How the logic of the quantifiers: "All", "Some", and "Not All" apply to Canadian mutual funds

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What is a PFIC?

The acronym “PFIC” stands for “Passive Foreign Investment Corporation”. For your reading pleasure, I refer you to:

S. 1297 of the Internal Revenue Code which defines what a PFIC is; and

S. 1291 of the Internal Revenue Code which describes the “default taxation” of a PFIC.

Assuming that all Canadian mutual funds are PFICs, the results are horrific. I have written about this problem in two separate submissions to the U.S  Senate Finance Committee.

First, 2014 – “PFIC Taxation and Americans Abroad“; and

Second 2015 – Richardson Kish – “Canada U.S. Mutual Fund Comparison” – Submission 6 of 7 – Senate Finance Committee – April 15, 2015

The PFIC rules are one of the most abusive forms of the U.S. taxation of Americans abroad.  Since 2010, Canadian residents, who are either deemed to be, or are U.S. citizens, have been told that their Canadian mutual funds are PFICs. The IRS has NOT taken a clear position that Canadian mutual funds are PFICs. That said, the IRS does NOT enforce U.S. tax law. The tax compliance community is the interpreter and enforcer of U.S. tax law.

The analysis in both of above submissions ASSUMES that ALL Canadian mutual funds are PFICs. This may or may not be true. It’s important to consider the question.

Are Canadian mutual funds PFICs?

There are four possible answers to this question. Let’s consider this in terms of the “logic of the language”.

1. Some Canadian Mutual Funds are PFICs.

The word some means “there is at least one that”. It could (but does NOT have to) logically include ALL.

2. All Canadian Mutual Funds are PFICs.

The word “all” means every single one of them.

3. Not ALL Canadian Mutual Funds are PFICs.

The words “Not ALL”, mean NOT every single one, but there could be at least one that is a PFIC, and it leaves open the possibility that NO Canadian mutual fund is a PFIC.

4. No Canadian Mutual Funds are PFICs.

The word “No” means not a single one.

Unless, we are in category “2” (All) or category “4” (No), then one must consider whether YOUR Canadian mutual fund is a PFIC. If you have read this far, I am fairly certain that you are hoping that either:

A. Canadian mutual funds are NOT PFICs; or

B. Your Canadian mutual fund is NOT a PFIC.

This leads to the questions of:

Why would a Canadian mutual fund be a PFIC?

If you purchased your mutual fund before 2010, then you had never heard the word “PFIC”. You thought you were making a safe, conservative investment. Starting in 2010, you began hearing:

“My lowly Canadian mutual fund might be a PFIC. What’s that? (This also came as a surprise to the IRS.) What happened was that an IRS Counsel included a statement in a non-binding unrelated opinion, that a Canadian mutual fund might be a corporation under U.S. law. This was described as follows:

In a Chief Counsel Advice released on January 22, 2010, the IRS ruled that a Canadian decedent’s RRSP is not included in his gross estate for US federal estate tax purposes, because the RRSP’s Canadian mutual fund holdings were most likely classifiable as corporations for US tax purposes.

(The opinion NEVER used the word PFIC or explored the possibility that, if a Canadian mutual fund was a corporation, that  it would make Canadian mutual funds PFICs.) Nevertheless, the tax compliance community quickly decided, on the basis of this ruling, that if Canadian mutual funds were “corporations” under U.S. law, then (because they were also “Passive”, “foreign”, “investment”, (you fill in the blank) ______” they must be PFICs. One example of the rush to “PFICize” Canadian mutual funds appears here:

Earlier this year, the Internal Revenue Service changed its views with respect to the US tax treatment of non-US mutual funds. This change in policy was the result of Chief Counsel Advice (CCA) 201003013, issued on January 22, 2010, which determined that a Canadian mutual fund should be classified as a corporation rather than a trust for US tax purposes—this, despite the fact that many Canadian mutual funds are classified as trusts for Canadian tax purposes.

This classification of Canadian mutual funds as corporations for US tax purposes caused two major changes in the US tax treatment of these mutual funds:

  1. Canadian mutual funds that hold US stock no longer have to be included in the gross estate of a Canadian resident for US federal estate tax purposes;

  2. US citizens or US residents (“US persons”) may be subject to the passive foreign investment company (PFIC) rules with respect to Canadian mutual funds.

This strikes me as a completely misleading statement. An IRS Chief Counsel decided, in the context of an Estate Tax issue, that a Canadian mutual, although a trust for Canadian purposes, was a corporation for U.S. purposes. The IRS did NOT decide that Canadian mutual funds were PFICs. Read the decision yourself here:

1003013

The ruling (which should be read by all) concludes with:

If the Canadian mutual funds held by Decedent’s RRSP are classified as corporations for U.S. tax purposes, the shares of the mutual funds would not constitute U.S. situs property under § 2104(a) and would not be includible in Decedent’s U.S. gross estate.

(The underlying assets also would be excluded from Decedent’s U.S. gross estate.) You indicated that the RRSP held shares in several mutual funds that are organized as trusts. However, a mutual fund may have been formed as a “trust” under Canadian law, but be properly classified as a corporation under U.S. law. Based on the information provided, it appears that all the Canadian mutual funds held by Decedent’s RRSP would be classified as corporations for U.S. tax purposes.

 The important point is this:

Once the tax compliance community decided that Canadian mutual funds were PFICs, Canadian mutual funds became PFICs.

Think of it. One night you went to sleep thinking that you had made a safe investment. The next morning you woke up to the realization that  you had a PFIC. Yes, that’s what happened.

Why might YOUR Canadian mutual fund NOT be a PFIC?

How about because it couldn’t have been the intent of Congress to prevent Americans abroad from investing in mutual funds in the country of their residence. As David Kuenzi of Thun Financial pointed out in a nice “op ed” to the Wall Street Journal:

U.S. reporting rules for non-U.S. registered mutual funds are a particularly good example of the problem. An American family living in Germany that buys five or six different German-domiciled mutual funds to create a diversified portfolio is faced with tax complications that almost defy belief. They will have to report each of their six non-U.S. mutual funds on separate forms, every year. The IRS Instruction manual for this Form 8621 estimates that the time needed to prepare the form include “Recordkeeping, 15 hr., 4 min; Learning about the law or the form, 11 hr., 13 min; Preparing and sending the form to the IRS 20 hr., 21 min.”

In other words, the U.S. government expects this family to spend more than 200 hours annually preparing and filing the forms necessary to report their six mutual funds bought from a local German investment advisor. Furthermore, once the filing is made, the tax payers will find their investment gains taxed annually and subject to a tax rate no less than 39.6%, and potentially much higher.

Few U.S. tax preparers have any understanding of the special rules regarding non-U.S. assets and income. So Americans abroad can routinely expect to find major mistakes in their returns. They can also expect to pay anywhere from three to 20 times as much to have a return prepared compared to the cost of a similar domestic filing. The point is that middle-class Americans abroad face a nearly impossible task in both saving for their future financial needs and properly preparing their U.S. tax returns.

One of the many ironies embedded in this Orwellian tax nightmare is that the complex foreign asset and foreign income reporting rules were not written with Americans abroad in mind. Their original purpose was to discouraging Americans living in the U.S. from using off-shore tax shelters. As originally intended, the rules were a reasonable legislative response to a gaping tax loophole. Applied to Americans living abroad, however, they are absurd.

But, that is a common sense answer. We know that the the U.S. tax treatment of Americans abroad is NOT based on Common sense. They are based on the strict and aggressive application of the law.

Okay, then let’s consider some law – at least some Canadian law

Max Reed is a U.S. Canadian lawyer in Vancouver. He recently published the following blog post which refers to a more extensive analysis.

“Certain Canadian mutual funds aren’t PFICs”

It’s an interesting analysis. I recommend it to you. (I also recommend it to your tax preparer.)

Basically, the argument is (as I understand it) that:

1. If an entity is NOT a corporation then it is NOT a PFIC.

2. Some Canadian mutual funds are NOT corporations.

Therefore, some Canadian mutual funds are NOT PFICs.

I suggest that you read his analysis where he explains why NOT all Canadian mutual funds are corporations.

A quick preview of his reasoning includes:

For various technical reasons, the chief determinant as to whether a Canadian mutual fund trust is classified as a PFIC under US tax law is whether all the investors of the mutual fund trust have limited liability for the debts and obligations of the fund. There is no gradation of liability. It’s like pregnancy – you are either pregnant or not. Likewise, you are either liable or not. If any investor is potentially liable for the debts of the fund, then the fund is not a PFIC.

Commencing in 2004, various provinces passed legislation guaranteeing limited liability to investors in mutual funds. Governments don’t pass laws without reason. So it stands to reason that before these laws were in place, investors in Canadian mutual fund trusts had some liability risk. Indeed, in 2003, the Bank of Canada issued a report concluding that the personal liability of investors in Canadian mutual fund trusts was possible. The Governments of Alberta and Saskatchewan identified the same risks as a reason why they enacted legislation to fix the issue.

My thoughts on this …

This is very imaginative and very creative. It is also the result of what is clearly a great deal of work. (Thank you for this.) It is my sincere hope that it “forces the tax compliance people back to the drawing board”. This is particularly true for those who are trying to “clean up” past compliance problems.

A potential problem might be …

The Internal Revenue Code is the governing law that is used to determine the classification of “entities outside the U.S.” . The question is, whether the fact that under Canadian law, something is not a corporation, is sufficient to mean that under U.S. law it would not be a corporation.

In any case …

Thanks Max for a wonderful, creative, imaginative and possibly persuasive analysis!

Conclusion …

If Max Reed is correct, then the answer to the question is (I think) either:

1. Some Canadian Mutual Funds are PFICs.

The word some means “there is at least one that”. It could (but does NOT have to) logically include ALL.
or
3. Not ALL Canadian Mutual Funds are PFICs.

The words “Not ALL”, mean NOT every single one, but there could be at least one that is a PFIC, and it leaves open the possibility that NO Canadian mutual fund is a PFIC.

John Richardson – Follow me on Twitter @Expatriationlaw

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