Tax Insights: New regulations for passive foreign investment companies: What they mean for Canadian mutual fund owners

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Issue 2014-01

Temporary and final regulations recently issued by the Internal Revenue Service (IRS) and Treasury Department provide guidance for owners of passive foreign investment companies (PFICs).

The new rules require holders of Canadian mutual funds to file annual information reporting returns for taxable years ending after December 30, 2013. Individuals with small mutual fund holdings and mutual funds held in certain foreign pension plans are exempt.

Although the new rules affect all PFICs, this Tax Insights focuses on PFICs that are Canadian mutual fund trusts, which can include income trusts, real estate investment trusts (REITs) and Exchange Trade Funds (ETFs) that are structured as mutual fund trusts for Canadian income tax purposes.

The US PFIC rules are designed to prevent taxpayers from:

  • deferring tax on passive income earned through foreign corporations, or
  • converting this income into capital gains that are taxed at preferential rates

A PFIC is a foreign (non-US) corporation that meets one of the following tests:

  • 75% or more of its gross income is passive income
  • 50% or more of its average assets produce, or are held to produce, passive income

Canadian mutual funds trusts are considered to be PFICs.

The new regulations affect US persons who own investments in PFICs. US persons include:

  • US citizens and green card holders
  • individuals who meet the substantial presence test under the Internal Revenue Code (and do not qualify for the closer-connection exception)

Starting 2013, the new regulations require all US persons that directly or indirectly own shares in a PFIC at any time during the year to file Form 8621. Previously, Form 8621 had to be filed only in certain circumstances.