ELI5: Foreign Withholding Tax

It's important to diversify globally. This is especially true for us up north. Canada only has a handful of public companies and these companies span very few sectors (finance and natural resources).

Investing overseas does comes a cost. Taxes. Today we discuss foreign withholding tax and how we can properly manage it.

What is Foreign Withholding Tax?

These are taxes for dividends paid by foreign companies to Canadians.

The tax is withheld from your dividends behind the scenes so are often overlooked. A major oversight as they can put a heavy drag on performance if not managed.

How Much Are These Taxes?

The amount varies by country, typically ranging between 15% and 25%.

Are These Taxes Recoverable?

If the tax occurs in your non-registered account then you'll receive a tax credit that you can apply against your income.

For dividends paid to your registered accounts (TFSA, RRSP, etc.), the tax is unrecoverable.

How Can I Reduce My Taxes?

Tax consequences come down to what you're holding and where. For ETF investors there are some guidelines to follow.

RRSP: US-Listed ETFs that hold US stocks

Example: ITOT

Canada has a treaty with the US that eliminates foreign withholding tax in the RRSP. No similar treaty exist with any other country.

You'll need to convert your Loonies to Dollars to buy the US-listed ETFs. This is costly, unless you use Norbert's Gambit.

TFSA and Non-Registered: Canadian-Listed ETFs holding foreign securities directly

Example: XEF

Our tax treaty with the US only applies to the RRSP so there's no benefit in converting currency and buying in USD. You're better off keeping it simple buying Canadian-listed ETFs.

But be careful! You'll want to buy the right ones. Canadian-listed ETFs can hold foreign securities directly or can hold a US-listed ETF that holds foreign securities.

You'll want to avoid the latter as they create an additional layer of tax. When dividends are paid, the non-US foreign country withholds taxes before paying the US, and then the US withholds taxes before paying you.

A Canadian-Listed ETF holding foreign securities directly only has taxes withheld by the foreign country. No US middleman, no second layer of tax.

Conclusion

Taxes can get complicated but if you're portfolio is large enough it's worth taking the time to make sure you have the right investments in the right accounts. Happy savings!

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