What Is a PFIC? Passive Foreign Investment Companies
The two tests, why Canadian mutual funds and ETFs are usually PFICs, and the elections that soften the tax
Reviewed by the Fairlight Accounting cross-border tax team — U.S. & Canadian Tax Desks
A passive foreign investment company (PFIC) is a foreign corporation whose income is at least 75 percent passive or whose assets are at least 50 percent passive. A U.S. owner's gains and excess distributions are taxed at the highest ordinary rate plus interest unless an election is made. Canadian mutual funds and ETFs are usually PFICs for Americans.
On this page
The two tests
| Test | Threshold | What counts as passive |
|---|---|---|
| Income test | 75 percent or more of gross income is passive | Dividends, interest, rents and royalties (not from an active business), capital gains on investments |
| Asset test | 50 percent or more of assets (by average value) produce passive income or are held for it | Cash (generally even working capital), securities, investment real estate |
Meet either and the corporation is a PFIC for that year — and once a PFIC for a shareholder, generally always a PFIC for that shareholder's shares unless a purging election (a deemed sale or deemed dividend under section 1291(d)(2)) is made — the "once a PFIC, always a PFIC" rule of section 1298(b)(1).
Why Canadian funds are the common case
A Canadian mutual fund trust or a Canadian-listed ETF is generally a corporation for U.S. tax (a trust that can vary its investments is a business entity under Reg. 301.7701-4(c), and a foreign business entity whose members all have limited liability defaults to corporate status under Reg. 301.7701-3(b)(2)), and it holds securities — so it meets both tests. A U.S. citizen in Canada holding Canadian funds in a non-registered account, or a Canadian who moves to the United States still holding them, holds PFICs. Inside an RRSP or RRIF, the treaty's deferral (Article XVIII(7)) shelters them, and no Form 8621 is required for PFICs held through a foreign pension fund whose income the treaty taxes only on distribution (Reg. 1.1298-1(c)(4)). A TFSA gets no such shelter.
The three regimes
| Regime | How it works | When it's available |
|---|---|---|
| Excess distribution (default) | All gains, and distributions above 125 percent of the prior three years' average, are spread over the holding period — amounts allocated to prior PFIC years taxed at each year's highest ordinary rate plus interest, the current year's share as ordinary income | Always — the default if no election |
| Qualified electing fund (QEF) | Shareholder includes its share of the fund's ordinary earnings and capital gains each year | Only if the fund provides an annual PFIC information statement |
| Mark-to-market | Shareholder includes the annual increase in value as ordinary income (losses limited) | Only for marketable stock (regularly traded) |
Many Canadian fund companies now publish PFIC annual information statements, which make the QEF election possible — but not every fund does, so check each holding.
Form 8621
Each PFIC is reported on its own Form 8621 with the U.S. return — for each year a distribution or disposition occurs, a QEF or mark-to-market election is made or in effect, or the shareholder's total PFIC holdings exceed US$25,000 at year-end (US$50,000 on a joint return — Reg. 1.1298-1(c)(2)). An unfiled Form 8621 keeps the statute of limitations open for the whole return until three years after it's filed — only for the related items if the failure had reasonable cause (section 6501(c)(8)).
Frequently asked questions
Is my Canadian mutual fund a PFIC?
Almost certainly, if you're a U.S. person — and held outside an RRSP or RRIF (a TFSA included), the full PFIC rules apply. Canadian mutual fund trusts and ETFs are treated as foreign corporations holding passive assets.
What is the PFIC tax rate?
Under the default regime, the highest ordinary rate on the allocated gain for each prior year, plus an interest charge — often worse than the gain's ordinary tax.
How do I avoid the PFIC regime?
Make a QEF election (if the fund provides the statement) or a mark-to-market election (if the shares are marketable), or hold U.S.-domiciled funds instead.
Are funds in my RRSP PFICs?
They are technically PFICs, but the treaty's deferral for RRSPs generally removes the annual Form 8621 requirement.
Official sources
The IRS explains: “A U.S. person that is a direct or indirect shareholder of a passive foreign investment company (PFIC) files Form 8621 if they: Receive certain direct or indirect distributions from a PFIC. Recognize a gain on a direct or indirect disposition of PFIC stock. Are reporting information with respect to a QEF or section 1296 mark-to-market election.” — Internal Revenue Service, About Form 8621, Information Return by a Shareholder of a Passive Foreign Investment Company or Qualified Electing Fund, https://www.irs.gov/forms-pubs/about-form-8621
Next step
Fairlight Accounting is a cross-border accounting and tax practice with a U.S. Tax Desk and a Canadian Tax Desk. Our U.S. Tax Desk and Canadian Tax Desk handle PFIC identification and Form 8621 preparation, QEF and mark-to-market elections, purging elections, and portfolio restructuring for U.S. persons holding Canadian funds. See pricing or book a call.
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U.S. and Canadian filings prepared together by our U.S. and Canadian Tax Desks.
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