By default, the Horizons ETFs are generally regarded under U.S. tax law as a corporation. As a result of a Canadian investment fund being regarded as a default corporation by the IRS, investors who own Canadian investment funds and who file U.S. tax returns will generally be considered to be holders of a “Passive Foreign Investment Company” (PFIC). Note that all U.S. citizens and green card holders are required to file a U.S. tax return even if they are residents of Canada or another country. Other Canadian residents with significant ties to the U.S. may also be required to file U.S. tax returns.
A PFIC is defined under U.S. tax rules. PFIC rules are intended to prevent U.S. taxpayers from securing preferential tax treatment, such as tax deferral, from investing in foreign securities in comparison with U.S. domestic securities. “Passive” is not meant to reflect on the investment strategy of the ETF: both active and passive ETFs managed by Horizons ETFs can be “Passive” for this purpose.
To help investors who file U.S. tax returns avoid the negative consequences of owning a PFIC (see below), Horizons ETFs has commenced providing PFIC Annual Information Statements for many of its funds.
This allows U.S. taxpayers to elect to treat these ETFs as “Qualified Electing Funds” (QEFs) on their U.S. tax returns. This election gives U.S. investors access to capital gains tax rates on their holdings of these funds.
Reporting Regarding owning a PFIC?
Each year, U.S. taxpayers must report each PFIC that was held for any portion of the tax year on a separate IRS Form 8621. On this form, taxpayers may make the mark-to-market election or the “Qualified Electing Fund” (QEF) election. There are also various supplementary elections that are beyond the scope of these materials. Annual IRS Form 8621 reporting is required for each PFIC that is directly or indirectly held by the investor, regardless of which election is made. However, it should be noted that an investor with indirect exposure through a PFIC to its underlying PFIC(s) may not be required to include in income the distribution from the lower-tier fund pursuent to IRC 1293(c).
Under the mark-to-market election, investors report all income and gains (both realized and unrealized) each year.
Under the QEF election, investors report their pro-rata share of the fund’s earned income for U.S. tax purposes. Investors also receive an increase to their tax cost basis in units of the funds, to correspond with amounts included in income under the QEF election.
The PFIC reporting from Horizons ETFs provides investors with information required to file a QEF election. In certain situations, such as cases where units of a fund decline in value during a tax year, other elections may be more advantageous. Investors should consult with a qualified U.S. tax professional for guidance on which election is most advantageous for each fund, taking into account statutory restrictions on revoking elections in subsequent tax years.
Horizons ETFs has elected an initial reporting period for U.S. tax information for QEF election purposes of May 1, 2016, through April 30, 2017. That information would be used by a U.S. Person when filing their 2017 income tax return in April 2018.
How do investors calculate the account level PFIC factors for the QEF election?
For each PFIC, a tax preparer will require the following: 1) the PFIC Annual Information Statement (AIS) for the fund provided by Horizons ETFs; and 2) account statements for the tax year provided by the tax payer’s investment dealer.
The AIS will provide the pro-rata share of the fund’s ordinary earnings and net capital gain per unit per day.
To calculate one’s individual amounts for a QEF election, you will multiply the number of unit days you held the fund (including weekends) by the pro-rata amounts on the AIS.
To calculate the number of unit days, you will multiply the number of units held by the number of days those units were held during the tax year. For example, for an account that held 100 units of a fund for the full year (i.e. 365 days), the number of unit days would be 100 x 365 = 36,500. If those units were held for 180 days, the number of unit days would be 100 x 180 = 18,000. This value would then be multiplied by the pro-rata values on the AIS and reported on IRS Form 8621.
If the number of units changes over the course of the year, the unit days calculation should be adjusted accordingly. For example, consider an account that starts the year with 100 units, then 65 days into the year, another 100 units are purchased (increasing the total number of units to 200). If no other changes are made for the remaining 300 days of the year, the unit days calculation would be: (100 units x 65 days) + (200 units x 300 days) = 66,500 unit days. In counting days, the day that units of a fund are purchased does not count, but the day that the units are sold does count.
Some ETFs have their own daily pro-rata amount and may have indirect exposure to additional ETFs that are PFICs (these are noted with “Please refer to the specific statement for indirect investment allocations.”) and the pro-rata amounts for those are referenced.
While the lower-tier fund PFIC factor information is provided, it is picked up proportionately by the top fund by series. Your tax advisor should be able to compare the factors provided and determine the overall PFIC income inclusion rate applicable to you.
When an investor makes a QEF election for his investment in a PFIC, he should over the lifetime of his investment (from date of purchase to date of disposal) not include in his taxable income any more income (or loss) that he recognizes ‘economically’. For example if an investor purchases 10 units of PFIC A for $20 per unit, and sells them 5 years later at $22 per unit his economic gain is: 10 x (22 – 20) = $20. The amount he should pay tax on is also $20. This should not change if PFIC A is also invested in PFIC B, and the investor makes a QEF election for PFIC B.
Investor purchases 10 units of PFIC A for $20 per unit. PFIC A has 10,000 units outstanding. In PFIC A’s portfolio of investments is PFIC B. PFIC A owns 1,000 units of PFIC B until June 30, when it sold 500 units (at a gain).
In year 1 of Investor’s investment: PFIC A reports Ordinary Earnings of $2 per unit and Net Capital Gains of $3 per unit. It makes no distributions. PFIC B reports Ordinary Earnings of $8 per unit and Net Capital Gain of $4 per unit. It makes a distribution of $3 per unit on July 30.
Investor would include in his US personal tax filings $2 x 10 + $3 x 10 + $8 x (750**/10,000) x 10 + $4 x ((750**/10,000) x 10) = $20 + $30 + $6 + $3 = $61. However since PFIC B made a distribution to PFIC A (which was included in PFIC A income) pursuant to IRC 1293(c) Investor may be able to reduce income inclusion by $3 x (500/10,000) x 10 = $1.5. Taxable Includable income is then $59 (rounded).
(**750 represents 1,000 units for ½ year and 500 units for ½ year)
Investor adjusts his tax basis in his investment from $200 to $259.
In year 2 (January 1) investor sells his investment for $22 per unit or $220. Economically he made $20. His tax inclusion for the year is $220 – $259 = a loss of $39. Add that $39 loss to prior year taxable income of $59 represents an overall taxable income of $20 over two year.
Investor may make an election to defer payment of tax until he receives distributions or makes a disposal.