What's all the fuss?

One result of these proposals is a forthcoming amendment to the Income Tax Act that has dire consequences for Canadian investors who own US-based mutual funds like the low-cost funds from The Vanguard Group and exchange-traded funds (ETFs) such as SPYs, QQQs, DIAs, WEBs, HOLDRs, iShares and similar securities.

Under the proposed changes these types of securities will now be included in the definition of FIFs. The result is that Canadian investors will be required to pay income tax on the amount by which these securities increase each year. This will effectively make the ownership of such securities impractical.

For example, if you own US-based mutual funds/ETFs and these shares increase in value during a calendar year, you will be required to include in your income and to pay tax on the full amount of that increase each and every year. In effect you would pay the full tax rate on an annual basis on these investments as they accrue unrealized capital gains. This is absurd, and is inconsistent with existing capital gains tax policy. In order to catch tax evaders who use offshore accounts the government is proposing to make the ownership by Canadians of popular types of US investments impractical.

Under current legislation, you are only required to report and pay tax on any distributions or dividends that are paid to shareholders. To the extent that this income is capital gains or dividends from eligible Canadian corporations this income is taxed at a reduced rate. The current regulations are consistent with the way that Canadian mutual funds and ETFs are taxed today. Under the proposed new legislation not only will you be required to pay tax on the full increase in value of your shares, but also the amount of tax will be calculated at the higher, ordinary income rates.

Finance's foray down the slippery slope of taxing unrealized capital gains, and taxing them at ordinary income rates, should disturb all taxpayers, even those who are not directly affected by this legislation.

The result is that ordinary law-abiding, tax-paying Canadian investors will be caught unwittingly in a broad trap that CCRA wants to set in order to catch sophisticated tax evaders. Moreover, those who currently invest in the US will be placed in a "catch-22" situation: (a) if they keep their investments they will be forced to pay punitive taxes each year on "income" that they won't see for possibly decades into the future, and (b) if they sell their US holdings in order to avoid the new rules they will be subject to immediate taxation on accumulated capital gains.

The proposed changes are grossly unfair and punitive to ordinary Canadian investors. They should be amended to exclude US-based mutual funds, ETFs and similar types of investment vehicles. Specifically, the original exemptions contained in the 1999 Budget Plan must be retained, i.e.

"The rules would not apply where the foreign-based investment fund annually distributes or allocates to Canadian investors all of the fund's income to which those investors are entitled."

"That investment funds situated in the United States not be subject to these rules since tax avoidance and deferral opportunities are not a concern through the use of such vehicles."

Tax evasion -- NOT!

"It is important that the income tax system not provide a means for Canadians to avoid Canadian income tax by transferring funds to offshore trusts or accounts. The proposed rules intend to provide a fair and workable approach to dealing with this complex area." ...Finance Minister Paul Martin, June 2000

The proposed rules do not provide a fair and workable approach to honest, law-abiding, tax-paying Canadian investors who have legitimate investments in the United States!

Mutual funds and ETFs receive income in respect of interest, capital gains and/or dividends that they earn on the underlying stocks, bonds and other securities in which they invest. Funds/ETFs that are based in Canada, the US and most major countries attribute this income, and make payments in respect of it, to the investors who hold units or shares in these funds/ETFs. They do so in order that the unitholders -- not the fund sponsor -- will be responsible for paying tax on that income. The investors who receive such income are in turn required to report the income and to pay tax on it at the appropriate rates.

The fund/ETF sponsors and/or dealer/brokers are required to send investors information slips (e.g. T3/T5 in Canada, 1042S in the US) that detail all income earned in the previous tax year with a breakdown of the type and amount of income, e.g. interest, capital gain, dividend. Moreover, they may be required to withhold tax at source on some or all of this income.

To "encourage" compliance with tax regulations, copies of such information slips are also sent to the tax authorities. Consequently investors have the information they need to include an accurate report of such income in their tax returns. It is also understood that the tax authorities in Canada and the US, among others, exchange such information with each other in an effort to locate unreported foreign income. Finally, CCRA requires taxpayers who invest outside of Canada to report their holdings by means of annual declarations such as T1135.

By contrast, mutual funds that are based in offshore "tax-haven" countries often do not pay out distributions on interest, capital gains and/or dividends because such income is not taxed in those countries. Instead they reinvest this income back into the assets of the fund. This has the effect of letting such income compound tax-free, and provides the owners of such funds the opportunity to evade paying tax on it in their home country.

However, Canadians who own US mutual funds and/or ETFs are not trying to evade tax. In any case, there are many mechanisms already in place, including those described above, that make it very difficult in practice to do so.

The effect of the proposed changes with respect to US funds/ETFs is not to encourage compliance with the requirement to pay tax on income, but rather to penalize law-abiding taxpayers who for a variety of reasons own US-based funds/ETFs. This proposal is both unfair and unnecessary.

If you already own US mutual funds or ETFs

On the other hand, if you try to avoid this by selling your funds/ETFs once the legislation passes, you will be immediately liable for tax on all of the capital gains that have accrued. The longer you've owned these funds/ETFs and the more they've appreciated in value, the more tax you will have to pay.

Either way, you lose!

Why do Canadians own US-based investment funds?

1. US mutual funds and ETFs charge annual fees that are a small fraction of those charged by comparable Canadian mutual funds.

2. US funds/ETFs offer a much broader variety of asset classes in which to invest than are available in Canada.

3. The taxpayer may have immigrated to Canada from the US, where such funds/ETFs were originally purchased.

4. The taxpayer may have at one time worked in the US, where such funds/ETFs were originally purchased.

5. The taxpayer may have inherited such funds/ETFs from relatives in the US.

You are affected even if you hold these securities in a Canadian brokerage account!

What do we mean by US funds/ETFs?

• Open-end mutual funds such as those from Vanguard, Fidelity, Janus, et al are similar to Canadian-based mutual funds. There are many reasons why Canadians might own US-based mutual funds even though these funds are not generally available in Canada. The previous section, "Why do Canadians own US-based investment funds?," provides several explanations for how and why Canadians might come to own them.

• Closed-end mutual funds which are similar in structure to ETFs but lack the "creation unit" mechanism to arbitrage out any premium or discount to their net asset value (NAV). US closed-end funds trade on stock exchanges like the NYSE and AMEX.

• Shares of certain companies like Microsoft and holding companies like Berkshire-Hathaway:

  The rules may apply even to individual foreign or U.S. stocks like Microsoft Corp., says Robert Spindler, chair of the joint committee on taxation for the Canadian Institute of Chartered Accountants. The new rules may apply to stocks if at least half their assets are in investments -- including cash, of which Microsoft has plenty. It could apply to many technology startups and corporations divesting themselves of assets. And most individuals won't be in a position to figure out such complexities, Spindler says.¹

• Exchange-traded funds have structural differences, so even that term could be misinterpreted. For example:

  Unlike many ETFs that are structured as unit investment trusts, BGIs are registered as open-end funds. ... one of the primary flaws of the unit investment trust structure of ETFs ... is termed dividend drag. It occurs because the SPDR accumulates dividends that are only reinvested quarterly. This will change, however, when Barclays introduces its S&P 500 index ETF. Barclays plans to take advantage of the regulated investment company structure that allows it to increase returns by securities lending, investing undistributed dividends in repurchase agreements, and using futures. These are techniques that are not available to the UIT-structured SPDR but are currently available to mutual funds.²

This website refers to "US-based mutual funds and ETFs" but even that terminology may be too narrow, especially if it turns out that certain stocks are also affected. Perhaps a better term is something like:

publicly-traded US investment funds and stocks.

What you can do

The mutual fund industry in Canada has no interest in making US-based funds/ETFs accessible to Canadians, especially since US-based funds/ETFs are charge significantly lower fees. It's doubtful that the US mutual fund industry even knows about the proposed legislation, let alone cares about it. The only people who will be adversely affected are individual investors like you and me. It is up to us to petition Ottawa to change this legislation.

If you are concerned about the consequences if this legislation is passed, please make and submit your comments as follows:

Fax your submissions if possible. You can send text faxes without charge by e-mailing them to the TPC service as described below. If possible fax or mail your submissions to the following three people (avoid sending e-mail as it is more likely to be lost or deleted):

1. The Hon. Paul Martin
   Minister of Finance
   Department of Finance Canada
   140 O'Connor Street
   Ottawa, ON K1A OG5
   Fax: (613) 992-4291
   Phone (613) 992-4284
   E-mail: Martin.P@parl.gc.ca
   TPC: Click here to send fax via e-mail¹

2. Mr. Len Farber
   General Director Legislation
   Tax Policy Branch
   Department of Finance Canada
   17th Floor, East Tower, 140 O'Connor Street
   Ottawa, ON K1A 0G5
   Fax: (613) 992-4450
   Phone (613) 992-1916
   TPC: Click here to send fax via e-mail¹

3. Your Member of Parliament

How to contact your Member of Parliament

¹How to send a fax for free by e-mail

To send a fax by e-mail to your MP, look up their fax number, then address your e-mail to:

remote-printer.firstname_lastname@1613nnnnnnn.iddd.tpc.int

After you have sent each e-mail you will receive a confirmation also by e-mail as each fax is transmitted.

Now an even easier way to fax Ottawa! Norm Rothery, proprietor of the Directions website has kindly put together a form that will automatically generate the sample letter with your name, address and phone number. Just surf over to Fight the Tax Fax Generator and follow the simple, er, Directions. Thank you Norm!

What to tell them

What we're telling them

What else can you do?

1. Remember, please fax your submissions to all three parties above before the September 1st deadline.

2. Please e-mail a copy of your submission to Stop the tax on US funds/ETFs. Identities will be held in strict confidence!

3. If you can, please fax copies of your submissions to the leaders of the opposition parties:
   • CA: Mr. Jason Kenney, Finance critic
     E-mail: kenneJ@Parl.gc.ca
     Fax: (403) 225-3504
     Tel: (613) 992-2235

   • BQ: Mr. Gilles Duceppe
     Tel: (613) 992-6779
     Fax: (613) 954-2121
     E-mail: Duceppe.G@parl.gc.ca
     

   • PC: Mrs. Elsie Wayne
     Tel: (613) 947-4571
     Fax: (613) 947-4574
     E-mail: Wayne.E@parl.gc.ca
     

   • NDP: Ms. Alexa McDonough
     Tel: (613) 995-7224
     Fax: (613) 992-8569
     E-mail: McDonough.A@parl.gc.ca
     

4. Telephone your Member of Parliament to followup your submission. Be sure to offer additional "encouragement" or information to back up your case.

5. Contact your local media. Tell them why this is newsworthy. Refer them to this site, and to the Media Coverage section below.

6. Contact potentially interested investment groups, clubs or professional associations about making their own additional submissions.

7. If you can contribute time or offer other assistance please e-mail us as above.

History

Related links

About the campaign

Media coverage

Globe and Mail
Ottawa backs down on taxing of U.S. funds [Rob Carrick, 08Sep00]
War on taxing foreign content far from over [Rob Carrick, 29Aug00]
Planned tax protectionist for fund firms [Rob Carrick, 22Aug00]
Proposed tax on index units casts too wide a net [Rob Carrick, 15Aug00]

Toronto Star
Martin's new tax will hit U.S. traded funds [Ellen Roseman, 23Aug00]

Montreal Gazette
Tax grab might kill small investors' ETF party [Don Macdonald, 25Aug00]

Winnipeg Free Press
Last Chance to Voice Opposition to Stupid Law [David Christianson, 31Aug00]

Vancouver Sun
Money moves offshore for a reason [David Shymko, 28Aug00]
Legislation would hirt little guy, too, planners tell gov't [Michael Kane, 25Aug00]

Victoria Times Columnist
Ottawa 'to hit taxpayers' [Andrew Duffy, 26Aug00]

CKNW AM 980 - Vancouver 
Terry Greene of Macdonald-Shymko and Bylo Selhi "appeared" on Peter Warren's call-in show. This is now available for your listening enjoyment on Real Audio or Windows Media Player here. Click on the Sunday, August 27, 2000 12:35PM edition then, when the player starts, skip forward to exactly 1hr 31min 10sec into the show.

Quicken.ca
Taxation to the nth degree [Richard Croft, 28Aug00]

Gordon Pape
Internet Wealth Builder: Tax Nightmare Looms [21Aug00]

Investment Executive
Ottawa spikes tax rule: Online outcry saves exchange-traded funds [James Langton, Oct00]
Finance spares foreign exchange-traded funds [07Sep00]
Tax rule proposal could kill ETFs [James Langton, Sep00]
Proposed tax changes will snuff out ETFs [James Langton, 15Aug00]

Investment Funds Institute of Canada
Submission to Department of Finance Canada    [01Sep00]

The Weathy Boomer
How the campaign got started
Stop tax on US mutual funds/ETFs held by Canadians (1)
Stop tax on US mutual funds/ETFs held by Canadians (2)
Reader response to ETF tax issue
What's left if the Foreign investment entity tax stays put?
new  ETF exemption from phantom tax: a Pyrrhic victory?

The Fund Library
Revenue Canada's Taxation of ETF [Steve Kangas, 23Aug00]
Stop tax on US funds/ETFs held by Canadians

MyBC Money
Controversial plan looms: Tax trouble possible for foreign securities [Dan Hallett, 23Aug00]

Morningstar US
Risky Business [John Rekenthaler, 25Aug00]

Bylo Selhi reports that besides snow, ice hockey, and expensive booze, you have yet another reason to avoid Canada: protectionist legislation. Apparently, Canadian lawmakers have drafted legislation that would make it impractical for Canadian investors to own U.S. mutual funds and Exchange Traded Funds. He's organizing a protest here.

IndexFunds.com
Tax Proposal in Canada Raises Questions [Dan Hallett, 25Aug00]

The Motley Fool
Standing Up for Canadian Fools [Bill Mann, 30Aug00]

FundAlarm
From the Oct00 monthly Highlights and Commentary:

Power to the people! Canadian authorities have killed a proposal to tax the unrealized gains in U.S. funds owned by Canadian investors.....Here at FundAlarm, we got on the bandwagon by suggesting that U.S. investors boycott Molson beer, which at least one Canadian newspaper seems to have taken seriously.....Much of the real credit, however, belongs to the homegrown Web site of "Bylo Selhi," who helped rouse the peace-loving Canadians into an e-mail and letter writing frenzy.....Kudos to Mr. Selhi.