempts the capital gain entirely. America, by contrast, usually treats the very same security as equity, so the coupon becomes a dividend and every dollar of gain is taxable. Consequently, one holding produces two incompatible sets of numbers on two returns.
Furthermore, AT1 bonds have become a fixture of private bank portfolios since 2023. Yields of 7% to 9% on investment-grade bank names attract exactly the readers we work with: investment bankers, fund partners and company owners who already understand credit risk. However, very few of them understand the tax risk. At TaxYork we regularly rebuild returns where AT1 bonds were reported as ordinary bond interest on the US side, or where a UK-exempt gain was simply left off the Form 1040.
Accordingly, this guide explains how both tax systems classify the securities, what happens on a coupon, a sale, a call, a conversion into shares and a total write-down, and how the foreign tax credit really behaves. It also covers FBAR and Form 8938 reporting, the fund-wrapper trap, and a full worked case study with real numbers.
What AT1 Bonds Actually Are
AT1 bonds are also called contingent convertible securities, or CoCos. Investopedia's explanation of contingent convertibles sets out the basic mechanics: the bank pays a fixed coupon that resets every five years, there is no maturity date, and the issuer may call the security after the first reset. Moreover, if the bank's Common Equity Tier 1 ratio falls below a trigger, the security either converts into ordinary shares or is written down.
In a typical recent prospectus filed with the US Securities and Exchange Commission, the trigger is a CET1 ratio below 7.00%. At that point the holder's debt claim is released permanently in exchange for shares. In addition, the issuer may cancel any coupon at its sole discretion, and cancelled coupons never accumulate. Therefore, these are not bonds in the ordinary sense, and the tax codes of both countries recognise that.
Why the Classification Gap Matters to High Earners
The gap matters because it changes the rate, the source and the timing of tax. Specifically, a UK additional-rate taxpayer pays 45% on the coupon, while the IRS would charge 20% plus the 3.8% net investment income tax. Similarly, a sterling issue that is exempt from UK capital gains tax remains fully taxable in America. As a result, a portfolio that looks tax-efficient from a London desk can carry a substantial American bill that nobody budgeted for.
How the IRS Classifies AT1 Bonds for US Holders
The IRS has never issued a ruling on bank capital securities specifically. Instead, classification depends on the general debt-versus-equity factors, and issuers state their position in the prospectus. That position is remarkably consistent for UK banks.
The Prospectus Statement That Drives Your US Return
A 2025 prospectus supplement for a UK bank's contingent convertible securities filed with the SEC states plainly that the securities and any conversion shares "will be treated as equity for U.S. federal income tax purposes." Accordingly, the coupons are treated as dividends to the extent of the issuer's earnings and profits. Any excess is a return of capital that reduces your basis, and anything beyond basis is capital gain.
Furthermore, the issuer's position binds the issuer, not you, but departing from it requires disclosure and a strong argument. In our experience, almost no individual holder has a reason to take the contrary view. Therefore, the starting point for AT1 bonds issued by UK banks is equity treatment, and your return should follow it unless your specific prospectus says otherwise. Issues from banks in other countries can differ, so always read the tax section of the offering document.
Qualified Dividend Income and the Holding Period
Because the coupon is a dividend from a UK corporation, it generally qualifies for the preferential rates in Internal Revenue Code section 1(h)(11). A UK bank is a qualified foreign corporation because it is eligible for the benefits of the US-UK income tax treaty, which you can find through the IRS list of US income tax treaties. Consequently, the top federal rate is 20% rather than 37%.
However, the holding period test applies. You must hold the security for more than 60 days during the 121-day period that begins 60 days before the ex-dividend date. Notably, active traders who buy just before a coupon and sell shortly after can lose qualified status. In addition, the prospectus cited above confirms that the coupons are foreign-source income and generally fall into the passive basket for foreign tax credit purposes.
Why Equity Treatment Removes Currency Gain on Dollar Issues
Equity classification has a helpful side effect. Section 988 currency rules apply to debt instruments denominated in a non-functional currency, but they do not apply to stock. Therefore, a sterling-denominated issue held by an American produces a single capital gain or loss measured in dollars, with no separate ordinary currency gain. Similarly, a dollar issue carries no currency element at all on the US side. By contrast, HMRC measures everything in sterling, so a dollar issue produces UK currency gains and losses even when the dollar price never moves.
How HMRC Taxes AT1 Bonds Held by UK Residents
Britain takes the opposite view of AT1 bonds. For the issuing bank, the Finance Act 2019 Schedule 20 hybrid capital instrument rules replaced the earlier regulatory capital securities regime. Those rules keep the coupons deductible for the bank and exempt transfers from stamp duty.
Coupons Taxed as Savings Interest
For an individual holder, the coupon is interest and is taxed as savings income. HMRC's Corporate Finance Manual at CFM37850 explains that the power to cancel or defer interest is disregarded when deciding whether a payment is a distribution. Consequently, the coupon is not a dividend in Britain, so the dividend allowance and dividend rates do not apply.
Accordingly, you pay 20%, 40% or 45% under the current UK income tax rates. Additionally, the personal savings allowance is £500 for higher-rate taxpayers and nothing at all for additional-rate taxpayers, as gov.uk's guidance on tax-free savings interest confirms. Importantly, the November 2025 Budget legislated a two-point rise in savings income rates from 6 April 2027, which takes the additional rate on these coupons to 47%.
No UK Withholding on Listed Issues
Most issues are listed on a recognised stock exchange, so the quoted Eurobond exemption in section 882 of the Income Tax Act 2007 allows the bank to pay gross. Therefore, you receive the full coupon and settle the UK tax through Self Assessment. Notably, that timing matters for the US foreign tax credit, because the UK tax is paid on 31 January after the tax year, often in a different US tax year from the coupon.
The Qualifying Corporate Bond Test Splits Sterling and Dollar Issues
This is where most planning goes wrong. Section 162(1B) of the Corporation Tax Act 2010 deems a hybrid capital instrument to be a "normal commercial loan", which is the first limb of the qualifying corporate bond definition. The second limb, in section 117 of the Taxation of Chargeable Gains Act 1992, requires the security to be expressed in sterling with no provision for conversion into or redemption in another currency.
Consequently, sterling AT1 bonds held by individuals are generally qualifying corporate bonds. Gains are exempt from UK capital gains tax, and losses are not allowable. By contrast, dollar and euro issues fail the sterling test, so gains are chargeable at the 18% and 24% rates shown on gov.uk's capital gains tax rates page, and losses are allowable. The currency of issue, not the credit quality, therefore decides the entire UK capital outcome.
Coupons and the Foreign Tax Credit: Where the Real Cost Sits
At first glance, the coupon on AT1 bonds looks safe for a UK resident. Britain taxes it at up to 45%, America taxes it at up to 20%, and the foreign tax credit should eliminate the US charge. That conclusion is mostly right, but it hides two costs.
The Credit Covers Regular Tax but Not the 3.8% Surtax
You claim the UK tax on Form 1116 against the US tax on the coupon. Because the UK rate is higher, the regular US tax on the coupon is usually reduced to nil. However, the net investment income tax under section 1411 applies at 3.8% on dividends once modified adjusted gross income exceeds $200,000 single or $250,000 joint.
Importantly, the Federal Circuit held on 31 August 2026 that the US-UK treaty does not allow foreign tax credits against the net investment income tax. Consequently, every dollar of AT1 coupon received by an American high earner in London costs 3.8% in America on top of the full UK rate. On a $2 million position yielding 8%, that is $6,080 a year that no credit can touch.
High-Taxed Income Moves to the General Basket
The coupon starts in the passive category, but section 904 moves passive income that bears foreign tax above the highest US rate into the general category. At 45% UK tax against a 37% top US rate, AT1 coupons are high-taxed. Therefore, they usually land in the same basket as your UK salary, alongside the excess credits that salary already generates.
Additionally, the qualified dividend rate differential adjustment reduces the foreign-source income used in the credit limitation. As a result, excess UK tax on the coupons generally carries forward rather than producing any US benefit. Our guide to tax credit carryovers for UK tax paid explains how to keep that pool alive for a year when it can be used.
Cancelled Coupons and Return of Capital
If the bank cancels a coupon, neither country taxes anything, because nothing was paid and nothing accrues. However, the US equity treatment adds a subtle point. Dividend treatment depends on the issuer having earnings and profits. If a bank paid coupons in a loss year with no accumulated earnings, part of the payment would be a return of capital that reduces your basis instead. Therefore, keep issuer earnings disclosures with your records for any year in which the bank reports a large loss.
Sales, Calls and the Capital Gains Mismatch
Capital transactions in AT1 bonds produce the largest surprises, because the two systems disagree about whether there is a gain at all.
Sterling AT1 Bonds: Exempt in Britain, Taxed in America
A sale of sterling AT1 bonds at a profit is free of UK capital gains tax under the qualifying corporate bond exemption. Yet the IRS taxes the dollar gain, measured using the exchange rate on purchase and on sale. Consequently, a profit can arise in dollars even when the sterling price barely moves, simply because sterling strengthened.
Moreover, that gain is generally US-source. Under section 865, a US citizen living abroad is treated as a non-resident for sourcing only if the foreign country taxes the gain at 10% or more. Because Britain charges nothing, the gain stays US-source, and your excess UK credits cannot shelter it. Therefore, the full 20% plus 3.8% falls due, with no offset.
Dollar AT1 Bonds: Chargeable in Both, Often in Opposite Directions
Dollar issues are chargeable in Britain, so both countries tax the gain. However, Britain measures it in sterling. If you buy when the pound is weak and sell when it is strong, a dollar gain can become a sterling loss. In that case the IRS taxes a gain while HMRC allows a loss, and no UK tax exists to credit. Conversely, a falling pound can create a UK gain on a security that made no dollar profit.
Accordingly, we plan dollar disposals around both currencies. Where the UK gain is large enough to carry at least 10% UK tax, section 865 treats the gain as foreign-source and the UK tax becomes creditable. Where it is not, the treaty's re-sourcing article rarely helps, because there is little or no UK tax to re-source.
Issuer Calls and Section 302
Most holders of AT1 bonds exit when the bank calls the security at par on a reset date. For US purposes, the prospectus treats a redemption as a sale producing capital gain or loss. Notably, if you also hold ordinary shares in the same bank, section 302 could in theory recharacterise redemption proceeds as a dividend. In practice, a portfolio investor whose percentage interest does not increase will usually meet the "not essentially equivalent to a dividend" test. Our article on UK preference shares and US tax explores the same equity-classification logic in more depth.
Conversion, Write-Down and Bail-In: Planning for the Bad Day
Investors buy AT1 bonds for yield, yet the tax position on the trigger event is what separates careful planning from expensive surprises.
Automatic Conversion Into Ordinary Shares
Under US equity treatment, the prospectus states that you generally recognise no gain or loss when the securities convert into ordinary shares. Your basis and holding period carry over into the shares. Therefore, the US loss only crystallises when you later sell those shares, which may be at a much lower price.
In Britain, a conversion of securities into shares is generally treated as a reorganisation rather than a disposal. However, the qualifying corporate bond rules in section 116 apply special base cost mechanics where a sterling issue converts. Consequently, the UK and US base costs for the same shares will usually differ, and you must track both from the conversion date onwards.
Total Write-Down and the Lost UK Loss
A full write-down is the scenario that hurts most on sterling issues. Because a qualifying corporate bond loss is not allowable, a sterling holder who loses everything gets no UK relief at all. By contrast, the prospectus confirms that a US holder recognises a capital loss equal to basis on a complete cancellation under the UK bail-in power. Under section 165, that loss offsets capital gains plus $3,000 of ordinary income a year, with the balance carried forward indefinitely.
However, the US loss is US-source and offsets gains that would often have been sheltered by UK credits anyway. Therefore, its real value depends on your future US-taxed gains. Our guide to capital loss carryovers for US-UK investors shows how to deploy it.
Lessons From the 2023 Swiss Write-Down
In March 2023, Swiss regulators ordered about CHF 16 billion of a failing bank's AT1 capital written down to zero while shareholders received value. In October 2025, the Swiss Federal Administrative Court ruled in a partial decision that the write-down lacked a sufficient legal basis. Appeals to the Federal Supreme Court followed, and that court granted suspensive effect, so the outcome remains open.
For American holders, this creates a timing question. If you claimed a worthless security loss in 2023 and later receive compensation, the recovery is generally taxable in the year received rather than reopening 2023. In Britain, the treatment of any recovery depends on whether the original issue was a qualifying corporate bond. Accordingly, holders should keep their 2023 loss computations and settlement records together now.
Reporting AT1 Bonds: FBAR, Form 8938 and Fund Wrappers
Reporting failures, rather than tax errors, cause most of the penalties we see on AT1 bonds.
FBAR and Form 8938 for Securities Held in Britain
If you hold AT1 bonds through a UK private bank or platform, the account is a foreign financial account. You must include it on the FinCEN FBAR once all your foreign accounts together exceed $10,000 at any point in the year. Furthermore, the IRS Form 8938 guidance applies once foreign assets exceed $200,000 at year end or $300,000 at any time for a single filer living abroad, doubled for joint filers.
Notably, the same securities held in a US brokerage account are not specified foreign financial assets. Consequently, where you hold them affects your reporting burden, although many US brokers restrict access to these issues. If you have already missed reporting on a UK investment account, our FBAR and FATCA compliance service can bring the filings up to date.
AT1 Funds Are Usually PFICs
Many investors hold AT1 bonds through a UK or Irish fund rather than individual issues. For a US person, a non-US fund is almost always a passive foreign investment company, reported on Form 8621. Without a qualified electing fund or mark-to-market election, gains are taxed at the top ordinary rate plus an interest charge.
Therefore, direct holdings of AT1 bonds are far simpler for Americans than fund exposure. The issuing banks themselves state that they do not expect to be PFICs, although that is an annual factual test. Our guide to long-term asset funds and PFIC rules explains the fund trap in detail.
ISAs and the Accrued Income Scheme
You can hold listed issues inside a stocks and shares ISA, which removes UK tax on the coupons. However, the IRS ignores the ISA wrapper entirely, so the coupons remain dividends on your US return with no UK tax to credit. Consequently, an ISA converts a coupon that is fully sheltered by UK credits into one that bears 20% plus 3.8% in America.
Additionally, buying or selling between coupon dates can bring the UK accrued income scheme into play for securities of this kind. Our article on the accrued income scheme and US tax explains why HMRC and the IRS treat accrued interest so differently, and our UK gilts guide covers the closely related sovereign exemption.
Case Study: An American Banker Holding Sterling and Dollar AT1 Bonds
The following illustrative case study uses realistic figures. Morgan is a US citizen living in London, an additional-rate UK taxpayer and a single US filer with modified adjusted gross income well above $200,000. Morgan holds $2,000,000 of dollar AT1 bonds with an 8% coupon and £1,000,000 of sterling AT1 bonds with a 7.5% coupon. We assume an exchange rate of $1.30 to the pound throughout the year.
The Annual Coupon Position
The dollar issue pays $160,000, or £123,077. The sterling issue pays £75,000, or $97,500. HMRC taxes the combined £198,077 at 45%, giving £89,135 of UK tax, which is $115,875.
On the US side, the $257,500 of coupons are qualified dividends. Regular US tax at 20% would be $51,500, and the UK credit eliminates it completely, leaving $64,375 of excess credit to carry forward. However, the net investment income tax of 3.8% adds $9,785 that nothing can offset. Consequently, Morgan's true combined rate on the coupons is about 48.8%, not 45%.
The Exit Year
Morgan had bought the sterling issue at par when the pound stood at $1.22, a dollar basis of $1,220,000. Morgan sells it for £1,060,000 at $1.30, or $1,378,000. HMRC charges nothing, because the gain on a qualifying corporate bond is exempt. However, the IRS sees a $158,000 long-term gain. At 20% plus 3.8%, that costs $37,604, and because the gain is US-source, the $64,375 of excess UK credits cannot touch it.
Meanwhile, the dollar issue is called at par. Morgan paid $1,900,000 when the pound was at $1.22, a sterling cost of £1,557,377. The $2,000,000 redemption is worth only £1,538,462 at $1.30. Therefore, HMRC allows a £18,915 capital loss, while the IRS taxes a $100,000 gain at 23.8%, costing $23,800, again with no UK tax to credit.
What Planning Achieved
Morgan's previous preparer had reported the coupons as interest, ignored both capital disposals on the US return, and never filed Form 8938 for the private bank account. We corrected the classification, which cut regular US tax on the coupons to nil, and we reported the $61,404 of US capital tax properly. Furthermore, we used the £18,915 UK loss against a UK-chargeable share gain, which pushed that gain's UK tax above the 10% sourcing threshold and made it creditable. The reporting gap was fixed before any IRS contact, which preserved the most favourable penalty position.
How TaxYork Can Help
AT1 bonds sit at the intersection of bank regulation, two tax codes and two reporting regimes, and generic preparers rarely connect all three. Our team prepares the US and UK returns together, so the coupon, the credit and the capital position are planned as one.
Comprehensive US and UK Return Preparation
We classify each holding from its prospectus, compute dollar and sterling base costs side by side, and claim every available credit. In addition, our US tax return preparation for expats covers Form 1116, Form 8960, Form 8938 and the FBAR in a single engagement. Where earlier years were filed incorrectly, we prepare amended returns and the necessary disclosures.
Planning Before You Trade
Before you buy, sell or accept a call, we model both currencies, both tax systems and your carryforward credits. Furthermore, our treaty optimisation service identifies when a UK charge can be made creditable rather than wasted. That planning frequently saves more than the cost of the engagement.
Conclusion
AT1 bonds are a legitimate high-yield holding, but for an American in Britain they are taxed as debt in one country and equity in the other. The coupon is UK savings income at up to 45% and a US qualified dividend that still bears the uncreditable 3.8% surtax. Moreover, sterling issues escape UK capital gains tax entirely while remaining fully taxable in America, and a total write-down gives a sterling holder no UK relief whatsoever.
Therefore, the right approach is to hold AT1 bonds directly rather than through funds, track base costs in both currencies, plan disposals around the 10% sourcing test and report every foreign account. Ultimately, careful cross-border preparation turns an expensive mismatch into a manageable one. Professional bodies such as the ICAEW tax faculty and the Chartered Institute of Taxation publish useful background, but the numbers depend on your own portfolio.
Contact Us
If you hold AT1 bonds, CoCos or bank capital funds as an American in Britain, we can review your position and prepare both returns correctly. Please contact us to arrange a confidential review. Alternatively, email hello@taxyork.com or call 020 3488 8606 to speak with our US-UK tax specialists.
Disclaimer
This article provides general information about the US and UK tax treatment of AT1 bonds and other bank capital securities held by Americans living in Britain. It does not constitute tax, legal or investment advice, and it is not a recommendation to buy or sell any security. Tax rules, rates, treaty interpretations, court decisions and HMRC and IRS practice change frequently, and the correct treatment depends on the terms of each prospectus and your personal circumstances. You should obtain professional advice before acting. TaxYork accepts no liability for action taken on the basis of this article alone.