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%).