Q: I am both a Canadian and American. At this juncture, I will not give up my American citizenship since my family is down there and I am only 33. I have maxed my RRSP and I want to invest in ETFs in a non-registered account but I understand there are issues with U.S. tax liabilities.
There are over a million Americans in Canada. My question is simple: what platform can an American in Canada use to acquire indexes or ETFs with minimal tax liability and simplicity for IRS reporting?
A: As you likely know, Megan, American citizens need to file U.S. tax returns every year on their worldwide income, regardless of where they live. That means one million U.S. citizens in Canada should be filing with the IRS. Not all of them do.
There is a bilateral agreement between Canada and the U.S. to avoid double taxation and because Canadian tax rates are generally higher than U.S. rates, many Canadian tax filers have no U.S. tax liability on their U.S. returns. That doesn’t mean you don’t need to file or worry about what you invest in here in Canada.
When it comes to your non-RRSP investing, you have two things you need to consider, Megan – types of accounts and types of investments. If you plan to open or have opened a Tax Free Savings Account (TFSA) or Registered Education Savings Plan (RESP), these could cause U.S. tax issues.
The tax incentives to open these accounts may be partially or fully negated. The additional U.S. tax reporting may drive up your U.S. tax preparation costs considerably. There are extensive, complicated forms for your accountant to prepare and significant penalties if you ignore this obligation.
In addition, TFSAs and RESPs are not considered tax sheltered for U.S. tax purposes. The investment income is taxable on your U.S. return. RESP government grants – Canada Education Savings Grants or CESGs – are taxable in the U.S. as well.
Generally, Americans should avoid TFSAs and RESPs. You can still take advantage of an RESP for your children, but consider having a non-U.S. spouse or other family member as the subscriber.
If you want to invest in index funds or exchange-traded funds (ETFs), Megan, you must be careful in a non-registered account. Canadian index mutual funds (or any mutual funds for that matter) and Canadian-listed ETFs can also cause increased U.S. accounting costs and complexity. These are considered Passive Foreign Investment Companies (PFICs). PFICs require significant disclosure on your U.S. tax return that could take many hours of additional time for your accountant to prepare.
Many Canadian mutual fund and ETF companies are trying to make U.S. tax reporting easier for U.S. investors. This makes their investments more marketable within Canada to Americans, but also to potential U.S. resident investors.
If you want to invest in passive investments, U.S.-listed ETFs may be the simplest option in a non-registered account from a U.S. tax compliance perspective. However, from an investment perspective, a Canadian resident may have better Canadian options or more comfort investing in Canadian investments.
If that’s the case, at the very least make sure your Canadian index funds or ETFs are PFIC-compliant and provide PFIC reporting to investors for their U.S. accountants, Megan. Check with the mutual fund or ETF company or your investment advisor. And speak to your U.S. accountant to understand the tax rules and additional accounting costs that your Canadian investment accounts and Canadian investments may cause.
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