Passive Foreign Investment Company (PFIC) and Why You Should Avoid Them

Written by Carson Hamill CIM®, CRPC®, Associate Financial Advisor and Dean Moro BComm, CIM®, Associate Financial Advisor

If you are a U.S. citizen or Green Card holder and reside in Canada, you need to be aware of passive foreign investment company (PFIC) rules and the potential tax liability from owning them. This post will help educate you on this important investing topic. Questions we will answer in this article:

What Is Passive Foreign Investment Company (PFIC)
Why PFIC Exists
Who Is impacted by PFIC?
Impact of Owning a PFIC?
How Are PFICs treated in Registered and Non-Registered Accounts?
How to Avoid PFIC Issues as a U.S. Individual in Canada
To Avoid PFIC, What Should You Invest in?

What Is a Passive Foreign Investment Company (PFIC)?

A PFIC, is a foreign non-U.S. entity, with at least 75 percent of its gross income derived from non-business operations, like investments (the income test); or at least 50 percent of its assets are held for generating passive income (the asset test).

The most common examples of PFICs are non-American mutual funds and Canadian exchange traded funds (ETFs). Other PFIC examples include:

• Hedge funds - based outside the USA
• Startup’s – based outside the USA
• Insurance companies – based outside the USA
• Segregated funds – but this is not clear with the IRS
• Real estate investment trusts (REITs), unless engaged in an active business

PFICs are subject to harsh tax regulations by the IRS and often investors are not aware they have exposure to PFICs. PFIC reporting is required by U.S. citizens and Green Card holders who own shares or units of a PFIC at any time during the year and are required to file Form 8621 with the IRS. As this is an additional and often complex form, you will need to pay your tax advisor additional fees to prepare these.

PFICs and their shareholders are required to keep very accurate records of all transactions that the PFIC may earn, including:

• Cost basis
• Dividend received
• Undistributed income

Why the PFIC Rules Exist

The PFIC tax rules were introduced in 1986 with the objective of closing tax loopholes, as U.S. taxpayers sought offshore tax shelters to reduce their income tax. The goal of these reforms was to eliminate these loopholes and tax these offshore investments at the highest marginal rate, which would disincentivize taxpayers from participating in these types of investments.

Who Is Impacted by PFIC Tax Treatment?

A U.S. individual who owns Canadian mutual funds or Canadian ETF’s will be impacted by the PFIC rules.

A person is considered a U.S. individual if they are the following:

• U.S. citizen
• U.S. residents
• Green Card holder

Impact of Owning a PFIC?

If you own a PFIC investment, or have been reading about PFIC, you have probably heard about IRS Form 8621. Each year that a U.S. individual owns a PFIC they will need to file the IRS Form 8621.

IRS Form 8621 is very lengthy and complicated. The IRS estimates that Form 8621 may take up to 40 hours to complete. It is used to report gains, distributions, income and increases in qualified electing fund (QEF) elections. An IRS form 8621 is required for each PFIC, whether it was indirectly owned, or directly owned by the U.S. individual. Due to the complexity of the form, it would be very wise to work with a tax professional.

How Are PFICs Treated in Registered and Non-Registered Accounts?

PFIC rules apply to non-registered taxable accounts, as well as TFSAs, RESPs and RDSPs. Clients should discuss the treatment of PFICs in RRSP and RRIF accounts with their cross-border tax accountants, especially if they live in a taxable U.S. state.

It is always recommended that clients speak to a U.S. tax specialist about these procedures and filing obligations.

How to Avoid PFIC Issues as a U.S. Individual in Canada

If you are a U.S. individual living in Canada, the easiest way to avoid PFIC related issues is to avoid owning securities that qualify as PFICs. Avoid Canadian mutual funds and ETFs.

To avoid PFICs, what should you invest in?

As a U.S. individual residing in Canada, you can avoid PFICs by investing in the following securities:

• U.S. listed equities and bonds
• U.S. listed ETFs

Once again, it’s always best to consult a cross-border financial advisor to discuss an appropriate portfolio for your situation.

Next Steps

If you’re planning on moving to Canada and need assistance with your investments, estate planning, and portfolio management, please call or email us at Snowbirds Wealth Management as we specialize in cross-border financial planning and wealth management. We work closely with experienced cross-border lawyers and accountants to ensure you have a team behind you.

About Snowbirds Wealth Management

Gerry Scott is a portfolio manager and founder of Snowbirds Wealth Management, an advisory firm focussed on the cross-border market. Together with Dean Moro and Carson Hamill, associate financial advisors with Snowbirds Wealth Management, they provide investment solutions for Americans living in Canada, and Canadians residing in the United States. Licensed in both Canada and the U.S., they provide tailored investment solutions to minimize the tax burden when moving assets across borders. To schedule an introductory call, please CLICK HERE.

Statistics and factual data and other information are from sources RJLU believes to be reliable but their accuracy cannot be guaranteed. It is for information purposes only and is not to be construed as an offer or solicitation for the sale or purchase of securities nor is it meant to replace legal, accounting, taxation or other professional advice. We are not tax advisors and we recommend that clients seek independent advice from a professional advisor on tax-related matters. The information is furnished on the basis and understanding that RJLU is to be under no liability whatsoever in respect thereof.

Raymond James (USA) Ltd. advisors may only conduct business with residents of the states and/or jurisdictions in which they are properly registered. Investors outside the United States are subject to securities and tax regulations within their applicable jurisdictions that are not addressed on this site. Raymond James (USA) Ltd. is a member of FINRA/SIPC.