Americans Living and Investing in Canada
There are approximately 1 million Americans living and working in Canada, with approximately the same number of Canadians in the U.S. Globally, Canada and the United States are the only developed economies to grant unconditional birthright citizenship. Canada’s tax system is based on residency (as are most developed economies) and the U.S. collects taxes based on citizenship. If you combine these factors along with the longest, friendliest international boarder in the world you can end up with some very convoluted tax situations.
A common issue for many US citizens living in Canada is the complexity of investing in PFICs. PFIC stands for passive foreign investment company under US tax law. PFIC investments are subject to punitive tax rules designed to discourage US taxpayers from potentially obtaining tax deferral benefits through non-US investment products. You may ask yourself what is a PFIC investment? This can get very confusing very quickly so I will endeavor to keep things as simple as possible.
An investment is a PFIC if it meets any of these tests:
Income Test
>75% of gross income for its taxable year is passive.
Passive income includes:
- Dividends
- Income
- Interest
- Capital gains
- Royalties
- Rents
- Annuities
Asset Test
>50% of the average percentage of assets held during the taxable year is assets that produce or are held for the production of passive income.
Canadian mutual funds and exchange traded funds (ETFs) are classified as PFIC.
You own a PFIC. What do you need to do?
When a US taxpayer holds a PFIC outside of a RRSP or RRIF account they are required to file Form 8621 for each PFIC. Investors should consult with their cross-border tax accountant regarding the various tax elections available.
- QEF election – can only use if the fund has elected to provide QEF information (pro-rata income allocation)
- Mark to market election – increase in investment value taxed as ordinary income year to year
- Do nothing (Section 1291) – pay tax at highest rate and pay interest
- Other elections are available for special situations
The PFIC election rules are very complex so it is highly recommended investors use a cross-border tax accountant for preparing these forms.
What is the qualified electing fund (QEF) election?
The qualified electing fund election allows a taxpayer to include their pro-rata share of income and gains of the investment in their US income. A taxpayer can only use the QEF election if their PFIC investment issuer has elected to report each investor’s share of the fund’s earnings and gains determined under US tax law.
A number of Canadian mutual fund companies have elected to report QEF information in order to make their mutual funds accessible to Canadian resident/US citizen investors.
A Canadian mutual fund provided QEF election information; does this resolve the PFIC problem?
This resolves the issue of possibly paying excess tax on unrealized income. However, Form 8621 is still required to be completed for each fund and the information is not necessarily easier to input. The fund will provide their QEF information through some public means such as their website so taxpayers may have to dig for the information or request it from the fund company. Raymond James Ltd. and Raymond James (USA) Ltd. are not aware of any fund companies sending QEF information directly to known US citizens.
Investors should take into consideration the higher expense to prepare multiple Forms 8621. QEFs may solve the excess taxation problem, but not the inconvenient compliance problem.
What are possible solutions to the PFIC problem?
Canadian mutual funds and ETFs should be restricted to RRSP and RRIF accounts as well it isn’t advisable to hold PFICs in TFSA or RESP accounts as they are treated as taxable accounts under US tax. The purchase of individual stocks and bonds is the best option as well as US domiciled ETFs.
Canadian licensed Raymond James Ltd. advisors who have also obtained appropriate U.S. licensing through Raymond James (USA) Ltd., are able to help American and Canadian investors with assets on both sides of the border consolidate their investment accounts and create a holistic cross border wealth management solution.
Sources: Raymond James Ltd. Private Client Solutions, the Globe and Mail, Financial Post, Wikipedia