For Americans who own Canadian mutual funds, complex rules regarding Passive Foreign Investment Companies or PFIC because of lobbying efforts of the mutual fund industry. Starting in 1986, many Americans used foreign mutual funds to gain tax deferral on income that was not distributed to them. However, with the new rules on PFIC, the IRS has changed its view of the tax treatment of these foreign mutual funds. A PFIC exists when 75% or more of its gross income for the taxable year is passive income or 50% or more of the average fair market value of its assets are assets that produce or are held for the production of passive income. Passive income includes dividends, interest and its equivalents.
Because of the new rules for PFIC, the IRS now classifies Canadian mutual funds as corporations for U.S. tax purposes. Therefore, the income received from a PFIC or from the sale of a Canadian mutual fund that is PFIC will be subject to U.S. tax and interest penalties.
It is recommended that Americans who own Canadian mutual funds to make the appropriate election for their investment holdings. And with the passing of the Hiring Incentives to Restore Employment or HIRE Act, taxpayers have no choice but to comply.
In addition to the requirement of filing a U.S. tax return and other IRS forms, Americans residing abroad are also required to declare their foreign assets. And with the HIRE Act, Canadian banks and investment firms doing business with Americans must ask clients if they are U.S. citizens or residents starting January 1, 2013. If the client confirms his U.S. citizenship, banks are required to report account information to the IRS. If the client refuses to confirm his citizenship, the bank or investment firm will withhold 30% of any investment earnings and remit that to the IRS.
Reference: "Does your client have U.S. tax risk?" by Terry F. Ritchie, January 27, 2012, advisor.ca