Foreign Withholding Tax | Summary and Q&A

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August 3, 2018
by
Ben Felix
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Foreign Withholding Tax

TL;DR

Foreign withholding tax can have a significant negative impact on investment returns if not managed properly, especially for Canadian investors.

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Key Insights

  • 🚕 Foreign withholding tax can have a significant negative impact on investment returns, particularly for Canadian investors.
  • 💐 Different structures of ETFs and types of investment accounts result in varying levels of foreign withholding tax.
  • 👂 US listed ETFs in RRSPs can eliminate foreign withholding tax, but currency conversion costs may outweigh the benefits in some cases.
  • 👂 Canadian listed ETFs that own US listed ETFs in TFSAs or RESPs incur two levels of unrecoverable foreign withholding tax.
  • 🥹 Directly holding international stocks through Canadian ETFs or Canadian index mutual funds reduces the complexities of foreign withholding tax.
  • 📼 Asset location, optimizing which assets should be held in each type of account, is a strategy to minimize foreign withholding tax.

Transcript

xecGlobal diversification is universally  accepted as beneficial to investors,   but foreign withholding tax is a tricky  little detail that can eat into your   investment returns. When a foreign company  pays a dividend to a Canadian investor,   the company’s home country will often impose  a tax on the dividend. The amount of tax   withheld by th... Read More

Questions & Answers

Q: What is foreign withholding tax and how does it impact investment returns?

Foreign withholding tax is a tax imposed by foreign governments on dividends paid to Canadian investors. If not managed properly, it can significantly reduce investment returns, sometimes more than the management expense ratio on most ETFs.

Q: Are there different levels of foreign withholding tax?

Yes, there are two levels. Level One withholding tax is the tax levied by any foreign country, including the US. Level Two withholding tax is an additional 15% withheld by the US government on dividends paid to Canadian investors by Canadian listed ETFs that own US listed ETFs.

Q: How does the type of account affect foreign withholding tax?

US securities held in an RRSP or other retirement accounts do not have any tax withheld by the US on dividends. However, TFSAs and RESPs are subject to withholding tax. For taxable accounts, foreign taxes withheld can generally be used to offset Canadian taxes.

Q: What are the best strategies to minimize foreign withholding tax?

Holding US listed ETFs with US stocks in an RRSP can eliminate foreign withholding tax. Alternatively, holding Canadian listed ETFs of US stocks in an RRSP or TFSA incurs a 0.25% unrecoverable withholding tax cost. Holding Canadian ETFs that hold international stocks directly can also reduce tax implications.

Summary & Key Takeaways

  • Foreign withholding tax is a tax imposed by a foreign country on dividends paid to a Canadian investor.

  • There are three main structures of ETFs that Canadian investors may encounter: US listed ETFs, Canadian listed ETFs that hold US listed ETFs, and Canadian ETFs that hold stocks directly.

  • The type of account also affects the tax implications, with RRSPs exempt from US withholding tax but other accounts like TFSAs and RESPs subject to it.

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