Somehow I missed this which is shocking because I don’t normally miss anything. I will also add this letter was CCed to our friend Kevin Shoom at the Department of Finance in Ottawa.
The U.S. through the introduction of the Foreign Account Tax Compliance Act (FATCA) and other means is targeting activities in tax havens – Canada, with its long history of collaboration and effective tax-treaty agreements with the U.S., is clearly not in that category.
In this context we believe the application of PFIC rules, now and in the future, to Canadian mutual funds has a significant adverse impact on American mutual fund investors who are living in Canada. These include: payment of a higher than required level of tax; potential levying of punitive tax charges; and significant compliance costs due to the complexity of the regime. As a result mutual funds may be avoided as an investment and individual securities chosen instead as the PFIC rules do not apply.
Under U.S. PFIC rules, dispositions of Canadian mutual funds along with certain distributions from these funds are taxed at the rates that apply to earned income (as opposed to the preferential tax rates that apply to capital gains). Depending on the timing of the distributions and/or dispositions, punitive interest charges may also be imposed.
The complexity of the PFIC regime leads to significant compliance costs both for the American investor resident in Canada and the Canadian mutual fund company. Our concern is that when faced with the prospect of the punitive tax treatment and/or the additional tax return preparation costs, American investors will choose to divest themselves of their Canadian mutual funds rather than deal with the alternative.
The IRS estimates that 5 to 7 million American citizens reside abroad. Of that total, approximately 1 million American citizens are estimated to reside in Canada. The implementation of FATCA beginning in 2014 will likely increase the number of Americans residing in Canada who will file US tax returns each year. Although the intent of FATCA is to catch Americans evading U.S. tax by investing offshore, these rules cast a wide net, and will include compliant Canadian taxpayers who are Americans by birth and have lived and worked the majority of their lives in Canada.
As financial services companies in Canada will comply with FATCA, there will be a much greater awareness of who is a U.S. tax filer and how the U.S. tax filings are complicated by the PFIC rules for mutual funds – an issue not well understood to date.
Of course, it sounds so reasonable to us. I wonder if the US officials will simply think the best course of action is the one that nets more $ for the US gov. I expect they will. After all, why make things easier for all those tax cheats/traitors who live abroad?
A really great letter. The PFIC rules are devastating because PFIC income is treated as a separate class of income and not eligible for offset by foreign tax credits either in the US or in the home country (at least as I understand it). It creates blatant double taxation. If I sold all my PFICs, I would be facing marginal rates of 86-89.6% on my gains and effective rates well into the 100-150% territory since they are all under the excess distribution regime and would have many years of back interest applied.
I thought the position of the OECD was interesting – “The Organisation for Economic Co-operation & Development (OECD) in principle is sensitive to these sorts of issues and has adopted the position that
an investment in a collective investment vehicle should not result in a different incidence of tax than if the securities were owned directly.”
Sadly, even if you are US resident, the US has adopted a stance in opposition to the OECD with the rules on qualified dividends and ordinary dividends meaning you can pay a much higher rate of tax on a dividend through a collective investment vehicle than if you owned the underlying shares.The PFIC rules which are just an abomination.
@Tim thanks for finding this.
@Edelweiss great comment.
Let me add the following:
There may be some who think Ederweiss is exaggerating the problem. He is NOT. The PFIC rules are NOT rules of taxation. They are rules of confiscation. What is fascinating about “PFIC” confiscation is the history of the regulations or rather lack of them.
PFICS appeared in the law as part of the 1986 tax reform I suspect (and have seen similar suggestions from others) that they were in part a result of a lobby from U.S. investment funds to keep homelanders from investing outside the U.S. So, they are likely one more example of those with money “buying a favor” from their elected representatives.
Regulations: As of this date, (unless it is very recent) the IRS has not finalizede any PFIC regulations. All there is a decision of an IRS counsel in 2010 which said that a Canadian mutual fund was a corporation – and by inference a mutual fund because it was a corporation – is a PFICorporation. In other words, mutual funds are PFICs because an IRS lawyer says so.
Now what is incredibly problematic is that the “cross border professionals know this”. Yet, they are behaving as though the law is that Canadian mutual funds are PFICs. Without a regulation (which the IRS is bound by, but you are not) or a clear statement in the law that a Canadian mutual fund is a PFIC, you are free to take whatever position you want. Now, I am not saying that a Canadian mutual fund is NOT a PFIC. I am simply saying that the first indication of this came in 2010 and there are no regulations that say that it is. Yet, the accountants and lawyers (particularly those in the US) are simply doing the bidding of the IRS. Those who could be seriously affected by this (and this is anybody who has owned mutual funds for a long time) should consider this point. Have a conversation with your advisor. Ask them where in the law it says that a Canadian mutual fund is a PFIC. Ask why, all of a sudden in 2010 this new form of confiscation magically appeared from the heavens.
Now on the issue of the “OECD”. One of the reasons that US tax laws are a problem is that they operate in direct opposition to the retirement planning laws of other countries. Here is the principle:
US tax laws are designed to punish any form of tax deferral.
Canadian and other countries tax laws are designed to facilitate retirement planning through tax deferral.
In other words, US tax laws, of which the PFIC thing is just one possible example, are designed to directly attack the ability of people to save for retirement. They are so complicated, so punitive, so irrational and so hard to believe, that most countries considering the IGA issue don’t even understand what it is that they are dealing with.
Now on this particular submission. It was nice that they took the time to write. But, I would point out the whole submission is completely to benefit them because they don’t want to do the paperwork. They want people to invest in mutual funds so that they will get the business.
Finally, the person who wrote this letter clearly does not understand how the taxation of these things (assuming they really are PFICs) really works. Not only are the gains not taxed at the capital gains rate, but they are taxed at the highest marginal rate that exists. The highest rate that exists.
To come full circle: PFICs are not about taxation. They are about confiscation!
@US Citizen Abroad
Further to your point about the US penalising retirement savings, one of the odd distinctions about US mutual funds versus most any other collective investment scheme outside the US is the US requirement to distribute realised capital gains. I’m pretty sure that any collective investment vehicle that does not distribute realised capital gains is automatically a PFIC.
The tax treatment of collective investment vehicles is a huge driver in the explosion of ETFs and index funds since they are far more tax efficient (in addition to offering lower fees) than mutual funds because they have very little turnover of the underlying holdings and therefore distribute very little in the way of realised capital gains.
“I’m pretty sure that any collective investment vehicle that does not distribute realised capital gains is automatically a PFIC.”
Well, the point is that nobody knows for sure. Your comment about how this drives the market for ETFs and index funds in interesting. I know that in the UK, advisors talk about a “tax compliant” portfolio (and they are talking about US tax).
I am waiting for somebody to liquidate their mutual fund portfolio, take the position that it is ordinary capital gain and fight it. There are strong arguments for why mutual funds meet the PFIC test, but … they are just about the confiscation of assets, nothing more.
What are people in the UK doing about this problem?
Thank you everybody for your great analysis. This is valuable information worth passing around. (Sorry if I sound like spam, but it’s true :-)).
“In other words, US tax laws, of which the PFIC thing is just one possible example, are designed to directly attack the ability of people to save for retirement. They are so complicated, so punitive, so irrational and so hard to believe, that most countries considering the IGA issue don’t even understand what it is that they are dealing with.”
Has Kevin Shoom read your analysis?
@bubblebustin, Kevin Shoom and the rest of those at Finance must already be aware of the tortured history of the Canadian RRSP and the IRS, as well as the other savings vehicles (TFSA, RESP, RDSP, etc.) the US refuses to exempt from draconian and labyrinthine ‘foreign trust’ status, reporting and penalties.
The PFIC rules should be known to those responsible for negotiating tax treaties with the US.
And if they know and do nothing, then that makes them complicit. The Harper government refuses to highlight it in public in order to warn us and the rest of the > 1 million Canadian families affected – as well as Harper and previous governments being unable or unwilling to do anything to stop the punitive and torturous US treatment of our Canadian savings and investment options – even though in the long run, it is in Canada’s interest to encourage us to amass assets for retirement and disability.
You have the option of having the holdings treated under the excess distribution regime which has advantages and disadvantages compared to the mark to market regime where the increase in value in USD is taxed every year. The advantage is that dividends of less than 125% of the 3 year average are treated as ordinary dividends and only the excess over 125% is taxed at the highest marginal rate (at least I think this is the case). An additional advantage is that the excess distribution regime applies only to distributions. The UK market has the distinction of Accumulation class and Income class shares. Income class shares pay a dividend while Accumulation class shares do not. As such, only the funds in Income class shares are subject to taxation under the excess distribution regime while the Accumulation shares are not and all of those gains are fully tax deferred. The disadvantage is that the excess distribution regime will wipe you out totally if you intend to maintain your US citizenship. When you sell an excess distribution regime holding your gain (in USD, of course) is allocated evenly over the holding period and taxed at the highest marginal rate in each period with interest applied to the tax owed in each period. If you have a long holding period of say, 5 or 10 years or more, you’re $*&@£%. A 6% interest rate on the tax owed will double the tax owed in 12 years from a 36-39.6% marginal tax rate to 72-79.2% effective tax rate. You also can’t offset any of the gains with losses from other PFICs in contrast to regular capital gains (not sure if this is the case with mark to market regime). In a nutshell, the excess distribution regime can save US tax today but at the expense of an almighty day of reckoning.
My UK advisors told me I had PFIC holdings and I didn’t dispute this. They’ve since been replaced due to their crapness. My US advisor didn’t adopt a different stance.
I’ve never investigated a “US tax compliant portfolio”. I presume that such a portfolio invests in US mutual funds and/or US ETFs and/or individual shares (to take advantage of the qualified dividends rate) and also does reporting to the IRS. I also presume that such a portfolio would come with disproportionately high fees.
Thanks didn’t know about the two different types of UK mutual funds. That does provide better opportunities than in Canada. Thanks also for highlighting what happens on the sale – i.e. the “capital gain”:
1. Being taxed at the highest possible rate for the year; and
2. The gain being prorated over each year of the holding period; (and just so that your point is clear to all)
3. Interest is applied to and from each year of the holding period. They treat you as though you owe them money because the gain was not distributed each year – this is absolutely criminal.
You are giving a great description of this in all its “retirement destroying horror” but here is how it can be EVEN WORSE and will be for a certain class of person – particularly in Canada.
Kevin Schoom are you listening?
Many people in Canada own corporations. In fact, it is advisable for many professionals to carry on business in this way. Those corporations with investment income are subject to the Subpart F anti-deferral rules. If somebody is subject to both the Subpart F and the PFIC rules (yes this is possible) that person has one and only one option. Here is the option.
You go out and you buy a gun. You spend one last evening with those who are close to you. You then blow your brains out!
I am not kidding.
This is what the most financially responsible Canadians have in store for them when they find out about this. When will they find out? If the Harper Government signs an IGA with the US.
I do NOT believe that the Government of Canada understands this problem in its entirety. Would you be willing to collect these comments (including the one about the interaction between PFICs and SubPart F), perhaps organize them and send them to him. I don’t think he will believe it, but anyway.
If not, let me know and I will attempt this later. To be honest, I am just too angry (Sometimes I really upset myself when I write this stuff) at the moment.
If not, I will do it down the road when I am less angry.
I’d be happy to submit this to Kevin Shoom. It might take a day or two for me to sit down for that long right now. Just let me know if your anger subsides enough for you to do it yourself in that time 😉
You go ahead, if I think about this for one moment longer, I might take my own advice.
HEAVEN FORBID, USCitizenAbroad!
WE NEED YOU TOO MUCH!!!
@USCitizenAbroad and bubblebustin,
Just reading your dialogue is making me want to take USCitizenAbroad’s advice – not serious – but this whole US citizen-ship based taxation, PFIC, FBARs, FATCA, foreign trust, Canadian mutual fund mess is crazy-making. I wish Kevin Shoom was a US person! The only way to really ‘get it’ is to be one. The only way to really get persecution is to be persecuted, and that is what is happening to ‘US persons’ in Canada and throughout the world, except I doubt most of those affected (at least in Canada) even know about it yet.
I worry that when/if the banks start shaking out their ‘US person’ clients in Canada starting Jan 2014, there will be people who actually do take gun in hand to solve their unsolvable problem. We at IBS have had the ‘privilege’ and torture of having advance warning and somewhere to turn when we can’t take it anymore (i.e. support here at IBS), but imagine those who first find out about this whole ridiculous, unjustified, mind-bending jihad from the ‘nice lady at the bank’.
USCitizenAbroad and bubblebustin. Thank you for explaining all this. It is an aspect of this that I don’t really understand very well.
I appreciate learning more about this so that I can explain it to others.
It is very ironic that the next US ambassador to Canada will be a big US banker http://www.cbc.ca/news/world/story/2013/04/03/pol-us-ambassador-to-canada-obama.html . Is the US run by Goldman Sachs? http://www.opensecrets.org/industries/indus.php?Ind=F http://online.wsj.com/article/SB10000872396390444752504578024661927487192.html
A US banker would understand all this – but surely won’t use that understanding to help any US citizen/taxable persons in Canada – as an appointee, ally and funder of FATCAnatic Obama and Co. And Jacobson will be moving to his role at BMO http://www.cbc.ca/news/business/story/2013/05/21/business-us-ambassador-bmo.html – but I doubt that he will use his experiences dealing with the unrest over FATCA in Canada, and his new finance role to illuminate for his buddies – Obama, the Democrats and others in the homeland just how restrictive and punitive the rules are that bind all of us living outside the US from saving for our family, children’s education, and our old age.
The US is fully aware that what we’ve got isn’t illegal, or money laundering, or criminal, or terrorist funds. It’s all about rationalizing the confiscation of our post-tax legal Canadian assets – whether via extraterritorial double taxation or via draconian penalty structures. And if it also discourages US homelanders from investing money outside the US, well, that’s gravy to a US banker.
And what did Obama say about FATCA and DATCA during this meeting “…The CEOs of some of the biggest banks in the world…” met “..privately with President Barack Obama today, according to a Bloomberg report….”? http://www.bizjournals.com/jacksonville/news/2013/04/11/president-obama-meets-with-bank-of.html One of the participants was “….Bank of America … the largest bank in Northeast Florida, with 37 local branches and $20 billion in area deposits for a market share of 45.5 percent….” who of course would be part of that Florida Bankers Association lawsuit against the Treasury department http://www.orlandosentinel.com/mobile/os-florida-bankers-sue-irs-over-foreigner-rule-20130422,0,7733215.post to protest against ‘DATCA’ the domestic US version of FATCA .
USCitizenAbroad, you’ve done so much to help others here. Take good care of yourself too. We must come through this and not let the US rob us of anything more or ourselves and our wellbeing than it already has.
Absolutely. USCitizenAbroad, every word you’ve contributed to this site and on yours speaks my exact feelings. You will never know how much you help others!
@US Citizen Abroad,
Hang in there! Do take care. I know it’s hard to really relax with this garbage in one’s life, but maybe taking a break will help. But don’t stay away to long — you post excellent helpful material, both here and on your site. Best wishes.
Please all take care of yourselves and loved ones. I am absolutely a minnow who chanced on IBS when struggling to deal with my own sudden awareness. It is with a mixture of horror and fascination that I read the posts of much more financially adept persons than myself. I learn fast and this has been a major learning experience for me. I pass it on to those who have half an ear and I do believe awareness is spreading – once again, take good care of yourselves for the sake of all of us.
There is an easy way to deal with PFICs, professional corps and subpart blah blah blah, FUBAR, 1040 8854 etc.
Ignore it all. This whole mess was desighned for USCs residing in the US or those bent on leaving the US. It’s an extraterritorial money grab. If you are a Canadian citizen without US assets, you are protected. Don’t tell your FI if you happen to have been born in the US. Don’t have more than 1 million in one account. Bob’s your uncle. Sauve qui peut.
1. If you have a non-US address you nowadays can’t buy US Mutual Funds, even for IRAs.
2. As a US Person you can’t buy non-US Mutual Funds easily any more either.
As a result, just get over it and buy shares/EFTs/ADRs on NYSE/NASDAQ … you will get nice 1099’s and it will make your reporting requirements during tax season easier. It also supports US economy, since you invest in US markets/exchanges. Go where your money is welcomed, and discard it from where it’s not welcome.
@Bubbllebustin @Calgary @Badger @Pacifica
Re comment – this shows the problem with the online world and how things can be misinterpreted. Not intended to be taken literally. That said, @Bubblebustin would really appreciate it if you would write Kevin Shoom.
Regardless, thank you for your kind sentiments – much appreciated.
That all works well for people who are not already in the U.S. tax system. It doesn’t work so well for those who are. A big part of the problem here is that there are U.S. citizens abroad who have been (so they thought) U.S. tax compliant for years. Then all of a sudden there is a 2010 policy change that tax professionals are interpreting to apply retroactively. This is one more example of how the people who did their best to be tax compliant are the ones who are being hurt the worst.
Question for you? What would you expect a U.S. person with many years of filings in the system to do?
A. Just stop filing
This is the problem for that group. It is obvious that one should not perjure oneself. So, I ask you again: How is the person who is well entrenched in the system to deal with this?
The management fees on mutual funds make them a bad investment, particularly in a low interest rate environment. The problem is for the people who already have them and have had them for years.
I don’t think anybody would buy mutual funds today regardless of tax issues. They are the first victim of years of low interest rates.
But, it is interesting that when it comes to Americans Abroad, they are disabled from effective retirement planing.
Again the problem with mutual funds is NOT the inability to buy them – it’s the inability to exit from them without financial ruin.