The US generally treats Canadian mutual funds and ETFs as passive foreign investment companies (PFICs). Unless you make an election, gains and large distributions are taxed at the highest US rate with an interest charge, and each fund can need its own Form 8621 every year.
Two exceptions help: funds held inside an RRSP or RRIF are exempt from Form 8621, and you skip the form when all your PFICs total $25,000 or less ($50,000 joint) at year end and you didn't sell or get an excess distribution.
What makes a fund a PFIC
A foreign corporation is a PFIC if at least 75% of its income is passive (interest, dividends, gains) or at least 50% of its assets produce passive income. A pooled investment fund meets that test almost by design. Most Canadian mutual funds and ETFs, whether set up as a corporation or a trust, are treated as foreign corporations for US tax purposes, so they are generally PFICs.
Not PFICs: shares of ordinary operating companies (a Canadian bank, railway or grocer), GICs and bank deposits, and funds organized in the US, such as US-listed ETFs.
Holding US-listed funds instead has its own Canadian tax and estate consequences. That is a decision for you and an advisor, not a tax-form question.
How a PFIC is taxed
Default: the excess distribution rules (section 1291)
If you make no election, nothing happens while you simply hold the fund and receive normal distributions. But when you sell, or receive a distribution larger than 125% of the average of the previous three years, the gain or the excess is spread over the years you held the fund. Each earlier year's share is taxed at that year's highest US rate (37% for recent years) plus interest, as if you had paid late. Gains under these rules are ordinary income, not capital gains.
Mark-to-market election
For funds that trade on a qualifying exchange, you can elect to report each year's rise in value as ordinary income. Declines are deductible only up to the gains you reported before. It costs tax every year but avoids the interest charge.
Qualified electing fund (QEF) election
If the fund publishes a PFIC Annual Information Statement, you can elect to report your share of its ordinary earnings and capital gains each year, keeping capital gain treatment. Some Canadian fund companies publish these statements; check your fund's website.
When you file Form 8621
Generally one Form 8621 per fund, per year. You can skip it for a fund taxed under the default rules when all of these are true:
- The value of all your PFIC holdings together is $25,000 or less on December 31 ($50,000 or less on a joint return).
- You didn't sell any of that fund during the year.
- You didn't receive an excess distribution from it.
Funds held in an RRSP or RRIF don't need Form 8621 at all: the PFIC rules except funds held through an arrangement treated as a foreign pension fund under a tax treaty. Funds inside a TFSA, FHSA or RESP get no such exception.