Dilemma of USC holding Canadian Mutual Funds

blairgoates · Post by **blairgoates** » Sat Mar 10, 2012 1:08 am

It seems to me that a USC holding Canadian mutual funds has a real dilemma. Assuming said mutual funds are passive foreign investment corporations and do not qualify as a Qualifying Electing Fund the options are:

1) opt for mark to market election which generates tax in US. The foreign tax credits cannot be applied in Canada since no corresponding taxable income is generated in Canada. Thus double taxation occurs when the funds are actually sold and taxed in Canada.

2) Sell the funds and and elect them to be treated as Sec 1291 excess distribution and go broke, ie pay excessive tax

3) Sell the funds, claim Canadian tax credits on US return and hope like hell that IRS doesn't audit and reclassify as Sec 1291 fund with excess distribution !

Do I have this right and what would you recommend ?

blairgoates · Post by **blairgoates** » Sat Mar 10, 2012 9:30 pm

No opinions? Surely others are dealing with this issue. Please email me your comments if you don't want a public post. I am very interested in other options and opinions.

Thanks

patti · Post by **patti** » Sat Mar 10, 2012 9:58 pm

For option 3, I wouldn't think there is any reason why FTC's for Cdn tax could not be applied to the sale. Now admittedly, they may not be enough to cover the full amount of US tax especially if a large portion is taxed at 35% (for prior years). Also, it won't help with interest penalties.

Here's another option:

4) Obtain Cdn citizenship (if you don't already have it). Keep the fund. Renounce US citizenship. Live your life in peace.

NickH · Post by **NickH** » Sun Mar 11, 2012 2:24 am

Patti, renouncing US citizenship does not affect outstanding tax and reporting obligations. blairgoates would be liable for US tax until he expatriates.

blairgoates, you're right, US citizens holding Canadian mutual funds is fraught with problems.

I read the Section 1295 treasury regulations for the QEF election and discovered that you must make the QEF election for your mutual fund AND any other PFIC the fund owns AND any PFICs they own, all the way down a chain of ownership, calculating your share of income for each fund. Good luck.

There is no such requirement for the mark-to-market election. However, you must mark-to-market each lot of stock separately. Furthermore, when you sell the fund you must consider the first bought lots of stock sold first. I've made a spreadsheet for this and it isn't pretty.

Both of the elections must be made on a timely filed return. If you bought the fund in 2011, this is no problem. Otherwise, you must coordinate a Section 1291 excess distribution with the MTM election for 2011. However, if you have money and a good accountant/attorney, you can obtain a private letter ruling to allow a late MTM election for the fund in prior years.

patti · Post by **patti** » Sun Mar 11, 2012 2:36 am

NickH - I was not addressing past tax obligations. The past is the past and blairgoates may or may not have legacy tax obligations to clear up. The question was about what to do with Cdn MFs now given future PFIC tax problems. So my answer stands. By renouncing, future tax problems disappear. Then he can keep his MFs and not worry about crazy PFIC rules any more.

blairgoates · Post by **blairgoates** » Sun Mar 11, 2012 11:03 am

Thank-you NickH and Patti for your comments.

It is my understanding to make the QEF election the fund must provide you information in approved IRS form and no Canadian mutual fund has qualified to do that because they must also adhere to SEC regulations which is added cost to them. Therefore this election is not an option.

Given that the QEF is not an option I believe I only have the three options as outlined in my original post.

Surely there must be other tax practitioners out there who are facing this dilemma with clients and I would like to know what they are advising.

Also, maybe I've missed the boat in my understanding of the situation and if so I hope to be set straight.

Thanks

NickH · Post by **NickH** » Mon Mar 12, 2012 12:50 am

A PFIC isn't required to conform to SEC regulations, they simply must compute ordinary earrings and capital gain "in accordance with U.S. income tax principles." The QEF election itself is actually quite simple: the fund provides a statement conforming to Treasury Regulations section 1.1295-1(g). The hard part is getting them and all the other PFICs down the chain of ownership to make that statement. Practically impossible.

Other than selling a PFIC immediately after purchase when you realize your mistake, the only practical choice is mark-to-market with first-in, first-out share tracking.

blairgoates · Post by **blairgoates** » Mon Mar 12, 2012 2:07 am

Thank-you NickH for your comments. I was not aware that some Cdn mutual funds were issuing statements if requested.

The problem I see with mark-to market is double taxation since the funds will be taxed in the U.S with no offsetting foreign tax credits then taxed again in another period in Canada when actually sold.

The best option is not to buy in the first place but if you have made that mistake and have held them for years I guess the mark-to-market is the way to go.

It's a hard sell to clients who want to just forget about them.

Thanks again !