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 complete return in Canadian {dollars} over the previous 50 years as of Dec. 31, 2021 was 2.1% greater than the S&P/TSX Composite complete return for a similar interval (11.7% vs. 9.6%). It solely is sensible for Canadian traders to have an allocation to U.S. shares.

One downside with proudly owning U.S. shares is withholding tax. To reply your query instantly, Neil, shopping for a Canadian-domiciled U.S. inventory change traded fund (ETF) will typically not keep away from U.S. withholding tax. Underneath 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 could 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 in all probability not matter. It is because it may be claimed as a overseas 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 typically pay 20% to 25% tax at minimal. So, this primary 15% simply reduces the last word tax legal responsibility.

For those who maintain a Canadian-domiciled U.S. inventory ETF in a registered retirement financial savings plan (RRSP), tax-free financial savings account (TFSA), or registered training 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 could possibly be a small worth to pay for diversification, given how tough it’s to entry sectors like expertise and well being look after an investor investing solely in Canada.

Withholding tax on RRSP investments

Apparently, 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 usually are not 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 yr for a typical S&P 500 ETF or S&P 500 constituent. The upper the dividend, the larger the profit, Neil.

Nevertheless, with a view to purchase U.S.-domiciled investments, a Canadian investor has to cope with overseas change prices. These can vary from 1.5% to 2% to purchase U.S. {dollars} with Canadian {dollars} in a brokerage account primarily based on the overseas change charge supplied. These overseas change prices may be diminished by utilizing a method generally known as Norbert’s Gambit, during which ETFs or shares are purchased in a single foreign money and bought in one other foreign money. On this case, the price 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.

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