Withholding tax on U.S. ETFs for Canadians
U.S. fairness markets represented about 46% of world fairness market capitalization as of the third quarter of 2022. The S&P 500 whole return in Canadian {dollars} over the previous 50 years as of Dec. 31, 2021 was 2.1% larger than the S&P/TSX Composite whole return for a similar interval (11.7% vs. 9.6%). It solely is sensible for Canadian buyers to have an allocation to U.S. shares.
One downside with proudly owning U.S. shares is withholding tax. To reply your query immediately, Neil, shopping for a Canadian-domiciled U.S. inventory alternate traded fund (ETF) will usually not keep away from U.S. withholding tax. Beneath the tax treaty between Canada and the U.S., there may be 15% withholding tax on dividends paid from a “firm resident” in a single nation to a resident of the opposite.
A Canadian-domiciled ETF—so, an ETF that trades on the Toronto Inventory Change, for instance—is taken into account a Canadian resident. So, if a Canadian-listed ETF receives a dividend from a U.S. inventory, as can be the case for a U.S. inventory ETF domiciled in Canada, there may be 15% withholding tax.
Registered or non-registered account: Does it matter?
If this funding is held in a non-registered account, the 15% withholding tax would most likely not matter. It is because it may be claimed as a international tax credit score that reduces the Canadian tax in any other case payable. This avoids double taxation. Even at a low stage of earnings, Canadian taxpayers usually pay 20% to 25% tax at minimal. So, this primary 15% simply reduces the final word tax legal responsibility.
In case you maintain a Canadian-domiciled U.S. inventory ETF in a registered retirement financial savings plan (RRSP), tax-free financial savings account (TFSA), or registered schooling financial savings plan (RESP), the 15% withholding tax can’t be recovered. The S&P 500 has a dividend yield of about 1.7% at present, so that implies a few 0.25% discount in return. Thoughts you, that may very well be a small value to pay for diversification, given how tough it’s to entry sectors like know-how and well being take care of an investor investing solely in Canada.
Withholding tax on RRSP investments
Curiously, Neil, there could also be a method round this withholding tax for an investor of their RRSP. U.S. shares and U.S.-domiciled U.S. inventory ETFs will not be topic to withholding tax for a Canadian investor holding them of their RRSP, registered retirement earnings fund (RRIF), or comparable retirement accounts. Shopping for U.S. shares and U.S.-listed inventory ETFs can subsequently enhance returns for a Canadian investor—by 0.25% per 12 months for a typical S&P 500 ETF or S&P 500 constituent. The upper the dividend, the larger the profit, Neil.
Nevertheless, as a way to purchase U.S.-domiciled investments, a Canadian investor has to cope with international alternate prices. These can vary from 1.5% to 2% to purchase U.S. {dollars} with Canadian {dollars} in a brokerage account based mostly on the international alternate fee supplied. These international alternate prices will be decreased by utilizing a method generally known as Norbert’s Gambit, through which ETFs or shares are purchased in a single forex and offered in one other forex. On this case, the fee could also be as little because the brokerage commissions to purchase and promote.
The withholding tax exemption for RRSPs doesn’t carry over to TFSAs or RESPs, Neil.
