Written by Max Reed The US Foreign Account Tax Compliance Act (FATCA) has generated a lot of attention in Canada. It recently became Canadian law, as a part of the...
Canadian mutual funds held inside of an RRSP should not cause US tax problems. Assuming that Canadian mutual funds are PFICs (a position that’s far from certain), holding them in an RRSP negates the bad tax consequences that would otherwise come with stock in a PFIC (high tax rate, nasty interest charge, complex paperwork). Here is the technical reason why this is the case. The Canada-US Tax Treaty applies to income taxes imposed by the US Internal Revenue Code. The PFIC tax regime is certainly an income tax regime and is thus covered by the Treaty. Paragraph XVIII(7) of the Canada-US Tax Treaty states that “taxation” may be deferred with respect to “any income accrued in the plan but not distributed by the plan until such time as and to the extent that a distribution is made from the plan or any plan substituted therefor.” This obviously applies to RRSPs. If Canadian mutual funds are PFICs, and they are held inside of an RRSP, then the PFIC charge described above may be permanently avoided. According to official IRS publications, when income comes out of an RRSP it is considered pension income and subject to tax as such. For instance, Rev. Proc. 2014-55 describes distributions from an RRSP as follows:
Distributions received by any beneficiary or annuitant from a Canadian retirement plan, including the portion thereof that constitutes income that has accrued in the plan and has not previously been taxed in the United States, must be included in gross income by the beneficiary or annuitant in the manner provided under section 72, subject to any applicable provision of the Convention
Note that Code Section 72 is the section that deems income from a pension plan to be taxable. As such, the IRS own view is that income taken out of an RRSP is pension income and the PFIC charges may not be applicable. Even if Canadian mutual funds are PFICs, there is no reporting required if the funds are held inside of an RRSP. Combined with the IRS’ understanding of RRSP income as pension income, this lack of reporting further suggests that a US court would not subject Canadian mutual funds held inside of an RRSP to the PFIC charge. Based on this, there is a very good argument that owning Canadian mutual funds inside of an RRSP shouldn’t cause US tax problems.