A simple algorithm for a QEF election on a Cdn Mutual Fund

[MGeorge]

I wanted to put this out there to see if anyone has some feedback on an idea that I had regarding 8621 reporting of Canadian mutual fund income. I apologize for the long post – but I am really interested in feedback if anyone can read through this.

It seems that the path of least resistance for Cdn mutual fund holders to stay in compliance with US tax laws is to take the “Mark-to-marketâ€￾ election. The big disadvantage being – it can lead to double taxation since gains in the US are not synchronized with gains in Canada – and there is no preferential tax treatment from any long term capital gains and dividends that one might be eligible to receive had it been a US mutual fund.

Reading the rules for the QEF election – it says quite clearly that a QEF statement is needed to properly make this filing election – or that sufficient information must exist so that the tax payer can calculate the required amounts.

First off, are these assumptions correct?

1. By law, US mutual funds must distribute 95% of internally generated income to share holders. Similarly, all Canadian mutual funds must distribute all internally generated income (interest received, dividends, capital gains from equity trades, etc).
2. Canadian mutual funds will not track which capital gain distributions are “long-term or short-termâ€￾ by the US definition. As long as the US taxpayer forfeits the long-term capital gain distribution treatment, the IRS won’t mind.

Here is the algorithm.

1. Take the QEF election based on information from the mutual funds annual report + T3 distribution data.
2. Report all capital gain distributions as “ordinary incomeâ€￾ for QEF purposes. Report dividends from Canadian corporations as “qualified dividendsâ€￾ as per the treaty. The dividend part would have to go on schedule B – not 8621.
3. Enter $0 for long term capital gain distributions since this info is not available.
4. When selling shares of the QEF, simply report NAV based gains on Schedule D and these may be long term if held for more than a year.

Pros/cons:
- Cons: Long term capital gain distributions (internal to the fund) are forfeited.
- Pros: If the fund is held more than a year – it keeps its capital asset character, then can be claimed as a long term capital gain once sold
- This allows better synchronization with the Canadian tax system and reduces likelihood of a double tax.

I’m interested in feedback. Please note – this is not advice, I’m not an accountant, and have no financial training.