Now is the time for some year-end mutual fund and ETF planning!

November 19, 2014

If you are a U.S. citizen living abroad, you have undoubtedly heard about some of the U.S. tax issues and challenges associated with Canadian mutual funds and exchange traded funds (“ETFs”) which are generally considered to be “passive foreign investment companies” (“PFICs”). If you have not heard, or would like a refresher on the topic, please see the blog written by Sidhartha Rao on November 20, 2012 titled “US Persons Holding Non-U.S. Mutual Funds”.

We generally advise our U.S. citizen clients to avoid investing in mutual funds or ETFs due to the reporting complexity and the significant risks of double taxation. For many “accidental” American citizens, much of their financial savings within unregistered plans, tax-free savings accounts, Registered Education Savings Plans and Registered Retirement Savings Plans may be invested in Canadian mutual funds and ETFs. Trying to unwind such investments within minimal US tax cost can be a challenge. However as such investment products often represent a ticking time-bomb, divesting sooner rather than later is usually for the best. You won’t feel happy about triggering a US liability but at least you have minimized the future liability.

The Canadian financial and investment industry has begun to address the inherent US reporting challenges and significant US tax risks associated with mutual funds. Some fund companies have taken significant steps forward in the last 12 months to assist with US reporting and have begun providing specialized fund reporting statements specifically for its U.S. citizen clients. This reporting, known as “QEF statements”, can greatly simplify the annual reporting which by extension reduces the tax compliance costs associated with the annual U.S. tax filing. Ask your financial advisor about how they are managing this issue and what reporting may be available.

With the recent drop of the Canadian dollar relative to the US dollar, now may be a good time to consider making some changes with some of your funds as there is now a potential 10%+ reduction in any gain computed for U.S. tax purposes. With the recent run-up of the markets in Canada and the U.S. over the last couple of years, this 10%+ cushion may help significantly to reduce any unrealized US tax burden.

Now before you rush to call your financial advisor to sell all your funds and ETFs, it would be wise to understand the Canadian and US tax implications as well financial services impact (i.e. such as deferred mutual fund charges). Better to know up front before you sell. If some of your fund companies are beginning to issue QEF statements, you may be able to make some changes to make the annual US reporting simpler without having to sell your funds and incur any sales commissions or deferred charges. One word of caution, taking advantage of any new QEF statement reporting will not be without a US tax impact.

With four weeks left in the trading year, there is still some time to review those mutual fund and ETF holdings and make some decisions about their future. All things being equal, divesting in some funds in late December 2014 will be better than in early January 2015 due to the impact of the pesky interest-deferral charge which creates so much US tax heart burn.