Q. What types of foreign investments can Canadian investors invest in their RRSP, TFSA and Non-Registered accounts that don’t charge withholding taxes?
Canadian investors get enormous benefit from diversifying their portfolios with U.S. and international stocks, but it can come at a cost – foreign withholding taxes.
In a nutshell, many foreign countries including the U.S. impose withholding taxes on dividends paid by their corporations to Canadian investors. This tax is generally 15% of the dividend. The tax you pay depends on two factors:
- the type of account your hold your investments in, and
- the structure of the investment.
So, let’s show an example.
Foreign Withholding Taxes
You want to buy 100 shares of Hershey Co. which is listed on the New York Stock Exchange. If you hold the shares in your RRSP you will receive the full amount of the dividend – US$61.75 per quarter, or approximately CD$82.
This is because the U.S. has a tax treaty with Canada that waives withholding taxes on dividends paid on stocks held in retirement (RRSP, RRIF, LIRA, etc.) or pension accounts.
If the shares are in a non-registered (taxable) account, the withholding tax ($12.30 in our example) will be taken and you will be paid $69.70. However, the tax amount you paid will appear on a T5 slip, and you can recover it by claiming a foreign tax credit on your income tax return.
If you purchase the shares for your TFSA, U.S. withholding tax will always be applied (you get a $69.70 dividend) – but you are not allowed to claim it.
Now, what if Hershey Co. (or other U.S. or foreign stock) is held in a mutual fund or ETF? Hold on to your hat because this is where it gets a bit more complicated. There are three different scenarios.
1. Canadian listed mutual funds and ETFs that hold U.S. and foreign securities directly
- TD US Index e-series fund
- BMO S&P 500 (ZUE)
RRSP: Since the fund itself pays the tax, you do not receive the exemption.
Non-registered account: Withholding tax is reported on a T3 slip and you can claim the foreign tax credit.
2. U.S. and International ETFs listed on a U.S. exchange
- Vanguard Total Market (VTI)
RRSP: You are exempt from U.S. withholding tax. But, if the ETF holds international stocks, each individual country will take its own tax amount.
Non-registered account: You’ll receive a T5 showing the U.S. amount paid and it is recoverable. International withholding tax is not recoverable.
3. Canadian listed ETFs that hold U.S.-listed ETFs (U.S. and International)
- iShares S&P 500 (XSP)
- Vanguard FTSE Developed Ex-N.A. (VEF)
RRSP: All U.S. and international withholding taxes are taken.
Non-registered account: You can recover the taxes withheld by the U.S., but the taxes from the non-U.S. countries are not recoverable.
Note: In all the above cases, U.S. and international dividends paid into a TFSA will have had the withholding taxes taken, and, because you won’t get T-slips for any security held in a TFSA, you are not able to recover the tax.
Retirement accounts are exempt from U.S. withholding taxes but not non-U.S. taxes. TFSAs will always pay them.
Holding foreign equities in a non-registered account may allow you to claim the foreign tax credit, but the dividends are taxed as income at your highest marginal tax rate – you can’t claim the dividend tax credit – and you pay income tax on half your capital gains.
Most investors should take full advantage of tax-sheltered accounts before investing in non-registered accounts. Don’t avoid them just to save a few dollars in recoverable withholding tax.
Keep in mind that foreign withholding taxes are just one of many costs of investing. Don’t make an investment decision entirely for tax reasons. Consider also – MERs, currency conversion fees, U.S. estate taxes (for significant holdings in U.S.-listed ETFs), and your personal income tax situation.
Look at the whole picture and don’t focus on minutia.