Global REIT mutual funds and ETFs invest in companies around the world that own real estate (for the purposes of generating income for their shareholders). If you’ve decided to include global REITs in your portfolio because of the diversification benefits they provide, you should also understand the foreign withholding tax differences between two of the product structures available to Canadian investors:
The DFA Global Real Estate Securities Fund Class F (DFA391) is an example of a Canadian-domiciled mutual fund that holds the underlying global REITs. Approximately 60% of the companies are US-domiciled (the US levies a withholding tax rate on dividends of 15%). The remaining dividend income is subject to various foreign withholding tax rates, depending on the country of origin. According to DFA’s most recent financial statements, the average withholding tax rate on dividends has been about 10%.
If you held this fund in an RRSP account, the foreign withholding taxes would be lost. If we assume a 4% dividend yield on a global REIT mutual fund, this tax drag would be approximately 0.40% per year (4% × 10% = 0.40%).
If you held this fund in a non-registered account, the foreign withholding taxes are generally recoverable. The downside is that you would be paying annual income taxes at your highest marginal tax rate on foreign dividends received.
The SPDR Dow Jones Global Real Estate ETF (RWO) is an example of a US-listed ETF that holds the underlying global REITs. It has similar country weightings as the DFA fund. One thing to keep in mind is that RWO’s financial statements will only include foreign withholding taxes levied from countries other than the US (since the ETF is US-domiciled). As expected, the average withholding tax rate on dividends has been lower than the DFA fund, at about 4%.
If you held this fund in an RRSP account, the international foreign withholding taxes of about 4% would be lost. The US foreign withholding taxes of 15% would not apply. If we assume a 4% dividend yield on a global REIT ETF, this tax drag would be approximately 0.16% per year (4% × 4% = 0.16%).
If you held this fund in a non-registered account, the international foreign withholding taxes of 4% would be lost. The US foreign withholding taxes (an additional 15% on all dividends) would generally be recoverable. The tax drag on this ETF would be similar to the example above (approximately 0.16% per year).
As always, you need to consider more than just foreign withholding taxes when making investment decisions. On this basis alone, US-listed global REIT ETFs appear to be more tax-efficient when held in an RRSP, and Canadian-domiciled global REIT mutual funds (that hold the underlying REITs) appear to be more tax-efficient when held in a non-registered account.
Brad Steiman, a director of Dimensional Fund Advisors Canada ULC, wrote an informative paper on the topic of international Foreign Withholding Taxes. In the paper, he discussed the tax implications of various product structures such as:
Steiman explained that the first two structures have similar foreign withholding tax implications when held in an RRSP; that is, the first level of international foreign withholding tax is lost. The third structure should generally be avoided in an RRSP, as it will result in “double-withholding taxes” (i.e. both US and international foreign withholding taxes are lost). Although the main concept is accurate, Canada and the US have entirely different tax treaties in place with the various countries; this will affect the overall amount of international foreign withholding taxes lost through each structure.
For example, let’s first look at a US-listed ETF that holds the underlying international stocks (Structure #1), the iShares MSCI EAFE ETF (EFA). By collecting information from the fund’s year-end statements, we can gain a better perspective on the amount of foreign withholding taxes levied on a US investor. On average, the foreign countries have withheld approximately 7.77% of dividends paid to US investors. This amount would be lost to a Canadian investor holding EFA in their RRSP.
We can then compare the results to those of a similar Canadian-domiciled mutual fund that holds the underlying international stocks directly (Structure #2), such as the TD International Index Fund e-Series (TDB911). Both EFA and TDB911 follow the same index, the MSCI EAFE, so this will give us a more “apples-to-apples” comparison. On average, the foreign countries have withheld approximately 10.77% of dividends paid to Canadian investors (3% more than levied on US investors through the first structure).
This decision will depend on many other factors, such as currency-conversion charges, management expenses, etc. Holding all of these factors constant, it would appear that the two structures are not as similar as they would initially appear. It is more beneficially to purchase US-listed ETFs that hold the underlying international stocks in your RRSP accounts (Structure #1). This could save you about 0.10% per year in non-recoverable foreign withholding taxes (MSCI EAFE dividend yield × 3% = 3.42% × 3% = 0.10%).
After releasing the PWL 2012 Rate of Return Calculator late last year, my email was flooded with requests for an updated calculator for 2013, so here it is. The PWL 2013 Rate of Return Calculator can also be used for any non-leap-year – feel free to use it for 2011, 2010 and 2009 calendar years (the 2012 calculator can be used for leap-years).
An annualized return is really just a sexier way to say “average return” – annualized returns are the type of returns frequently quoted in the media:
In order to calculate your annualized return over 3 or 5 year periods, you will need to first calculate your annual calendar year returns for all of the years in question (using our online calculators). Once you have done this, you will need to “chain-link” the annual returns, using the equations below (Microsoft Excel may be useful for this exercise):
Once you have calculated your annualized return, bring the information to your advisor – they should be able to provide you with a custom benchmark portfolio return in which to compare to. If they are reluctant (or unable) to provide you with this information, find a new advisor.