Living Next to the IRS: Part 5

Feb 15, 2019 | Mark Ryan


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The boom, the bigger boom and the long-necked-pecking goose that is the IRS.

When I moved in with my dad near Lougheed Mall in 1975, construction crews were just starting on one of the first high-rise apartment buildings there. It was right next to our tiny Cameron Elementary school field, and was both awe-inspiring and a big grey Goliath – just the first of many. 

 

Being a curious 13 year-old, I slipped through the non-existent security perimeter a few times after hours. A project of that magnitude up close was irresistible.  And I was just as fascinated with a small box full of heavy-duty bolts on the ground, and might have brought one home for a souvenir but for a dog barking about then. 

 

A couple of years later, the shiny finish on the complex’s concrete parkade went several stories down, and made for a stunningly smooth ride on my skateboard.  A year after that, all it took was my pocket comb to get past the locked door and onto the 24th floor roof with my girlfriend.  We liked to sit on the ledge, overlooking the entire Lower Mainland, and dream a little – not a worry in the world about what falling off might involve, or whether the overweight security guard could ever catch us in a footrace.

 

A few years after that, as a college student I sat on a couch with a few friends in an apartment on the 19th floor. A fine-looking British gal from school served me peach tea and chip-buddies, (an English concoction of hot French fries on generously-buttered white bread -- try it.)

 

Today I counted 27 such structures in an online image, and read about plans to explode the already cramped area with another 23 high-rises as part of a massive $7 billion dollar project called “The City of Lougheed.”  A private city built around a shopping mall. Gulp.

 

Southern BC is nice, but not for me anymore.  Its real estate economy is driven in no small part by immigration and foreign capital. And not for a moment do I consider that a blanket evil, but it is a thing – and a thing to be managed.

 

On the subject of international commerce and the government’s piece of the pie, hereafter is part 5 of our series – Living Next to the IRS.

 

As mentioned last week, the U.S. views American-held trusts and corporations in Canada as foreign legal structures, and notwithstanding that these structures are taxable in Canada, the U.S. taxes these structures quite differently, often resulting in double taxation.

 

U.S. Based Anti-Deferral Rules

There are two anti-deferral tax regimes in the U.S. dealing with interests that Americans in Canada might have in foreign companies. The first regime is concerned primarily with investments in foreign investment companies such as: non-U.S. mutual funds, pooled funds and ETFs, and is referred to as the Passive Foreign Investment Company (“PFIC”) rules. This regime results in taxation at the top U.S. federal tax rate of 39.6% (plus a possible interest charge) on distributions of income earned in prior years and on any gain from the sale of the shares of the PFIC itself. While the U.S. allows a foreign tax credit for Canadian taxes paid, the credit may not be sufficient to offset the U.S. tax. One simple solution to avoid the PFIC problems is to invest directly in stocks and bonds. Some foreign investment companies will provide PFIC

Annual Information Statements with information enabling the investor to treat a fund as a Qualifying Electing Fund (QEF) to avoid PFIC issues. Generally, PFICs held in RRSPs and RRIFs are exempt from the PFIC rules.

 

The second rule addresses interests that Americans in Canada have in non-U.S. companies controlled by U.S. shareholders. These are referred to as the controlled foreign corporation (“CFC”) rules. Americans in Canada must personally report passive income, such as dividend and interest earned in the CFC, in the year that it is earned even if this income is not distributed by the corporation. There is an exception to the CFC rules where the passive income is subject to a Canadian corporate tax rate exceeding 90% of the highest U.S. corporate tax rate (35% X 90% = 31.5%). When the CFC rules apply, a foreign tax credit for the Canadian corporate tax on this income is not possible, which may result in double taxation.

 

There may be an advantage for Americans in Canada to hold passive assets in an unlimited liability company (“ULC”) largely because they avoid the double tax problems that the above-noted structures do not, and they are not considered to be either CFCs or PFICs. This type of structure is best used as a corporate holding company or to own passive assets as the typical protection under a corporation from creditors does not apply. While Canada taxes ULCs as corporations, a ULC is considered a disregarded entity for U.S. tax purposes if owned by one person or a partnership if owned by more than one person. Hence, a ULC is not subject to the potentially adverse U.S. tax consequences of being a foreign corporation. However, all income and expenses of the ULC flow through to the U.S. shareholder, eliminating the potential for tax deferral.