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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.

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FT About the author: FT is the founder and editor of Million Dollar Journey (est. 2006). Through various financial strategies outlined on this site, he grew his net worth from $200,000 in 2006 to $1,000,000 by 2014. You can read more about him here.

{ 18 comments… add one }
  • Brian August 21, 2008, 9:40 am

    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.

  • FT FrugalTrader August 21, 2008, 9:43 am

    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.

  • Cannon_fodder August 21, 2008, 11:02 am

    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?

  • Dividend Growth Investor August 21, 2008, 11:43 am

    That’s why its pays to hold most of your stocks, mutual funds and ETF’s in a tax deferred account..

  • R I August 21, 2008, 11:50 am

    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

  • AverageCFA August 21, 2008, 12:01 pm

    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

  • Ryan August 21, 2008, 1:15 pm

    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.

  • Tax Resource August 24, 2008, 11:09 pm

    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.

  • Buygood September 8, 2008, 12:38 am

    US withholds 15% tax on your dividend income and does not tax on your capital gain.

  • Buygood September 8, 2008, 12:44 am

    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.

  • Brian October 23, 2008, 3:20 pm

    Hi Frugal Trader,

    If the investments are in a registered account. Does the US still withhold the 15%?

  • Joe January 15, 2009, 12:49 pm

    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.

  • Sue January 14, 2010, 2:43 pm

    What if you buy US stocks with your Tax Free Savings Account? Do you still pay the withholding tax?

  • FT FrugalTrader January 14, 2010, 3:05 pm

    Sue, the TFSA is not exempt from withholding tax.

  • zdad December 14, 2010, 5:31 am

    I am not sure I am understanding this correctly.

    In your example:
    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

    in essence you are still paying 40% in taxes on the $100 dividend right?
    the only difference being that 15% is being withheld immediately, and the remaining $25 you get to enjoy (and invest) until tax time. so if you were paid the dividend in the 1st qtr you would have 3 more qtrs to make money off of the $25 that you will owe.
    Is my understanding of this correct.

    if I were to hold this same investment inside my RRSP. I would not have to pay the witholding tax at all but would i have to pay tax on the dividend at all assuming i make no withdrawals.
    after I retire, i would then pay at lower marginal tax rate as income but what about all the dividend income i rec’d.

  • FT FrugalTrader December 14, 2010, 8:52 am

    @zdad, your understanding is the same as my understanding. :)

  • aria December 29, 2011, 5:07 am

    I plan to be holding all my US and International Investments in my RRSPs. I see the clear benefit of not having to pay any withholding taxes when US investments are held in an RRSP, but are there any taxes or fees that will be levied once I sell my US Securities that are in my RRSPs (to free up capital, or to withdraw money from my RRSPs..etc.?)

    Your help would be greaty appreciated! I have other US mutual funds in RRSPs at a couple of CDN banks, in addition to my discount brokerage, but I do not believe I have ever filled out a W-8 Ben, as the investments were always in RRSPs.

    Thanks in advance :)

  • Graham November 5, 2012, 12:42 pm

    Regarding ASRs. I hold one (Sasol SSL) in my RRIF. There was never any tax withheld, so I enjoyed the full dividend. However, South Africa recently changed their method of taxing companies and now 15% of the dividend is withheld. In the RRIF, I just lose that amount. (In this case, it is not a big problem, because change in taxation meant dividends increased!)

    I was considering moving ADR to taxable account. But in reading above, perhaps I would still lose the 15% South African withholding? Then US would apply 15% and eventually I would pay tax at marginal rate. If that was 40%, I would lose 55% of dividend?? That will happen too in RRIF, but tax will be deferred until withdrawal.

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