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 traders to have an allocation to U.S. shares.
One downside with proudly owning U.S. shares is withholding tax. To reply your query straight, Neil, shopping for a Canadian-domiciled U.S. inventory trade traded fund (ETF) will typically not keep away from U.S. withholding tax. Below the tax treaty between Canada and the U.S., there’s 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’s 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’s 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 degree of revenue, Canadian taxpayers typically pay 20% to 25% tax at minimal. So, this primary 15% simply reduces the last word tax legal responsibility.
When 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 the moment, so that implies a few 0.25% discount in return. Thoughts you, that might be a small worth 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 approach round this withholding tax for an investor of their RRSP. U.S. shares and U.S.-domiciled U.S. inventory ETFs are usually not topic to withholding tax for a Canadian investor holding them of their RRSP, registered retirement revenue fund (RRIF), or comparable retirement accounts. Shopping for U.S. shares and U.S.-listed inventory ETFs can subsequently increase 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 better the profit, Neil.
Nevertheless, with a view to purchase U.S.-domiciled investments, a Canadian investor has to take care of overseas trade 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 trade price supplied. These overseas trade prices could be decreased by utilizing a method generally known as Norbert’s Gambit, by which ETFs or shares are purchased in a single forex and bought 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.