Since Canada makes up only a small fraction of the Global Investment Market, you may already have considered diversifying your portfolio with U.S. and international stocks. Not only do they optimize geographic diversification and mitigate risk, they also allow you to invest in industry sectors that are not otherwise available in Canada.
As you diversify your portfolio you may be surprised to learn that many countries impose a tax on dividends paid to foreign investors; although Canada has tax treaties with most developed countries, additional administrative filings are generally required for the treaty tax rate to apply.
Here are 4 things to keep in mind as you evaluate investment alternatives outside of Canada:
- United States: If you are purchasing US dividend-paying stocks, consider holding them within your RRSP/RRIF versus your TFSA/RESP or taxable non-registered account. According to the tax treaty between Canada and the US, there is no withholding tax on dividends received on shares within your RRSP/RRIF(1) . The same does not apply to dividends paid on US stocks held within your TFSA or RESP. US dividends paid on stocks held within your TFSA or RESP will be reduced by withholding taxes paid, generally 15% of the dividend paid provided you have filed IRS Form W-8BEN with your broker, otherwise it can be as much as 30%. Lastly, dividends paid on US stocks held within your non-registered account are subject to withholding tax. You should be able to claim back the tax as a foreign tax credit, up to 15%, upon filing your Canadian Tax Return.
- United Kingdom: For UK Stocks, the good news is that under U.K. domestic law there is generally no withholding tax on dividends paid to non-residents(2) . As a result, holding UK dividend-paying stocks within your RRSP or TFSA would allow you to benefit from foreign equity exposure without additional foreign tax. You may also consider holding them within your taxable non-registered investment account. In this case remember that the dividend received would be fully taxed as there is no dividend tax credit for foreign dividends.
- Other Countries: For other foreign dividend-paying stocks it will depend upon the country, their tax laws and their specific tax treaty with Canada. As a general rule, if you hold foreign dividend-paying stocks within a registered account you may end up paying foreign taxes not otherwise eligible for a foreign tax credit. You’ll need to balance out the additional foreign tax cost versus the overall tax benefit of sheltering the investment in your registered account. Foreign taxes paid on dividends in your taxable non-registered account should in general qualify for a Canadian foreign tax credit.
- Canadian mutual funds & ETFs: Lastly, if you are considering holding Canadian mutual funds or ETFs that hold US and international equity directly keep this in mind. Foreign taxes paid by mutual funds or ETFs held within your taxable non-registered investment account will be reported on a T3 which allows you to claim a foreign tax credit when you file your Canadian Tax Return. Unfortunately if you hold these investments within your RRSP or TFSA, any foreign taxes paid are not otherwise recoverable.
The taxation of foreign investments is a complex area of tax. As you consider foreign investment alternatives speak with your advisor to determine how to best structure your investments to minimize foreign withholding taxes.
(1) Canada US Tax Convention Article XXI(2) exempts income exclusively earned to provide pension, retirement or employee benefits.
(2) KPMG TaxNewsFlash – July 29, 2014 No 2014-41 Canada and U.K. Agree to Amend Tax Treaty.