Reader Question: How Does Investment Withholding Tax Work?
Regular reader, Gil, emailed me with a question regarding withholding taxes on U.S securities.
I am wondering if you can provide some insight (to me or as an article for
all of your readers) regarding what the self-directed individual investor
must know with regards to non-resident withholding tax for Canadians
specifically when buying USD ETFs such as Vanguard.Some topics that are unclear to me include: US Estate Tax, IRS withholding
(15%/30% if you don’t file W-8BEN?) and how capital gains and dividends are
treated for tax purposes.
Great question! Lets start with capital gains and assume that the investments are in a non-registered account. U.S Securities face the same capital gains tax as Canadian securities. That is, if you buy a U.S security and it is sold for $1,000 profit, then $500 is taxable at your marginal tax rate. At 40% MTR, you would owe $200 in taxes on your $1,000 profit.
The biggest difference comes with U.S dividends/interest which face withholding tax. The default withholding tax on those distributions is 30%. But if you fill out a W-8BEN form from your brokerage, the withholding tax will be reduced to 15%. The withheld amount will be used to reduce the tax owed on the distribution. As you can see, the simple act of filling out the W-8BEN from your brokerage can free up 15% of your distribution to be used as you please.
Example
U.S Dividends and interest are taxed at your marginal rate. If you received a $100 U.S dividend, providing that the W-8BEN is completed, the brokerage would take $15 and deposit $85 to your account. When tax season comes around, you would pay tax on the $100 received. Assuming 40% tax bracket, $40-$15 (already paid)= $25 USD would be owed in taxes.
Sidenote:
If the U.S stocks are held within an RRSP, the dividends will not face any withholding tax.
14 Comments, Comment or Ping
1. Brian
Regarding the sidenote, what caveats are there to investing in US dividend generating stocks within an RRSP?
There are opportunities in the US markets to pick up great stocks, but I don’t want to be burdened with tax and regulatory penalties for shopping across the border.
Aug 21st, 2008 @ 9:40 am
2. FrugalTrader
Brian, the only caveat I can think of is that your dividend will be converted to Canadian dollars which means yet another forex hit from Canadian brokers. The only brokerage that I know of that allows USD to be held within an RRSP is Questrade.
Aug 21st, 2008 @ 9:43 am
3. Cannon_fodder
FT,
and if you have the US dividend stocks in your RRSP combined with a DRIP, could a brokerage hit you twice with forex? Convert it to Canadian, then convert it back to US to buy whole shares?
Aug 21st, 2008 @ 11:02 am
4. Dividend Growth Investor
That’s why its pays to hold most of your stocks, mutual funds and ETF’s in a tax deferred account..
Aug 21st, 2008 @ 11:43 am
5. R I
FYI,
Last september Canada and the US signed a new tax agreement that would eliminate withholding tax on interest. I think it has passed in Canada, but we are still waiting for US legislators to approve it. As of this moment, there is no withholding tax on interest paid in Canada to non-residents
Aug 21st, 2008 @ 11:50 am
6. AverageCFA
Withholding tax on dividends paid by ADR traded in US seems to depend on a treaty between Canada and the issuing country of the ADR, not USA. Did anyone come across a list of countries and withholding taxes a Canadian investor would pay on dividends received from non-US countries? For example, withholding tax on Nokia dividend is 28% even though NOK is traded on NYSE. How much will be withheld from a dividend paid by Abb Ltd (Swiss firm) or Barclays PLC (UK bank)?
Thank you
Aug 21st, 2008 @ 12:01 pm
7. Ryan
Great article. I have often struggled with ‘where’ to put my investments. Before learning about withholding tax I placed by US holdings in my non-RRSP (SPY) and my other international holdings in my RRSP Account (EEM and XIN),
I decided to keep this set up because even XIN is paying such a high dividend rate compared to SPY. So even though I am losing out on the withholding tax my total tax bill is lower because the higher dividends from XIN are in my RRSP.
Aug 21st, 2008 @ 1:15 pm
8. Tax Resource
A few points on the article and comments.
You can claim a credit for foreign taxes withheld in non-registered accounts. The credit is the less of the tax actually withheld or 15% of the amount of the total amount received (before withholding).
ADR’s can be a challenge because the foreign jurisdiction withholds the tax and if the ADR is traded in the U.S. you may not get it back.
Anything foreign should be very closely scrutinized. Sometimes a portion of the tax withheld is gone forever and you need to account for than when investing.
Aug 24th, 2008 @ 11:09 pm
9. Buygood
US withholds 15% tax on your dividend income and does not tax on your capital gain.
Sep 8th, 2008 @ 12:38 am
10. Buygood
But I have no idea how much it withholds from dividend from ADR traded in US. US definitely does not tax on this kind of dividend. So I am worried about it too.
Sep 8th, 2008 @ 12:44 am
11. Brian
Hi Frugal Trader,
If the investments are in a registered account. Does the US still withhold the 15%?
Oct 23rd, 2008 @ 3:20 pm
12. Joe
Brian,
From my experience, if you hold in a registered account, there is no 15% tax withheld.
For those of you who want to some exposure to US and global high divident stocks, there is a high dividend ETF from Claymore Investment–CYH , and they said
“By using the Forward Agreement, the income generated by the Global Yield Hog Index portfolio (generally foreign income) will be recharacterized and paid to Unitholders of the ETF primarily as distributions of return of capital and capital gains.”
So the tax on dividend and income would be dramatically lowered. If you marginal tax bracket is 40%, you have $1000 capital gain, you tax would be:
$1000/2*40%=$200, equivalent of 20% tax.
If buying high dividend US stocks directly , you have to pay 15% on the dividend, and on top of that the dividend after 15% tax will be treated as income.
Jan 15th, 2009 @ 12:49 pm
13. Sue
What if you buy US stocks with your Tax Free Savings Account? Do you still pay the withholding tax?
Jan 14th, 2010 @ 2:43 pm
14. FrugalTrader
Sue, the TFSA is not exempt from withholding tax.
Jan 14th, 2010 @ 3:05 pm
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