The Canadian investment funds industry lobby group is asking the U.S. government to exempt Canadian mutual funds owned by U.S. citizens living in Canada from onerous U.S. tax rules that it says unfairly targets these individuals.

The Investment Funds Institute of Canada, in a letter to the International Tax Reform Group of the Ways and Means Commission, argued for the removal of the application of the U.S. Passive Foreign Investment Company (PFIC) rules on Canadian mutual funds.

“We believe the application of the PFIC rules, now and in the future, to Canadian mutual funds has a significant adverse impact on American mutual fund investors who are living in Canada,” wrote Joanne de Laurentiis, president and CEO of IFIC, in the letter to the committee. The adverse impacts outlined were higher than normal levels of taxes, potential punitive tax charges, and compliance costs for these investors.

The U.S. government views foreign mutual funds, including Canadian mutual funds and exchange-traded funds, as PFICs, defined as an investment in which either 75% of the income it produces comes from passive investment, or more than 50% of its assets produce passive income.

A dual citizen who receives income from a Canadian mutual fund, or realizes a gain from its sale, would be subject to specific taxes and interest under the PFIC rules. That could mean that distributions from PFICs that would normally be treated as dividends in the Canadian tax system — or increases in value of the PFIC, which would be treated as a capital gain — would be taxed instead as ordinary income on the U.S. taxpayer’s return.

The PFIC issue has been a thorn in the industry’s side ever since a change in U.S. tax law in 2010 caught Canadian mutual funds and ETFs owned by U.S. taxpayers in the PFIC rules.

“Kudos to IFIC for taking the lead on a critical issue facing the estimated one million U.S. citizens living in Canada,” says Jamie Golombek, managing director of tax and estate planning at CIBC Private Wealth Management in Toronto, and the former chair of the taxation working group at IFIC.

“The ownership of Canadian mutual funds by dual citizens has been troubling these investors for years. Recently, the costs of complying with the U.S. PFIC rules have escalated such that the average dual citizen is being discouraged from even owning Canadian mutual funds. Hopefully, the U.S. legislature will realize that a Canadian mutual fund, by virtue of the fact that it distributes all of its income and gains annually, is simply not an abusive tax vehicle.”