Why Canadian ETFs Can Be a Problem for U.S. Citizens Living in Canada
Ask a Canadian investor what they should own in a low-cost investment portfolio and Canadian exchange-traded funds (ETFs) will often be part of the answer. And mutual funds are still one of the most common investment vehicles for savers.
For most Canadians, there is nothing unusual about these products. However, a U.S. citizen living in Canada may face very different tax consequences from owning the same investment. The reason is a U.S. tax regime with an intimidating name: the Passive Foreign Investment Company rules, usually shortened to PFIC.
What Is a PFIC?
Canadian mutual funds and many Canadian-listed ETFs can qualify as PFICs for U.S. tax purposes. Owning a PFIC can result in additional U.S. tax reporting, complicated calculations, and potentially unfavourable taxation. In many cases, a U.S. citizen who owns a PFIC may need to file IRS Form 8621.
The default PFIC rules can also produce surprisingly punitive tax results. Rather than simply taxing a gain when you sell an investment, certain distributions and gains can effectively be allocated over the period you owned it and subjected to special tax calculations and interest charges.
In other words, an investment that looks completely ordinary on a Canadian tax return can become considerably more complicated on a U.S. tax return.
Can the PFIC Problem Be Avoided?
There are elections that can sometimes produce a better U.S. tax result.
One is the Qualified Electing Fund, or QEF, election. It generally requires specific annual information from the fund company and results in certain income and gains being reported annually. Some Canadian investment fund providers make the necessary PFIC information available for certain funds, while others do not. As a result, whether a QEF election is practical can depend on the specific fund you own.
Another possibility is a mark-to-market election for qualifying marketable investments. This generally results in annual taxation based on changes in the investment's value rather than waiting until it is sold.
These elections have their own eligibility, timing, and reporting requirements, so neither is automatically the right answer. The important point for an investor is to identify a potential PFIC before buying it rather than discover the issue years later. There may also be non-PFIC alternatives like individual stocks or bonds, or U.S.-listed ETFs.
The Account Matters Too
The investment itself is only part of the analysis because where you hold it can matter as well.
PFICs are often most problematic in taxable investment accounts and Canadian registered accounts that do not receive the same favourable treaty treatment as RRSPs and RRIFs.
The same Canadian ETF can therefore create very different U.S. tax and reporting considerations depending on the account in which it is held.
This is also why saying that U.S. citizens should never own Canadian ETFs goes too far. The type of investment, the account, the available tax elections, and the investor's circumstances all matter.
Don't Forget the Cost of Compliance
Tax is not the only cost to consider.
A relatively small investment might generate little additional U.S. tax but still require extra tax forms, calculations, recordkeeping, and professional preparation every year. In some cases, the cost of complying with the PFIC rules can be more significant than the tax itself.
Review Before You Invest
If you already own an investment that may be a PFIC, that does not necessarily mean you should sell it immediately. Selling can itself have tax consequences, and the appropriate treatment can depend on how long you have owned the investment and how it has been reported in the past.
The best time to identify a PFIC issue is before you invest. And if you are a U.S. citizen living in Canada, review not only what you own but where you own it.
Cross-border investing is not necessarily about avoiding Canadian investments. It is about building a portfolio that works in both countries rather than discovering after the fact that a simple investment created a complicated tax problem.
Need help with your Canada-U.S. cross-border financial planning?
If you are a U.S. citizen living in Canada, we can help you look at your finances from both sides of the border.
This article is intended for educational purposes only and does not constitute personalized advice. The strategies and information discussed may not be suitable for your individual situation or may not be up-to-date and current. Please seek guidance from a licensed professional for advice specific to your circumstances.
Blog Contributors
Recent Posts
Subscribe to our newsletter
Want to stay up to date with our most recents articles?
Sign up below to receive emails whenever we have a new story!