# For US citizens in Canada: mutual funds and form8621



## Rosepetal (May 20, 2013)

Posting this after discussion of PFICs and Canadian mutual funds in this thread earlier on this forum.

The upshot for those who haven't ever heard of this (like me earlier this month):
Canadian mutual funds are complicated for US tax filers.
They are PFICs and you have to file the insanely unreadable Form 8621 with your US tax filings for your Canadian mutual funds.

After much panic over the "mark to marketing" accounting option, which basically means acting as if you had sold the whole mutual fund every year BUT reporting the capital gain as ordinary income not capital gain, I think that if, like me, you have been just reporting your mutual fund dividends as dividends, and capital gain distributions as capital gain distributions, you probably want to make the QEF election. 

This is for those of you poor Canucks-with-US-filing-obligation who, like me, are already invested in Canadian mutual funds. If you're not, maybe it's better to look into the other investment options mentioned in the thread cited above.

Here is a helpful article written for Joe Consumer.. thanks, Fidelity! ( This comes from Fidelity Canada and is not applicable for non-Canadian residents):
http://www.fidelity.ca/cs/Satellite/doc/pfic_overview.pdf


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## BBCWatcher (Dec 28, 2012)

Rosepetal said:


> ....you probably want to make the QEF election.


If you can. As I understand it, the fund manager has to support this.


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## Rosepetal (May 20, 2013)

BBCWatcher said:


> If you can. As I understand it, the fund manager has to support this.


Yes, since FATCA most Canadian big financial institutions are beginning to realize how many "US persons" with filing obligations they have among their investors.... 

it pisses me off that it is the Canadian financial institutions that have to take on the burden of figuring out how to report to the US. You know this has to impact their cost of doing business, and thus their returns. So all Canadians are impacted by FATCA, not just those of us with US filing obligations.


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## BBCWatcher (Dec 28, 2012)

Rosepetal said:


> Yes, since FATCA most Canadian big financial institutions are beginning to realize how many "US persons" with filing obligations they have....


Ah, that's excellent news then.

One interesting, quirky option to explore is whether you still have the option to make mark-to-market elections on a QEF-reporting fund and, if so, whether that's a better option, bearing in mind the scenario I described of a hypothetical, typical "middle class" holder of a foreign mutual fund. As I understand it, QEFs mean you've got, for all intents and purposes, the equivalent of a U.S. mutual fund. M2M, in contrast, means you're resetting the cost basis on the entire holding. When you're highly shielded (via the FEIE, notably), you are in a good position to take some amount of M2Ms within your zero percent tax bracket. And that's a good thing to get the cost basis reset. Double check all that, but that's my understanding how it all works.

That particular form of tax optimization isn't _directly_ available if it's a U.S. mutual fund unless you engage in "tax loss harvesting" (or in this case "zero tax bracket harvesting"), and in order to do that you need to avoid running afoul of the wash rules. M2M-eligible QEF-reporting PFICs don't seem to have that shortcoming.

Note that, if you haven't been taking QEFs from the beginning of your holding, you have to "purge" the PFIC to then start taking QEFs.


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## BBCWatcher (Dec 28, 2012)

Rosepetal said:


> ....it pisses me off that it is the Canadian financial institutions that have to take on the burden of figuring out how to report to the US. You know this has to impact their cost of doing business....


I disagree with you here. They don't _have_ to do anything. It's up to each fund manager whether they provide QEF reporting. I assume that some do and some don't.

Likewise, it's up to each fund manager whether they can and do comply with, say, Australian tax reporting in order to be more attractive to Australian residents. Yes, there's some regulatory and reporting burden to market and legally sell a Canadian mutual fund in Australia. The fund manager can decide whether or not that's an undertaking that makes sense in their individual fund's self-interest.

You can insert any country in place of Australia in that example. It's the same principle.

However, if you think there ought to be a globally agreed standard for tax and financial reporting, so that financial institutions have a single set of reporting/compliance/regulatory standards to worry about in order to market and service their products globally, you and I might agree. That said, as I'm fond of saying, "Be careful what you wish for."  A globally agreed standard for tax and financial reporting would have some "interesting" side effects, and those side effects may not be entirely to your (or my) liking.

As one small example, if I'm correct, your non-U.S. QEF-reporting mutual fund is a bit better than its hypothetical (or actual) U.S. counterpart because, paperwork aside, there's a choice of M2M or QEF treatment without running afoul of the wash rule. So some taxpayers, particularly middle class taxpayers, can effectively make that non-U.S. mutual fund U.S. tax free, even upon ultimate disposition. Pretty cool. A globally agreed standard would presumably close that not-so-little loophole.


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## Bevdeforges (Nov 16, 2007)

OK, we are well aware of your satisfaction with the Best of All Possible Worlds and how the US handles taxation of their citizens. I think it might be nice if you would show some consideration for those in vastly different circumstances from your own who find the rules and processes onerous, complicated or a general problem.

The so-called GATCA (Global version of FATCA) is more likely to concentrate on non-resident accounts, since the US is the only major country that taxes based on citizenship rather than residence. And in many countries, accounts held by non-residents are already subject to different regulation than those of local residents.

In any event, we're not here to convince anyone of the Infinite Wisdom of the US Government or those Congresscritters who write these classics of legislation. We're here to try to help those with practical questions on the various "peculiarities" of the laws across all countries.
Cheers,
Bev


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## maz57 (Apr 17, 2012)

Rosepetal said:


> Yes, since FATCA most Canadian big financial institutions are beginning to realize how many "US persons" with filing obligations they have among their investors....
> 
> it pisses me off that it is the Canadian financial institutions that have to take on the burden of figuring out how to report to the US. You know this has to impact their cost of doing business, and thus their returns. So all Canadians are impacted by FATCA, not just those of us with US filing obligations.


One by one the big Canadian financial institutions are implementing a low cost solution to all of these US reporting complications. They are simply refusing to accept people with any sort of US filing obligation as customers. It will take a few years because the FATCA rollout is still in its early stages, but eventually all "US persons" will be ferreted out, eliminated as customers, and the "US problem" will no longer be the bank's problem.

Concurrently, permanent expats are shedding their US citizenship ASAP so they can live a normal financial life. (Either that or figuring out how to permanently hide their "USness".) The renunciation appointment line-ups at the US consulates in Canada are some of the longest in the world.

Thanks, US government, what a fabulous system you have created!


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## Nononymous (Jul 12, 2011)

maz57 said:


> Concurrently, permanent expats are shedding their US citizenship ASAP so they can live a normal financial life. (Either that or figuring out how to permanently hide their "USness".) The renunciation appointment line-ups at the US consulates in Canada are some of the longest in the world.
> 
> Thanks, US government, what a fabulous system you have created!


It's a small sample size, I admit, but a direct bald-faced lie to my investment advisor was enough to make the problem go away, for now. I'm pretty sure he knew I was not telling the truth. (Dual citizen, born in US to Canadians, living and banking in Canada most of my life.)


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## BBCWatcher (Dec 28, 2012)

Bevdeforges said:


> OK, we are well aware of your satisfaction with the Best of All Possible Worlds and how the US handles taxation of their citizens....


That's quite unfair. I never wrote or implied the arguments you suggest.

All I wrote is that, in short, paperwork aside, a QEF-reporting foreign mutual fund could very well have an exploitable U.S. tax advantage compared to its hypothetical or actual U.S. counterpart, especially for typical middle class overseas Americans, while still being U.S. tax comparable for everyone.

If I got the facts wrong, then point out where I made I mistake. But those certainly appear to be the facts.


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## shidareume (Mar 30, 2015)

There is no wash sale rule for gains, only for losses. So I don't see what advantage M2M confers here.


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## BBCWatcher (Dec 28, 2012)

shidareume said:


> There is no wash sale rule for gains, only for losses. So I don't see what advantage M2M confers here.


You just said it: avoidance of the wash rule for losses. As I understand it, the wash rule has a very low trigger threshold that can apply even if certain holdings are sold at a loss and others are sold with gains, particularly if you have a couple or more sales throughout the year. M2M occurs at the end of the year as a one-time event. Moreover, you have no trading costs (such as broker commissions) and no market non-participation with M2M tax accounting, so you can protect the yield better. And sales (versus M2M accounting) could trigger foreign tax liability anyway, so they're best avoided, especially in comparatively high income tax jurisdictions.

How big and important these differences and conveniences will be is situational, of course. I expressly pointed that out. But it's very interesting to me that a QEF-reporting foreign mutual fund has two non-sale options (M2M or QEF), as I understand it, and that you can choose whichever is more advantageous in your particular circumstances. It's an interesting little quirk that is potentially U.S. tax advantageous.


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## shidareume (Mar 30, 2015)

Sorry, I'm not following. Can you give a simple worked example to show what you mean?


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## BBCWatcher (Dec 28, 2012)

I can try. Let's try the example of a typical "middle class" American with a stint working overseas in Japan. This American earns $60,000 per year from work and $500 per year in miscellaneous other income (e.g. bank interest). This American is a single filer.

OK, this American invests in a pair of mutual funds in ordinary accounts (not tax-advantaged accounts, just to keep it simpler):

1. A U.S. mutual fund (e.g. Vanguard) with an initial contribution/value of US$10,000.
2. A Singaporean mutual fund with QEF reporting with an initial contribution/value of US$10,000.

Let's assume neither fund has interest/dividends just to keep the math simple. (Only for that reason.) For example, we can assume the fund managers invest only in incubator startups that pay no dividends. OK, now this American heads to Japan and becomes a resident there. His two mutual funds do really well and each rise in value US$2,000 per year. (Though the funds naturally bounce around a lot, and it's very difficult to time purchases and sales. Sometimes they go down first, then swing back up.) Let's suppose he spends 5 years in Japan. He then comes back to the U.S. and, in order to raise funds for a down payment on a new house, seeing that the funds are doing well at that moment, he sells both mutual funds. He should pay the same amount of U.S. income tax on both funds, right?

No, not actually -- or at least he need not pay the same rate of tax. First of all, in both cases there are no dividends, and both the 1099s and QEFs (as I understand it) would get reported as zero. (Though even if some QEFs got reported it wouldn't matter.) Singapore has no local income tax on passive investments, so even though it's Singapore source we don't have to worry about tax there in this example.

He has/had a couple choices with his Singapore mutual fund. The smart thing to do would be to take M2Ms instead of QEFs while he's living in Japan. That resets the cost basis each year, so when he gets back to the U.S. he'd only have a $2000 taxed gain instead of a $10000 taxed gain. His total $2500 of imputed passive income per year and his FEIE-protected $60,000 of earned income means zero U.S. income tax, and Japanese income tax isn't triggered on the M2M because there was no asset sale. That's all good stuff and all works well.

Could he do as well with his U.S. mutual fund? Well, he's got broker commissions to pay, and he's got timing problems. If he sells when there's a loss, he can't hop back into the same fund (or anything substantially similar). And/or he's got Japanese tax to pay when there's a gain, and that's at a higher rate (than zero, the U.S. rate in his circumstances while he's in Japan) and not deferred. True, he gets excess FTCs on passive income, but in this scenario he can never spend those excess credits, so no help there. If he doesn't sell each year to reset his cost basis then when he gets back to the U.S. and sells his mutual fund he's got a $10,000 taxable gain -- and more U.S. income tax to pay, most likely.

Hopefully you followed that, but there you go, that's pretty much how it works. If I'm correct, there can indeed be circumstances affecting a fair number of Americans that make QEF-reporting foreign mutual funds more U.S. tax advantageous than U.S. mutual funds held in ordinary accounts. In particular, it can happen when the American works overseas and then has a good opportunity to take M2Ms within a personal exemption, standard deduction, etc., particularly if outright fund sales would be foreign taxable (as in this example involving Japan, but that'd be true in many countries, even countries that have tax treaties).

Yes, this is a "surprising" result, but there you go -- sometimes the tax rules have surprising outcomes. Just as some people trade ideas on how to shop for the best bargains, some people trade ideas on how to avoid taxes legally.

By the way, I realize that this hypothetical Singapore mutual fund (unit trusts they're called here) doesn't necessarily have to be QEF reporting. It'd work just as well if this hypothetical American buys the mutual fund on Day 1 of his Japanese adventure. He's going to take M2Ms anyway, so the QEF reporting "protection" would be just a contingency.

Any of the tax preparers on this forum run into this sort of situation? Or have I stumbled into an interesting, quirky finding?


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## BBCWatcher (Dec 28, 2012)

I'll summarize the above in very short form. A foreign mutual fund sometimes offers the attractive option of allowing non-sale cost basis resets (mark-to-market) during periods of time when you have a low or zero tax rate (such as periods when working overseas and taking the FEIE), avoiding capital gains tax (especially foreign capital gains tax) during the resets and avoiding future taxes on gains. A domestic mutual fund does not offer mark-to-market cost basis resets unless you sell the asset, and the sale itself often triggers income tax.

Yes, that's "strange," but sometimes tax codes are strange and surprising.


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## shidareume (Mar 30, 2015)

Hmm, ok, you have found an unusual corner case of extremely limited usefulness. Though note that Japan won't tax that American's overseas income until that person has been here for 5 years, so you would need the person to be in Japan longer than 5 years for Japanese taxes to become a factor. And the wash sale rule seems irrelevant; if the goal is to use up a lower tax bracket, why would one sell in the case of a loss anyway?

The much more common case where 8621 comes into play will be where the existence of PFIC rules was not even suspected until after having made several years' worth of contributions to a local mutual fund, at which Section 1296 treatment rears its ugly head.


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## BBCWatcher (Dec 28, 2012)

Japan was just an example -- there are many other countries. Most countries don't have such a 5 year rule.

Yes, if you invest in something without fully understanding how it works (including tax implications) then it can be a costly mistake. That's broadly true, everywhere.


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