#PFIC and Canadian mutual funds revisted – Are they or aren’t they? http://t.co/H4gC8W0ciU
— US Taxation Abroad (@TaxationAbroad) October 23, 2014
Leaving aside the technicalities of “PFICs”, What you need to understand is:
1. Non-U.S. mutual funds are considered by many to be PFICS;
2. Certain controlled Foreign Corporations (in Canada your normal CCPC) may (depending on the assets and certain other considerations) be a PFIC.
The bottom line: PFICs are “tax cancer” and have the potential to subject you to taxes that exceed 100% of your gains (although in most cases it won’t be that high).
In any event, do NOT invest in non-U.S. mutual funds.
Those who already have “non-U.S. mutual funds” are advised to seek professional advice before selling them. To sell a PFIC is to create what is called an “Excess Distribution” which will taxed very very punitively. “Excess distributions” will result in very significant erosion of capital.
Note the following two comments about PFICs (A and B) in relation to a recent (July 3, 2012) article in the National Post.
(A) Prof. Krishna, thank you for your excellent article on this evolving story which affects up to 1 million Canadians (who happen to also have US citizenship). When you have time, you may want to report on the next controversy which will surely flare up … the dreaded “PFIC” or “Passive Foreign Investment Company” issue.Any Canadian who “comes clean” with the IRS will rue the day they had the audacity to own Canadian mutual funds or ETFs in their non-registered Canadian accounts. The IRS treats Canadian mutual funds and ETFs as “PFICs” or elaborate tax dodges and forces you to file onerous mini-tax returns for each one of them (Form 8621) … your accountant will charge you $500 per form. Even worse, the PFIC rules punitively tax your Canadian mutual funds and ETFs, thereby rendering them very poor investments.
Examples: your Canadian mutual fund went up in value by $1,000 this year? IRS will tax that “unrealized gain” as ordinary income. You sell your mutual fund at a profit? Taxed as ordinary income, not capital gains. Sell your mutual fund at a loss? Can’t use the capital loss against any other investment. In an instant, your portfolio of Canadian mutals funds/ETFs is decimated. What will thousands of Canadian/American dual citizens think when they see the negative impact on their investments? What will happen to Canada’s financial industry when 1 million Canadians have to sell their Canadian mutual funds and ETFs?
Canadians w/US citizenship will find that their rights to invest as Canadians are completely infringed by the US.
Personally, I’ve had to sell all my Canadian mutual funds/ETFs and redeploy my assets into individual Canadian stocks and bonds, which is the only way to avoid the PFIC nightmare. Yet another way the IRS will greatly complicate your life.
(B) Interesting article. I agree with TravelusMaximus1 he/she states:
“Any Canadian who “comes clean” with the IRS will rue the day they had
the audacity to own Canadian mutual funds or ETFs in their
non-registered Canadian accounts. The IRS treats Canadian mutual funds
and ETFs as “PFICs” or elaborate tax dodges and forces you to file
onerous mini-tax returns for each one of them (Form 8621) … your
accountant will charge you $500 per form. Even worse, the PFIC rules
punitively tax your Canadian mutual funds and ETFs, thereby rendering
them very poor investments.”
The point is right on, but to be specific:
As you know when when it comes to mutual funds you have issues on the sale (capital gains) and issues during ownership (distributions). The following is a description of how your basic Canadian mutual fund is taxed if you are a U.S. citizen.
First, the profit is treated NOT as capital gain but as ordinary income and is taxed at the highest possible rate (all of it not just 50% of it as is the case in Canada);
Second, whatever profit there is assumed to have been earned each year of the years of ownership. This means that you mut then pay an interest charge on the amount that is deemed to have been distibuted but was not.
Basically to the extent that the amount of the distribution exceeds 125% of the average of distributions over the the previous three years, you must pay another penalty-interest charge.
Bottom line: I have seen the tax returns of U.S. citizens where the amout of the tax exceeds the amount of the income.
This is the most unfair, punitive treatment known to man. You as a resident of Canada will be subjected to this if you (to use the words of TravelMaximus1) – “come clean” with the IRS.
The problem is first citizenship-based taxation. But the citizenship-based taxation is compounded by the decision to subject U.S. citizens abroad to the same rules as U.S. residents. Yes, Prof Krishna I would encourage you to write an article on this.
Incidentally, this is one of many incredibly unfair rules that U.S. citizens abroad are subjected to. U.S. citizens with Canadian corporations should take special note.
The only option for any U.S. citizen (with his/her eyes open) is to renounce U.S. citizenship.
The U.S. has the most unfair tax system in the world – bar none. If you are a U.S. citizen you need competent legal advice and you need to get it soon. FATCA is looming.