US estate taxes and Canadian mutual funds

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Norbert Schlenker
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US estate taxes and Canadian mutual funds

Post by Norbert Schlenker » 01 Dec 2010 13:57

There's a January legal opinion from the Office of Chief Counsel for the IRS that says ...
If the Canadian mutual funds held by Decedent’s RRSP are classified as corporations for U.S. tax purposes, the shares of the mutual funds would not constitute U.S. situs property under § 2104(a) and would not be includible in Decedent’s U.S. gross estate. (The underlying assets also would be excluded from Decedent’s U.S. gross estate.) You indicated that the RRSP held shares in several mutual funds that are organized as trusts. However, a mutual fund may have been formed as a “trust” under Canadian law, but be properly classified as a corporation under U.S. law. Based on the information provided, it appears that all the Canadian mutual funds held by Decedent’s RRSP would be classified as corporations for U.S. tax purposes.
Now this is advisory only, and written as a comment on a specific set of facts which will not apply exactly to other persons, but it's another point in favour of Canadian domiciled funds for individuals with substantial assets.
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Re: US estate taxes and Canadian mutual funds

Post by Doug » 02 Dec 2010 22:22

Yes, Canadian mutual funds are not subject to US estate tax. However, consider the following. Narrow your Canadian MFs/ETFs to index funds. Narrow your MFs/ETFs to those investing outside Canada. Don't consider MFs/ETFs that have total expenses of greater than 0.50%. Don't consider those that are currency hedged. Don't consider those with less than $100 million in assets. Don't consider index funds tracking fundamental indexes. Disregard the CIBC discount for those investing larger sums of money, as CIBC gives the impression that they would like to discontinue the discount.

How many MFs/ETFs are left? TD's S&P500 fund and TD's EAFE fund. Please correct me if I'm wrong.

If you're looking for index MFs/ETFs to invest outside Canada, you're almost forced to go to the US.

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Bylo Selhi
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Re: US estate taxes and Canadian mutual funds

Post by Bylo Selhi » 02 Dec 2010 22:47

Doug wrote:CIBC gives the impression that they would like to discontinue the discount.
Please explain.
If you're looking for index MFs/ETFs to invest outside Canada, you're almost forced to go to the US.
Actually not. There are lots of ETFs available now in Europe that track major indexes with MERs in the 20bp to 50bp range. TDW now allows you to trade on overseas exchanges, as does IB, so they're another option. Granted brokerage fees may be higher, there's FX conversion costs, as well as the potential for problems with local laws in the EU, but for those with an aversion to US estate tax issues this could be a viable option.
e.g. http://www.boerse-frankfurt.de/EN/index.aspx?pageID=123 and http://de.ishares.com/en/rc/
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Re: US estate taxes and Canadian mutual funds

Post by Doug » 02 Dec 2010 23:39

About CIBC's discount, it makes their MFs much more competitive compared to iShares and TD efunds. So it would make sense for CIBC to publicize their discount. However, CIBC's attitude towards its discount borders on secretive.

About European ETFs, I hadn't thought about that. However, the more I learn about US estate tax, the more reluctant I am to invest in foreign domiciled ETFs.

The following is about using a CCPC to avoid estate tax. When I die, if I have my assets in a CCPC, it looks like they won't be exposed to US estate tax. However, there would have to be tax paid to the CRA on the deemed disposition of the assets. When those assets are sold, there would have to be tax paid to the CRA and IRS. The CRA might give you foreign tax credit for the tax paid to the IRS. However, the IRS tax will most likely be greater than the CRA tax, as the CRA tax takes into account the tax paid on the deemed disposition, whereas the IRS tax doesn't. Remember also that you lose most of the foreign tax credit in a CCPC. I think it unlikely that the foreign tax credit will cover the entire IRS tax. So even with a CCPC, you will most likely pay a higher tax on US domiciled ETFs as opposed to Canadian domiciled MFs/ETFs. As I am far from a tax expert, I welcome criticisms.

Edited to include the following. When I die, tax will have to be paid on the deemed disposition of my assets to the CRA. As mentioned in the last paragraph, I believe that the IRS will not recognize the tax paid on the deemed disposition. So why not have my assets sold around the time of the deemed disposition? This means that the tax base of my assets will be the same for the IRS and the CRA. The CRA may give me foreign tax credit for the tax I paid to the IRS. However, as DavidR pointed out in the past, you lose 74% of the foreign tax credit in a CCPC. So my guess is that you'll still end up paying more tax on US domiciled ETFs as opposed to Canadian domiciled MFs/ETFs.

http://en.wikipedia.org/wiki/Estate_tax ... ted_States

The following is from wikipedia, not the ideal tax information resource. Also, there is uncertainty about where US estate taxes are going. Nevertheless, it does illustrate a point. For estate value between $1 million to $1.5 million, the 2011 estate tax will be 42%. That compares to capital gains tax of 23% or so in Canada. But that understates the difference. My guess is that the majority of many estates comes from money that has already been fully taxed, not unrealized capital gains. Those monies will be subject to double taxation via estate tax.
Last edited by Doug on 03 Dec 2010 00:22, edited 1 time in total.

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Re: US estate taxes and Canadian mutual funds

Post by Norbert Schlenker » 03 Dec 2010 00:22

All the more reason for a mutual fund company in Canada!
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Re: US estate taxes and Canadian mutual funds

Post by Bylo Selhi » 03 Dec 2010 08:12

Doug wrote:So it would make sense for CIBC to publicize their discount. However, CIBC's attitude towards its discount borders on secretive.
It's been like that since they introduced the rebate in 1999. The program has also been subject to change or discontinue since inception yet it remains intact even though the guy who put it in place is long gone. How does that suggest its imminent demise?
About European ETFs, I hadn't thought about that. However, the more I learn about US estate tax, the more reluctant I am to invest in foreign domiciled ETFs.
The US is unique in that, unlike any other country on the planet, they impose it regardless of the deceased's citizenship, residency or other connection with the US. Unless you believe that other governments are going to do something similar, then ISTM the use of overseas-based ETFs is worth exploring. Sure, there are going to be other issues, but can they be as bad as the US estate tax? You've done an awful lot of research so far on US estate tax and using a CCPC to avoid it. Perhaps it's worth doing a bit of research into what strikes me as a plausible alternative.

BTW while the links I provided are to German sites, German and Irish domiciled iShares trade in London and elsewhere on the continent, not just Germany.
Norbert Schlenker wrote:All the more reason for a mutual fund company in Canada!
Did Vanguard's comments at Bogleheads make you any more optimistic? ;)
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Re: US estate taxes and Canadian mutual funds

Post by brucecohen » 03 Dec 2010 08:56

Don't forget that there's a credit which shields a certain amount of assets from the US estate tax. It's explained here. In a nutshell, Canadians start off with the same US$2 million effective exemption ($1 million if Congress does nothing before yearend) that Americans get but this is then prorated based on the level of taxable assets as a percentage of total estate value.

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Re: US estate taxes and Canadian mutual funds

Post by marty123 » 03 Dec 2010 10:24

Bylo Selhi wrote:
Doug wrote:So it would make sense for CIBC to publicize their discount. However, CIBC's attitude towards its discount borders on secretive.
It's been like that since they introduced the rebate in 1999. The program has also been subject to change or discontinue since inception yet it remains intact even though the guy who put it in place is long gone. How does that suggest its imminent demise?
Considering that the buyers have a high likelihood of being into CIBC funds for this particular discount, and are therefore not the type to overlook MERs and fees, it would be difficult for CIBC to remove that discount. I'd expect to see HNW RRSP investors running for the exit, and a lot of pissed off HNW non-registered investors that will resent CIBC because they now are faced with capital gain tax or sticking with an expensive product.

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Re: US estate taxes and Canadian mutual funds

Post by Norbert Schlenker » 03 Dec 2010 10:41

Bylo Selhi wrote:Did Vanguard's comments at Bogleheads make you any more optimistic? ;)
Not much.
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Re: US estate taxes and Canadian mutual funds

Post by Doug » 04 Dec 2010 11:39

The problem with using foreign domiciled ETFs is the potential for double taxation. I have money in VEU, a Vanguard ETF the invests in countries outside the USA. Those countries, which includes Canada, have withholding taxes that American investors can recoup, but Canadians cannot. It decreases the yield by a bit less than 10%.

However, VEU in a CCPC will be subject to another level of taxation. There will be a 15% withholding tax imposed by the IRS on dividends. Outside a CCPC, a Canadian investor may be able to get foreign tax credit that completely offsets that 15% tax. However, as pointed out by DavidR, you lose around 75% of the foreign tax credit in a CCPC. So there is an additional 11% tax on dividends on top of the tax mentioned in the first paragraph.

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Re: US estate taxes and Canadian mutual funds

Post by Doug » 05 Dec 2010 12:56

Bylo Selhi suggested looking at ETFs outside Canada/USA. I looked for advice on the Bogleheads forum, as there are investors from outside North America there. As an aside, the Bogleheads forum is a rich source of information for Canadian index investors. Anyway, suggestions included iShares and Vanguard domiciled in Dublin. However, I was also warned about the complexities of taxation and the potential for double taxation.

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Re: US estate taxes and Canadian mutual funds

Post by Bylo Selhi » 05 Dec 2010 13:43

Doug wrote:Anyway, suggestions included iShares and Vanguard domiciled in Dublin. However, I was also warned about the complexities of taxation and the potential for double taxation.
Which differ from caveats about the complexities of taxation and the potential for double taxation that result from investing in iShares and Vanguard domiciled in the US?

My suggestion to look farther afield wasn't meant to suggest that there wouldn't be taxation issues to explore, only that US estate tax, the biggest gorilla in the room, wouldn't be one of them.
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Re: US estate taxes and Canadian mutual funds

Post by Shakespeare » 05 Dec 2010 13:46

The easiest way to avoid US estate tax is to spend enough that there isn't one. :wink:
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Re: US estate taxes and Canadian mutual funds

Post by Doug » 05 Dec 2010 14:06

As always, I appreciate the comments of Bylo Selhi, Shakespeare, Norbert and others. It's interesting to note that index funds are not new to Canada, but they haven't been particularly successful. Compare their sizes to other mutual funds; I believe there are active stock mutual funds that are in the 8 digit dollar asset range in Canada. What compounds the problem is the tendency of investment companies to not offer plain vanilla flavor index funds, but instead add other features, such as currency hedging or use fundamentally weighted indexes. As mentioned in a thread in the security selection section, I'm going to take a look at DFA funds. I'm coming to the conclusion that I should probably stick with domestic MFs/ETFs; using foreign domiciled MFs/ETFs adds another layer of complexity that may hurt an investor. About Canadian domiciled index funds investing outside Canada, finding a fund without gimmicks, and whose asset size gives me confidence in its longevity, is not easy.

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Re: US estate taxes and Canadian mutual funds

Post by Shakespeare » 05 Dec 2010 14:08

It's interesting to note that index funds are not new to Canada, but they haven't been particularly successful.
Canada seems to have a pretty distinct value advantage - possibly because the indexes are distorted by cyclicals.
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Re: US estate taxes and Canadian mutual funds

Post by adrian2 » 07 Dec 2010 12:13

Doug wrote:There will be a 15% withholding tax imposed by the IRS on dividends. Outside a CCPC, a Canadian investor may be able to get foreign tax credit that completely offsets that 15% tax. However, as pointed out by DavidR, you lose around 75% of the foreign tax credit in a CCPC. So there is an additional 11% tax on dividends on top of the tax mentioned in the first paragraph.
In a majority of cases, you're correct. However, as I've pointed out in the past, losing around 75% of the foreign tax credit in a CCPC is not always applicable -- at least you can count my particular situation where it isn't.

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Re: US estate taxes and Canadian mutual funds

Post by Outroupistache » 09 Dec 2010 07:42

I presume everyone noticed that the proposed Obama - Congress tax deal includes provision for USD$5M estate tax exclusion with a top rate of 35% as opposed to the $1M default if nothing happens. At the risk of revealing too much, that would fix my problem ....

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Re: US estate taxes and Canadian mutual funds

Post by Bylo Selhi » 09 Dec 2010 07:48

Outroupistache wrote:provision for USD$5M estate tax exclusion with a top rate of 35% as opposed to the $1M default if nothing happens... that would fix my problem ....
Until the next run at the estate tax. That's the reality of beltway realpolitick.
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Re: US estate taxes and Canadian mutual funds

Post by SoninlawofGus » 16 Dec 2010 08:47

One caveat to all this is that Americans who own non-registered Canadian mutual funds will likely be subject to PFIC reporting rules -- which are no fun from either a tax or reporting perspective.

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Re: US estate taxes and Canadian mutual funds

Post by snowback96 » 16 Dec 2010 22:04

SoninlawofGus wrote:One caveat to all this is that Americans who own non-registered Canadian mutual funds will likely be subject to PFIC reporting rules -- which are no fun from either a tax or reporting perspective.
I keep hearing mixed opinions on this one and don't know what to believe. A couple weeks ago, tax expert David Ingram (www.centa.com) posted a note on this topic and said:

"This was sent out to let people know that there can be big problems with Foreign ( to the US) Mutual Funds. In general, that fund from Canada is okay. But watch out for anything from another country and in particular, pay attention to something you and 8 friends may be thinking of doing."

Is it possible that the PFIC rules exclude Canadian mutual funds? Perhaps due to the pass-thru nature of Canadian funds combined with the strong IRS/CRA information sharing agreements???

It's frustrating when the experts disagree.

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Re: US estate taxes and Canadian mutual funds

Post by SoninlawofGus » 17 Dec 2010 08:10

I doubt the rules exclude Canadian funds. I too have seen mixed opinions, though I would not rely upon Ingram. In general, I do not trust his information (for various reasons).

For other opinions, see here, here, and here. The third article addresses the recent changes -- if I read correctly, most Canadian funds would fail the asset test and probably the income test as well.

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Re: US estate taxes and Canadian mutual funds

Post by snowback96 » 17 Dec 2010 23:07

SoninlawofGus wrote:I doubt the rules exclude Canadian funds. I too have seen mixed opinions, though I would not rely upon Ingram. In general, I do not trust his information (for various reasons).

For other opinions, see here, here, and here. The third article addresses the recent changes -- if I read correctly, most Canadian funds would fail the asset test and probably the income test as well.
Thanks for the links! I had not seen a couple of those. Sadly, this adds more cross-currents to the confusion. :cry:

Have you ever seen anything about whether Canadian REITs are treated as PFICs? Some foreign (non-US) REITs cause problems, but I have never seen anything specific about US taxation of Canadian REITs.

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Re: US estate taxes and Canadian mutual funds

Post by SoninlawofGus » 18 Dec 2010 10:18

I think I ran across a site that mentioned income trusts and REITs as a way of avoiding PFIC, but I can't find it today. Also, I would be concerned about running afoul of the normal trust reporting (the 3520 nightmare form) or some other weird requirement. Holding anything foreign called a "trust" -- no matter how it is structured -- would be something I would tread carefully with around the IRS.

Also, this discussion with "Bruce" (possibly Cohen?) is informative.

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