Can Canadian ETFs Escape PFIC Status? A CPA’s Perspective on “Reasonable” Tax Positions

I've had a lot of feedback on my original article about why Canadian ETFs may not be considered PFICs. Some of it positive, some of it skeptical, and plenty of the usual “yeah, well, that’s just your opinion, man” responses from tax season doomers. Fair enough. I’m a CPA, not a tax lawyer, and if you want a binding legal opinion, go pay someone who writes those for a living (I can make an introduction.)

But for those of you genuinely looking for a deeper technical dive into the issue, here it is: a more extensive breakdown of the classification rules, case law, IRS guidance (or lack thereof), and why the PFIC label isn’t as automatic as some would have you believe.

For US taxpayers, a Passive Foreign Investment Company (PFIC) is defined as any foreign corporation meeting certain passive income or passive asset thresholds under Internal Revenue Code (IRC) §1297(a).¹ In practice, this means PFIC status applies only if an investment vehicle is treated as a corporation for US tax purposes. Canadian exchange-traded funds (ETFs) and mutual funds often take the legal form of trusts in Canada. Whether they rise to the level of “foreign corporation” is the crux of whether they qualify as PFICs or not. If they are not corporations, they cannot be PFICs.

So below is a very tax nerd review of the specific reasons why Canadian mutual fund trusts and ETFs may not be considered PFICs. We cover the core definition of PFICs, the entity classification rules in the check-the-box regulations, Canadian legal provisions on investor liability, US case law beyond the Estate of Fung, IRS rulings, enforcement trends, and comparisons to other foreign fund structures.

PFIC 101: The Importance of “Foreign Corporation”

Under IRC §1297(a), a PFIC is any foreign corporation for which at least 75 percent of its gross income is passive or at least 50 percent of its assets produce passive income.² Two elements must both be present for PFIC status: (1) the entity is foreign, and (2) it is a corporation by US standards.³ Partnerships, trusts, and other non-corporate entities cannot be PFICs, no matter how passive their income.⁴ This distinction places a bright line around the PFIC regime: no corporate classification means no PFIC classification.

Many Canadian ETFs and mutual funds operate as trusts under Canadian law.⁵ They pool investors’ capital in portfolios of stocks and bonds, distributing income to unitholders. The question is whether these trust vehicles are deemed “corporations” when viewed through the lens of US tax rules.

Entity Classification Under the Check-the-Box Regulations

Overview of the Rules

Since 1997, the US Treasury regulations have used a “check-the-box” system to classify domestic and foreign business entities.⁶ Entities that are not on the IRS’s “per se corporation” list are called “eligible entities” and can often choose to be taxed as a corporation, partnership, or disregarded entity by filing Form 8832.⁷ If no election is made, the default classification rules apply.⁸

For a foreign eligible entity with multiple owners, the default classification depends on limited liability. If all owners have limited liability, the default is an association taxed as a corporation. If at least one owner lacks limited liability, the default is a partnership.⁹ Single-owner entities default to disregarded status if the owner does not have limited liability. In effect, the presence or absence of complete limited liability for every owner decides whether the default classification is corporate.

Why Canadian Mutual Fund Trusts Are “Eligible Entities”

A foreign entity can be a per se corporation only if it meets specific enumerated criteria under Treas. Reg. §301.7701-2(b), often referencing incorporation under foreign corporate statutes (e.g., Inc., Ltd., SA).¹⁰ Canadian mutual fund trusts are not incorporated; they are structured as trusts under Canadian law and are not listed on the IRS’s per se corporation list.¹¹

Moreover, these trusts do not qualify as “ordinary trusts” for US tax, because they are actively managed for profit, issue transferable units, and vary their investments.¹² Under Treas. Reg. §301.7701-4, a genuine trust exists only if trustees act primarily to protect property, without a business or profit motive. A Canadian ETF with a manager pursuing active or index-based strategies does not fit that profile. It becomes a “business entity” instead.¹³

Thus, Canadian fund trusts are neither per se corporations nor ordinary trusts. They are eligible entities that default to either corporate or partnership status based on the limited liability of their owners.¹⁴

Words Matter: Investor Limited Liability

Default Classification Depends on Liability

For Canadian mutual fund trusts with multiple unitholders, the check-the-box default classification hinges on whether all unitholders have limited liability. If every single investor is fully insulated from the trust’s debts, the default is a corporation. If even one unitholder could, in theory, be held personally responsible for the trust’s obligations, it defaults to a partnership.¹⁵

In US tax regulations, “limited liability” means an owner is not personally liable for entity debts solely by virtue of being an owner.¹⁶ The smallest possibility of personal liability for at least one investor means not all owners have limited liability, directing the classification to partnership.¹⁷

Canadian Statutory Protection

Historically, Canadian trust law did not guarantee limited liability for mutual fund trust unitholders. In some provinces, beneficiaries might be exposed if trust assets could not cover the obligations.¹⁸ Concerned about investor confidence, multiple provinces passed laws ensuring limited liability for trust unitholders:

• Alberta enacted the Income Trusts Liability Act in 2004
• Ontario enacted the Trust Beneficiaries’ Liability Act in 2004
• British Columbia, Saskatchewan, and Manitoba followed suit around 2005–2006

Before these statutes, unitholders of a mutual fund trust formed in those provinces did not enjoy explicit limited liability.¹⁹ Even after enactment, certain nuances apply, such as whether the fund meets “reporting issuer” thresholds under provincial securities law. Some older trusts still include disclaimers in their prospectuses warning that limited liability might not be ironclad.²⁰

The check-the-box rules do not generally reclassify an entity if state or provincial laws change post-formation.²¹ So a trust organized in 2002, when no liability shield existed, might retain its partnership default if unitholders were not uniformly protected at inception. In many cases, this means the entity was never a “foreign corporation” for US tax, so it never triggered PFIC classification.

Additional Case Law: Beyond Estate of Fung

Estate of Fung v. Commissioner often appears in discussions on theoretical liability in tax classification.²² However, there are other cases and rulings that reinforce similar principles:

1. Morrissey v. Commissioner, 296 US 344 (1935). Established that trusts actively carrying on a business can be taxed like corporations if they have corporate attributes. This paved the way for modern regulations but does not say every business trust is a corporation. Instead, each structure’s attributes must be weighed.
2. Littriello v. United States, 484 F.3d 372 (6th Cir. 2007). Confirmed that the check-the-box regulations are valid and that taxpayers must follow the default classification absent a formal election.
3. Helvering v. Coleman-Gilbert Associates, 296 US 369 (1935). Decided alongside Morrissey, emphasizing that whether a trust qualifies as an association depends on multiple factors, including limited liability. If the trust arrangement fails to protect all owners, corporate classification may not apply.

These precedents support the notion that liability matters. Where trust beneficiaries could theoretically be pursued by creditors, courts have leaned toward partnership-style classification.²³ In Fung specifically, the Tax Court emphasized that even if a creditor is unlikely to pursue personal assets, it is enough that the legal right exists.²⁴

IRS Rulings, Guidance, and Enforcement

Chief Counsel Advice 201003013

Many practitioners cite a 2009 Chief Counsel Advice (CCA 201003013) to claim Canadian mutual funds are corporations for US tax.²⁵ Yet a CCA is non-precedential and fact-specific.²⁶ In that memo, the IRS concluded certain Canadian mutual funds in a decedent’s RRSP “would be classified as corporations” based on assumed facts. The memo offered no deep analysis. It simply accepted that unitholders all had limited liability.²⁷ Chief Counsel Advice cannot be cited as binding authority, and the IRS has not repeated the same conclusion in regulations or revenue rulings.²⁸

Private Letter Rulings

Private Letter Rulings (PLRs) also highlight that foreign mutual fund trusts are “eligible entities,” free to elect partnership or corporate status.²⁹ For instance, PLR 200752029 confirmed that a foreign investment trust with multiple investors and active management was not a per se corporation, thus it could choose its classification by filing Form 8832.³⁰ PLRs are taxpayer-specific, but they show the IRS recognizes these trusts may elect or default to non-corporate status.

Enforcement Trends

No widespread IRS initiative has targeted Canadian mutual funds for PFIC misclassification.³¹ If the IRS firmly believed these trusts must be PFICs, it would presumably penalize taxpayers failing to file Form 8621. Instead, anecdotal reports suggest the IRS rarely challenges those who treat Canadian mutual fund trusts as non-corporate entities, especially when investors report their income currently.³² The Service appears more focused on unreported offshore accounts than on classification nuances where the taxpayer is paying tax properly each year.

Comparing Canadian ETFs to Other Foreign Funds

This classification dilemma also arises in other jurisdictions:

• Luxembourg: A Société d’Investissement à Capital Variable (SICAV) is generally a per se corporation, while a Fonds Commun de Placement (FCP) might not be.³³
• Ireland: An Irish Collective Asset-management Vehicle (ICAV) is typically a corporation, but a Common Contractual Fund (CCF) is often treated as a partnership or transparent entity.³⁴
• United Kingdom: Open-Ended Investment Companies (OEICs) are corporations, but certain unit trusts can default to a partnership classification if owners do not all have limited liability by UK law.³⁵

In each jurisdiction, the US classification hinges on the same question: is it an association or per se corporation, or is there an absence of full limited liability for all investors?

Conclusion and Practical Takeaways

Canadian ETFs and mutual fund trusts are frequently labeled as PFICs in practice. Yet that conclusion rests on the assumption that these trusts are corporations under US tax rules. The check-the-box regulations indicate otherwise if unitholders ever faced personal liability under Canadian law. In many cases, older trusts or funds formed in a province without robust statutory shields at the time of formation should default to partnership status, not corporate. That alone places them outside the PFIC regime.

Taxpayers taking the position that their Canadian ETF is not a PFIC must still report all income properly, disclosing the classification rationale if necessary.³⁶ They should document how provincial law affected unitholder liability and confirm no entity classification election overrides the default.³⁷ In the absence of clear or binding IRS guidance to the contrary, the case for partnership classification is solid, grounded in both the regulations and case law on liability.

This is not a loophole to avoid US tax. Canadian fund trusts distribute income, which must be reported currently, achieving the same anti-deferral goal that PFIC rules were designed to ensure. The critical difference is that should these vehicles not qualify as “foreign corporations” under a proper reading of the check-the-box framework, the PFIC rules simply do not apply.

Shoulders Of Giants Etc

A huge shout-out to Max Reed of Polaris Tax, who has been breaking down the PFIC classification of Canadian mutual funds since at least 2012. A lot of this analysis builds on the groundwork he laid over a decade ago. If you're deep into the cross-border tax world, his insights are worth following. So go check out his work at Polaris Tax and his articles on the subject.

Footnotes

1. IRC §1297(a).
2. Ibid. See also Treas. Reg. §1.1297-1.
3. IRC §1297(d) clarifies that branches, trusts, and partnerships are not included unless treated as corporations under Treas. Reg. §301.7701.
4. Treas. Reg. §1.1291-1(a) explicitly states that only ownership of stock in a foreign corporation gives rise to PFIC classification.
5. Many Canadian ETFs are organized as trusts rather than corporations to achieve flow-through status under Canadian tax law.
6. T.D. 8697, 1997-1 C.B. 215 (the Treasury Decision introducing check-the-box).
7. Treas. Reg. §301.7701-3(c).
8. Treas. Reg. §301.7701-3(b)(2).
9. Ibid.
10. Treas. Reg. §301.7701-2(b)(8) (listing specific per se foreign entities).
11. Canadian trusts are not enumerated as per se corporations. See also IRS Entity Classification Chart for Foreign Entities (unofficial references like IRS Publication 7008).
12. Treas. Reg. §301.7701-4 (distinguishing “business trusts” from ordinary trusts).
13. Ibid.
14. Treas. Reg. §301.7701-3(b)(2)(B).
15. Ibid.
16. Treas. Reg. §301.7701-3(d)(1)(ii).
17. Ibid.
18. See, for example, Trident Holdings Ltd. v. Danand Investments Ltd. (1988) 64 O.R. (2d) 65.
19. Ontario enacted the Trust Beneficiaries’ Liability Act, 2004. Alberta passed its own trust liability protection the same year, and Manitoba, Saskatchewan, and British Columbia followed.
20. Some prospectuses include disclaimers regarding unitholder liability in provinces lacking explicit statutory protection.
21. Treas. Reg. §301.7701-3(g) provides that an entity retains its classification unless it elects a change or undergoes certain major alterations. Statutory changes in liability law do not always force a reclassification.
22. Estate of Fung v. Commissioner, 117 T.C. 247 (2001), aff’d, 53 Fed. Appx. 328 (9th Cir. 2003).
23. Morrissey v. Commissioner, 296 US 344 (1935).
24. See Estate of Fung, 117 T.C. at 273–274.
25. CCA 201003013 (Sept. 28, 2009).
26. 26 USC §6110(k)(3) states Chief Counsel Advice is not precedential.
27. CCA 201003013 at 7.
28. Ibid.
29. See PLR 200752029 for a foreign “trust” similar to a mutual fund that was classified as an eligible entity.
30. Ibid.
31. No formal IRS enforcement directive targets Canadian ETFs for PFIC classification.
32. Several cross-border tax practitioners have noted minimal audit activity on this point, although anecdotal evidence is not conclusive.
33. Luxembourg SICAVs are often Societé Anonyme or Societé à Responsabilité Limitée, both per se corporations under Treas. Reg. §301.7701-2(b)(8). A Fonds Commun de Placement is a contractual fund, not automatically corporate.
34. Irish Common Contractual Funds are generally tax transparent for US purposes, while an Irish corporate fund is typically a PFIC if passive.
35. United Kingdom offers unit trusts and OEICs, with the latter always treated as corporations. Unit trusts may require separate entity classification analysis.
36. A reasonable disclosure on Form 8275 can help avoid accuracy-related penalties if the IRS disputes a non-PFIC stance.
37. If the mutual fund trust (or its manager) has filed Form 8832 to elect corporate or partnership status, that election supersedes the default classification.

Disclaimer: This content is for informational purposes only and does not constitute tax advice. Each taxpayer’s situation is fact-specific. Consult a qualified professional for personalized guidance.