Passive Foreign Investment Company

Fidelity is helping investors comply with U.S. PFIC tax rules

Fidelity knows there is concern among investors about the U.S. Passive Foreign Investment Company (PFIC) rules. These rules could significantly affect “U.S. persons” who hold Canadian mutual funds, so we are providing you with information about these complex rules.

We believe it is important for those who may be affected by these rules to have the information necessary to make informed decisions. However, we also believe that investors affected by these rules should not make changes to their Canadian holdings without first speaking with their advisors and a U.S. tax specialist.

Fidelity continues to make available, upon request, PFIC Annual Information Statements for all of our mutual funds for the 2016 tax year.  The 2016 PFIC Annual Information Statements will be available by March 3, 2017.

.

Learn more in our PFIC Overview PDF document

The following list of frequently asked questions has been created to help you better understand how PFIC rules might affect you.

Frequently asked questions on Passive Foreign Investment Company (PFIC) rules

1. Who are U.S. persons?

The definition of a U.S. person is broad and generally includes U.S. residents, U.S. citizens, U.S. green card holders, other persons with a substantial connection to the U.S. and certain entities organized in the U.S. It should be noted that U.S. citizens and green card holders are considered U.S. persons regardless of their country of residence. Some Canadian residents could be unaware that they have U.S. tax filing requirements.

2. What is a PFIC?

A PFIC (Passive Foreign Investment Company) is a non-U.S. corporation that has 75% or more of its gross income consisting of passive income or 50% or more of the average fair market value of its assets consisting of assets that produce passive income.

Passive income includes, among other things, dividends, interest, rent, royalties and capital gains from the disposition of securities.

The Internal Revenue Service (IRS) has confirmed that Canadian mutual funds are classified as corporations for U.S. tax purposes and, as such, are subject to the PFIC rules.

3. How do the PFIC rules work?

U.S. persons who own PFICs must report, annually, each PFIC investment on a separate IRS Form 8621 (Information Return by a Shareholder of a Passive Foreign Investment Company or Qualified Electing Fund). An investor or advisor can find Form 8621 here.

The U.S. taxation of PFIC can be punitive (see question 5 in part I below), although two elections may be available to improve the taxation:

  1. Mark-to-market election
    Under the mark-to-market election, investors must, on an annual basis,
    1. report all distributions (interest, dividends, capital gains, etc.) as ordinary income; and
    2. recognize all increases/decreases to the value of the fund as a gain/loss on their holdings as if the funds were sold at the end of each year. This gain/loss is rated as ordinary income.
  2. Qualified Electing Fund (QEF) election
    Under the QEF election, investors must, on an annual basis, include their pro-rata share of the mutual fund’s earned income for U.S. tax purposes.

    Please note that T3 and T5 slips issued by Canadian mutual funds are for Canadian tax purposes only and do not contain sufficient information to support a QEF election.

    Fidelity provides investors with all of the information they need to make a QEF election on Form 8621. Importantly, on disposition, the gain on a PFIC that has followed the QEF election is treated as a capital gain taxed in the year of disposition.

4. Which option, mark-to-market or QEF, is better?

Investors should consult their financial advisor or a U.S. tax specialist to make this decision. However, generally the QEF election is preferred, because it is more closely aligned with the tax treatment of mutual fund investments by both the U.S. and Canadian tax systems.

5. What are the consequences of not making a mark-to-market or QEF election?

If the U.S. person does not make one of the two elections above (mark-to-market or QEF), the following tax treatment would apply:

  1. Any gains recognized on disposition of the PFIC shares and distributions received from a PFIC during the year greater than 125% of the average distributions received during the previous three years would be taxed as ordinary investment income. This income would be considered earned over the holding period on a pro-rata basis.
  2. The amounts allocated to prior tax years will be subject to U.S. tax at the highest marginal rate and also subject to a deemed interest charge.

6. How should a PFIC be reported for a mutual fund with a fund-of-funds structure?

For a mutual fund with a fund-of-funds structure, the top-level fund and each of the underlying funds require a separate Form 8621 to be filed. Fidelity will provide the PFIC Annual Information Statements needed for both the top-level fund and the underlying funds, so that U.S. persons can make the QEF election.  Investors should consult with their U.S. tax specialist to understand the tax preparation costs associated with these types of holdings, as the costs may be higher than that of a single fund structure.

7. How does Fidelity help simplify the PFIC reporting requirements and tax preparation costs?

Fidelity offers comprehensive and individually customized PFIC reporting support for all its mutual funds to reduce the PFIC tax reporting burden.Investors, upon request, will receive a personalized AIS that reflects their allocation of ordinary earnings and net capital gains, and total distributions received for each top fund and any of its underlying funds. This is contrary to simply just receiving a general daily ordinary earnings and net capital gains factor, which requires an investor or their U.S. tax specialist to perform a potentially complex day-by-day calculation in order to arrive at the equivalency of information readily supplied by Fidelity’s AIS.

In addition, Fidelity is pleased to provide customized supplemental information along with the AIS to help facilitate the completion of Form 8621. 

8. Are investors at any U.S. tax disadvantage when investing in a mutual fund that regularly distributes return of capital (ROC)?

An investor that makes a QEF election for a mutual fund which regularly distributes ROC will not be at any U.S. tax disadvantage.

The investor will report their prorata share of ordinary earnings and net capital gains as shown on the AIS as additions to their U.S. tax basis. All cash distributions from the mutual fund will be treated as tax free ROC for U.S. tax purposes to the extent of previously taxed income reported on the AIS or to the extent of the client's remaining basis in that mutual fund. A U.S. tax specialist should be consulted to ensure the basis calculation considers all of these circumstances.

9. How do these rules affect different types of accounts, such as non-registered accounts, TFSAs and RRSPs?

These rules affect investments in non-registered accounts, TFSAs and RESPs. For PFICs held in retirement savings accounts such as RRSPs and RRIFs, most tax advisors suggest the PFIC rules should not be applicable. However, Fidelity recommends speaking with a U.S. tax advisor.

10. Why did Fidelity select April 30th as its PFIC fiscal year-end?

While any date can be chosen for a PFIC year-end, including December 31, Fidelity selected April 30 as the PFIC fiscal year-end for its Funds. An April 30 year-end allows Fidelity sufficient time to complete the PFIC analysis and schedules for all its mutual funds well before the time that most individual investors would request their PFIC information.

11. What are the tax implications of a U.S. person having a year-end that differs from April 30?

Each investor will report any PFIC having a year-end that falls within the investor’s tax year-end.

In the case of a Fidelity mutual fund, an investor who has a tax year-end that differs from April 30 simply experiences a timing difference. For individuals with a calendar year-end, there will be a seven-month deferral of PFIC income to the subsequent year, meaning PFIC income from May 1 to December 31 is deferred until the following year. This timing difference is eliminated once the position in the Fidelity PFIC is fully disposed of.

12. What if investors dispose of their PFIC after April 30, but before their tax year-end?

Investors who dispose of their PFIC holding after April 30, but before their taxation year-end, will simply pick up their remaining PFIC income in the subsequent tax year-end. Their next Annual Information Statement will reflect the number of days the PFIC was held between May 1 and the date of disposition.

Investors should speak with their U.S. tax specialist to discuss how to report the disposition of the PFIC for U.S. tax purposes.

13. What if an investor buys a PFIC after April 30, but before their tax year-end?

 

An investor who acquires a new PFIC holding after April 30, but before their tax year-end, will not be allocated a pro-rata share of the ordinary earnings and net capital gains of that PFIC until the following tax year-end.  However, an investor in this situation will be provided with certain information on their Annual Information Statement so that they can complete IRS Form 8621 in the year of acquisition, and discuss the appropriateness of a QEF election with their U.S. tax specialist in light of their personal tax circumstances.

 

14. How is a U.S. cost basis calculated?

The calculation of the U.S. cost basis is similar to the calculation of the Canadian adjusted cost basis, but additional considerations apply. For instance, if a QEF election is made, any amounts included in income (including those reported on underlying funds in fund-of-funds situations) increase the U.S. cost basis. Cash distributions under a QEF election decrease the cost basis while distributions that are reinvested in the PFIC (“property distributions”) do not. A U.S. tax specialist should be consulted to ensure the basis calculation considers all of these circumstances.

673508.6.0