Cross posted from RenouceUScitizenship
Warning!! If you don’t want to read this whole post, but want only to understand the bottom line, read this comment. – Furthermore, if you care about your fellow man, spread this information far and wide!
US uses #americansabroad to exact tribute from other nations isaacbrocksociety.ca/2012/06/12/the… and #PFICs + renounceuscitizenship.wordpress.com/2012/06/12/how…#FBAR #FATCA #OVDI
— U.S. Citizen Abroad (@USCitizenAbroad) June 13, 2012
As I finish this post I note that our very own Petros has written a wonderful post on the same theme. I begin by borrowing from his post where he notes that:
I have maintained that the actions of the United States government in recent years, reaching across borders to exact tribute from subjects who live within the jurisdiction of other sovereign countries, are hostile acts; this extra-territorial tax crack-down is potentially a casus belli. In earlier epochs, nations went to war in order to exact tribute. We are witnessing the United States presiding over the destruction of the world order which it was instrumental in creating after the end of World War II. It is only a matter of time before the nations realize that the United States has attacked them on several fronts in this financial war. Perhaps journalists will be the last to know, as most of them still seem to have a man crush on President Obama.
Exactly 200 years after the war of 1812, the U.S. appears to be on the attack again. How? By sending its citizens to other countries and then “exacting tribute” from them in a way that harms other governments.
Interestingly, this week, the following comment was on the ACA Facebook page:
I say with every ounce of facetiousness I can muster up: Every government of the world should stop letting Americans come to reside in their country. Eventually the ones that have slipped in before the draw bridge was raised will die off, leaving each country sanitized of these toxic elements. No more punishment for leaving the homeland, no more drain on anyone’s resources trying to hunt us down. Citizenship based taxation, the sacred cow of stupidity.
The author is correct. Countries must protect their sovereignty. Therefore, U.S. citizens should be banned from immigrating to any other country. U.S. citizens are a threat to the fiscal stability and sovereignty of any country. There are a number of reasons: including the inability of U.S. citizens to participate in normal financial planning and other vehicles of self reliance. I intend to do a series of posts exploring this theme. Today (as we get to the June 15 tax filing deadline) I offer you the “PFIC Edition”.
Lately I have been reading about the shortage of labor in Alberta. The suggestion is that this shortage could be helped by bringing U.S. citizens to Alberta. U.S. workers can come to Canada pursuant to NAFTA or by seeking to become permanent residents of Canada. Some of them will eventually become Canadian citizens and some may not. U.S. citizenship-based taxation means that the U.S. citizen in Canada will be subject to all tax reporting and information return requirements. Most countries use their tax laws as a way to encourage people to save for retirement, save for home, etc. You will see that the opportunities for U.S. citizens to do this are far more limited.
Financial Planning in Canada – The hallmark of smart financial planning in Canada is tax deferral
In Canada the public policy objective of encouraging responsible financial planing and savings is accomplished through a variety of vehicles that allow for the deferral of tax. This is accomplished in one of two ways:
1. Allowing an investment to accrue “tax free” until it is distributed. Examples include: RRSP, TFSA, RESP, etc. (in the case of an RRSP the contributor is even allowed a tax deduction in the year of contribution).
2. Allowing the use of a Canadian Controlled Private Corporation which allows for a threshold amount of income to be taxed a lower rate. The result is that one can accumulate a pool of investment capital more quickly. ( I think the “long run” value of this is dubious.)
In other words, the hallmark of smart financial planning in Canada is to invest and save in a way that defers tax.
The U.S. Tax System is designed to attack investments that are designed to defer tax – it is the opposite of Canada’s tax system
The U.S. Canada tax treaty seems to have carved out an “exception” for RRSPs (just make sure that you meet the “Form Nation” form requirement) making it possible for U.S. citizens in Canada to have an RRSP. That is the only “tax deferral” investment that the U.S. allows. For example, although a TFSA is a smart vehicle for retirement planning in Canada, it is not tax deferred in the U.S. In other words, income in the TFSA is reportable every year in the U.S. This means that a U.S. citizen in Canada who owns a TFSA is required to pay tax on income (assuming it stays in the TFSA) that was never received. This destroys the whole point of the TFSA. Now the question becomes: from a practical point of view how much tax is actually payable. It appears that all of it is taxable. Why? Investment income is NOT covered by the earned income exclusion. My primary point is that TFSAs provide an opportunity for a U.S. tax to be payable on income that was never been received. This is a major problem.
Note also that I am concentrating only on the tax implications of investments. As you know, the penalties for failing to report these investments are “life altering”. For those who are dying to read more: I offer you “Looking for Mr. FBAR“.
Investments that are particularly problematic for U.S. citizens in Canada
Mutual Funds = Tax Cancer: U.S. citizens should invest only in mutual funds that are in the United States!
Now for the record, my experience is that most mutual funds are bad investments. Although one cannot predict the future, my guess is that we are going to be in an long investment environment that has a “low rate of return”. The return on GICs is very low. Yet the management fees on Canadian mutual funds are very high. Although this post is not about evaluating the quality of investments, it is hard to make a case for investing in mutual funds. Furthermore, I want you to feel better with what I am about to tell you.
Canadian Mutual Funds = PFICs for U.S. Tax Purposes = The most punitive tax ever
The bottom line is that when it comes to PFICs you will be taxed:
– at the highest marginal tax rate (even as a capital gain)
– on money you actually receive
– on money that you did NOT receive but are deemed to have received
– and will be subject to the endless mindlessness of the “Form Nation” forms
That’s all you need to know. But, for those who want to understand a bit about PFIC:
There are two issues:
1. What is a PFIC – Explained by taxplannercpa.com
While many portions of the U.S. tax code possess confusing and sometimes harsh rulings, the tax regime for Passive Foreign Investment Companies (PFIC) is almost unmatched in its complexity and almost draconian features. Countless times, our international clients have come to us to prepare what they thought would be straightforward tax returns- only to later learn that the small investment they had made in a non-US mutual fund was now subjecting them to all the concomitant filing requirements and tax obligations. While it is beyond the scope of this article to cover all the numerous details related to PFIC reporting requirements, my hope is to provide guidance and insight into the world of PFICs.
History
The PFIC tax regime was created via the Tax Reform Act of 1986 with the intent to level the playing field for US based investment funds (ie mutual funds). Prior to the legislation of 1986, U.S.-based mutual funds were forced to pass-through all investment income earned by the fund to its investors (resulting in taxable income). In contrast, foreign mutual funds were able to shelter the aforementioned taxable income as long as it was not distributed to its U.S. investors. After the passage of the Tax Reform Act of 1986, the main advantage of foreign mutual funds was effectively nullified by a tax regime that made the practice of delaying the distribution of income prohibitively expensive for most investors. To employ this punitive regime, the IRS requires shareholders of PFICs to effectively report undistributed earnings via choosing to be taxed through one of three possible methods- Section 1291 fund, Qualified Election Fund, and Mark to Market election.Basics
Defined in the Internal Revenue Code (section 1297), a Passive Foreign Investment Company is any foreign corporation that has either:
1. 75% or more of its gross income classified as passive income (i.e. interest, dividends, capital gains, etc…), or
2. 50% or more of its assets are held for the production of passive income.While there are a few exceptions to above rules, most foreign mutual funds, pension funds, and money market accounts would be good examples of PFICs. Furthermore, many foreign REITS also get trapped in the PFIC web. Finally, a foreign holding company that possesses passive investments (like rental real estate or government bonds) would be subject to PFIC regulations if the company was set up as a corporation.
PFIC related information is reported on Form 8621 .
2. Is a Canadian mutual fund a PFIC – Explained by Terry Ritchie
Notice that the assumption that a Canadian mutual fund is a PFIC is the result of a 2010 IRS policy review! Yet, the IRS will treat a mutual fund owned prior to 2010 as a PFIC compounding the unfairness!
What about U.S. citizens who own Canadian mutual funds? Last year, the IRS changed its view of the U.S. tax treatment of foreign mutual funds. Starting in 1986, many Americans used foreign mutual funds to gain tax deferral on income that wasn’t distributed to them. Thanks to the lobbying efforts of the mutual fund industry, the government enacted a new set of complex rules regarding Passive Foreign Investment Companies. A PFIC exists when 75% or more of its gross income for the taxable year consists of passive income or 50% or more of the average fair market value of its assets consists of assets that produce or are held for the production of passive income.
Passive income includes dividends, interest and its equivalents, passive rents and royalties, annuities, gains from the disposition of stocks and securities and other assets, certain gains from commodity trading, and certain foreign currency exchange gains.
As a result of the 2010 IRS policy review, the IRS issued Chief Counsel Advice 201003013, stating Canadian mutual funds should be classified as corporations for U.S. tax purposes. Therefore, if an American citizen receives income from a PFIC or sells a Canadian mutual fund that is a PFIC, U.S. tax and interest penalties could apply.
U.S. citizens in Canada should not invest in Canadian mutual funds! In the words of Bradley Kirschner:
“There has been a lingering question about the US tax treatment of Canadian Mutual Funds in taxable accounts. This discussion does not apply to investments in RRSP accounts. In early 2010, the Internal Revenue Service issued a determination that most Canadian Mutual Funds are corporations for US tax purposes, even though they are organized as trusts under Canadian law. Because they are corporations, most Canadian Mutual Funds are Passive Foreign Investment Companies (PFIC).
A PFIC investor has burdensome US tax reporting as well as potentially confiscatory taxation. If a PFIC provides certain required information, the tax burden can be lessened, but this is not practical for must Canadian Mutual Funds.
There are two solutions—one short-term and one permanent. On a short-term basis you can report income on a “marked to market” basis in your US income tax return. This means that the change in value during the year will be reported as ordinary income. This, of course will, require additional valuation information each year, but it will avoid potential tax and interest charges that have the potential to exceed 100% of the income from the investment.
The second solution, and the one I recommend is divest your portfolio of all foreign mutual funds and invest in individual security issues. While this may not sound like a sensible solution for the Canadian investor, but it is the price of being a U.S. taxpayer.”
Conclusion: U.S. citizens cannot benefit from the same financial planning rules as other Canadians. U.S. Citizenship-based taxation does violence to the policy of the Government of Canada that its citizens/residents save for retirement and participate in responsible financial planning. This increases the likelihood that U.S. citizens in Canada will be dependent on the government for support. Canadian immigration policy discourages immigrants who are likely to impose undue costs on other taxpayers. For example, applicants who are believed to impose high costs on the health care system may not be given “permanent residence” status. The fact that U.S. citizens in Canada are disabled from effective financial planning is a strong reason why the Government of Canada should not allow U.S. citizens to immigrate to Canada!
This is another example of how citizenship-based taxation imposes a cost on the governments where U.S. citizens may reside!
Stupid is as stupid does
I know that the U.S. does not care about its citizens abroad. But, the fact is that U.S. citizenship-based taxation is very harmful to the U.S. economy. Some advice for the U.S.:
It is interesting that the PFIC rules are essentially anti-competitive. They must therefore be a direct violation of the NAFTA treaty. But as Arrow points out, the US doesn’t give a damn about NAFTA when it suits them.
Excellent work! You Facebook ACA contributor offers some very good advice 😉
*There is an additional aspect to these instruments for retirement–such as IRA’s and their equivalents in other countries. The funds immediately eliminate movement, by creating a 10% withdrawal penalty (in the US case) under the guise of forcing people to plan for their retirement. But with all the scandals, my mutual funds have lost money in the last 20 years. I now have no gains and no good method of moving my original investment out of the IRA’s til I am 59.5 yrs old. These programs lock money into their homeland financial systems.
Why should a person be penalized for opting out of a retirement plan?
Re: “As a result of the 2010 IRS policy review, the IRS issued Chief Counsel
Advice 201003013, stating Canadian mutual funds should be classified as
corporations for U.S. tax purposes. Therefore, if an American citizen
receives income from a PFIC or sells a Canadian mutual fund that is a
PFIC, U.S. tax and interest penalties could apply.”
Should we have the chief counsel of the IRS on speed-dial every time we want to contribute some savings for our families? Should we have a crystal ball, so that we can determine what the IRS will decide in the future, that will be backdated to penalize us years into the past?
How can US ‘persons’ ‘abroad’ make sound savings decisions based on the ever-present possibility of retroactively punitive judgements and ever-capricious whims of the US IRS? Have they got a form yet to report assets kept under our mattresses, or buried in the ground – like pirates? No doubt that will come – and be designed to be retro-active. Wait, have they considered imposing pre-natal taxation yet?
The US, is telling me what I am ‘allowed’ to do to survive old age and disability outside it’s borders, but won’t be providing me with any supports, or healthcare, or pension, or any other benefits. That places an extra burden on my non-US family, non-US country of permanent residence and other citizenship-of-choice. My fellow non-US citizens will be helping to support me with their non-US taxes, not my US brethren.
Great post. Amply illustrates the ridiculous history of these decisions –
almost all of which are designed to be punitive – retroactively. Am
looking forward to any parallel posts about the tortured history of the
IRS judgements on our other common savings options – ex. RDSPs, RESPs.
And any illumination of the reason why RRSPs finally were treated more
sensibly – but only if we fill in the same forms, year after year after
year, or pay 2000. for the privilege of a private letter ruling.
And the reasons for this has everything to do with ensuring the best deal for US financial institutions, at our expense. It has nothing to do with ‘fair’ taxation, or anti-crime, or any of those other disingenuous claims. It is price-fixing masquerading as a social contract.
I hope swisspinoy will be doing a post soon on the issue of how the US claws back Social Security from those who have earned it, if they work overseas and contribute to a foreign pension plan.
Yes the IRS is indeed stealing from other countries.
In France, like many countries, they give tax incentives to encourage savings for retirement and to encourage people to invest in real-estate and create housing for other French people. It is a sovereign French decision, using fiscal encouragement to stimulate a certain behavior among their citizens.
French citizens, who are also US persons, may not benefit from any of these initiatives because the US will top up and tax any tax free or tax-reduced investment.
Essentially, France will be subsidizing a social behavior and the IRS will be taking that subsidy and putting it in it’s pocket.
In this light, France should allow it’s citizens to OPT OUT of any subsidies and pay the tax directly to THEIR country, FRANCE, instead of having an outflow to the USA. I for one would sign up for the OPT OUT if I did not have the choice of renouncing US citizenship instead.
@Badger
Thanks for your comment. What people need to understand is that when it comes to U.S. persons investing in “foreign” mutual funds:
1. In the case of the individual holding the fund directly: the combination of the tax rate and the interest penalties (which vary on the holding period) can exceed the total gain from the fund.
2. In the case of the mutual fund being hold in a controlled foreign corporation (with a U.S. owner):
– the first tax hit will be to the U.S. shareholder as described in 1.
– then the corporation must pay the tax
In other words, it is possible that the total tax could in this case grossly exceed the entire gain from the sale of the fund.
This is incredible and is outright theft. I feel that we have a moral duty to get the word on this stuff out. It is absolutely essential that people who do not want to live in the U.S. renounce U.S. citizenship at the earliest opportunity. It is far too dangerous.
PFICs are the most dangerous thing to known to mankind – right up there with Mr. FBAR.
As I write this I can hardly believe this is for real – but it is NOT a nightmare. It is the reality of being a U.S. citizen.
Somebody should add this post and comment to all of the financial blogs in Canada.
Furthermore, these mutual fund companies do NOT warn people of this. If the mutual fund companies do NOT start adding warnings to U.S. citizens they will be soon be hit (and deservedly so) with class action lawsuits!
Please do your best to spread the word in the hopes of saving middle class families from financial disaster.
@renounceuscitizenship;
Very illuminating analysis – thank you for your good work. Will pass on to others. You’re right that it is immoral, unethical and outright theft. Was listening to a US citizen deliver a presentation on financial planning to other US citizens – all bad news regarding the downside of holding mutual funds, TFSAs, RESPs, RDSPs, etc. (far too late for many of us). Audience sat in extreme shock and widespread dismay palpable – obviously most had no idea. Hard pressed to offer any reasonable alternatives for saving.
@freeatlast;
Canada, (and the US) among other countries, offer the same/similar types of savings incentives you describe as promoted and engineered by France, for the exact same reasons. And, we’re penalized just like you, if we’re deemed US taxable ‘persons’ (not just citizens). So, if we’re US ‘persons’ INSIDE the US, we’re urged to save, and rewarded. But if we’re US ‘persons’ OUTSIDE the US, we’re penalized. That’s blatant systemic discrimination by the US – which purports to have some social contract with it’s citizens – but in fact treats us like chattel or indentured servants when we live abroad.
@renounceuscitizenship: “Furthermore, these mutual fund companies do NOT warn people of this. If the mutual fund companies do NOT start adding warnings to U.S. citizens…”
It’s actually pretty standard in the UK for mutual fund companies to try to prevent sales to US persons. For example:
with “U.S. Person” defined earlier in the document as either a US resident or a citizen.
Of course, this always appears in the small print of the Terms and Conditions that few folk read. And it’s very easy to gloss over the “or a citizen” part. But it’s there. And to be fair, I’m not sure what more these mutual fund companies could really do. Most UK investors these days buy funds through brokers, fund supermarkets, or some other “wrap”. That’s more like buying a share or an ETF, so mutual fund companies often have little or no real contact with their actual end customers.
How exactly do all of these “bilateral” tax treaties treat dual citizens, say somebody resident in Canada who is a Canadian-US citizen? Does Canada actually forcibly collect US tax on its own citizens who refuse to comply? Wouldn’t that be an implication that the Canadian government is treating their own citizens as a citizen of another country first and foremost? Or can Canadians basically just ignore the US entirely, not taking into account the various problems that may occur with opening a bank account, an issue which seems easy to work around there considering that you don’t need to show a passport or birth certificate to open an account?
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*Renounce,,, Is it possible to clarify the status of canadian mutual funds held within a RRSP? I have been told they are exempt from the PFIC rules so long as 8891 is properly submitted.
A taxpayer would submit his RRSP account number and balance but is not required to detail what is in the account.
I’ve also been told the opposite. Cheers.
@Chester, that’s a really good question. Is an RRSP always ‘just’ an RRSP, or does the underlying type (re GIC, vs. mutual fund, vs. etc.) override the RRSP type of reporting and forms required? If we’re trying not to fall into error, there should be clearer guidance.
@Chester
@Badger
The problem with the “is it possible to clarify” is that you ask a “cross border professional”. Now as you know, you need the form 8891 submitted (and somebody who has not been filing returns) would not have that form submitted. So, it seems to me that those people could be in trouble – but I don’t know.
What I have been told by “high priced” people who specialize in this kind of stuff is that as long as the form is properly filed (meaning it is an RRSP for U.S. tax purposes) that it doesn’t matter what is in it. This of course makes sense.
That said: I will tell you what I really think you should do. Get rid of the mutual funds so that you don’t have to worry about a rule change down the road. Frankly, IMHO most of them are such bad investments anyway, that one can do better in individual stocks.
So, cut and run (to use the words of Phil Hodgen) while the going is “semi-good”. Isn’t it pathetic that we can’t even get a binding answer on this question. My fear is that a binding answer is impossible because the IRS doesn’t know either and that’s why I would get out of them now.
So in conclusion:
If it turns out there is a PFIC problem, the problem will get worse and worse every day they are held so get rid of them.
If there is not a PFIC problem they are bad investments anyway, so get rid of them.
Seems to me that you should just get rid of them. But, hey – what do I know?
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Although it seems like a good idea to block US citizens from living abroad by refusing them residency, it could make some countries look overly discriminative. And it doesn’t help much for the ones already living overseas. Perhaps it would be better if the countries just pass laws that forbid residents from paying taxes to other countries for assets that do not reside in that country. Isn’t it a general principal of the US that US citizens should not break laws in other countries? And how could the US counter that? It’s impossible to force someone to break a law in another country.
*
@Heidelberger, as sane as your suggest seems to be, it would lead to further distress. Roger Conklin refers to his decision in 1977 to return to the US because Brazil had laws preventing him from paying his US tax–he had either to renounce his US citizenship or return to the US. The same would happen to nearly all the remaining US citizens abroad if countries passed a law like you suggest. This for the simple reason that US is so arrogant that it does not abide by its treaties, nor has it consideration for the laws of other countries nor for international law.
If the United States would just simply accept international law this whole problem would be solved. First, the United Nations Declaration of Universal Human Rights would prevent the US from doing what it is doing; secondly, the US also rejects both major international doctrines regarding dual citizenship (non-interference and dominant nationality). Truly, in the matter of extra-territorial taxation, the United States is a rogue. It is only because it has the most powerful nation in the world that it can maintain its veneer of respectability.