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International Foreign Withholding Taxes in an RRSP

January 24, 2013 - 17 comments

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:

  1. US-listed ETFs that hold the underlying international stocks
  2. Canadian-domiciled ETFs or mutual funds that hold the underlying international stocks
  3. Canadian-domiciled ETFs or mutual funds that hold a US-listed ETF that hold the underlying international stocks

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).

So which structure should I use in RRSPs?

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%).

By: Justin Bender with 17 comments.
Comments
  23/10/2014 8:32:12 PM
Justin Bender
@KS - you are correct that the "second" level of foreign withholding taxes (15% of the dividend paid from the US) is not withheld when you hold VEA or VWO in an RRSP. The issue is the "first" level of foreign withholding taxes (from the international companies to the US). This level is not reported on your statements, so you have to dig into the financial reports in order to estimate the tax drag (generally between 6% and 11% of the foreign dividend paid to the US).
 
  23/10/2014 4:12:31 PM
KS
Hi Justin,

Excellent article. I own VEA and VWO (both US-listed ETFs) in my RRSP and when I look at the last dividend per unit on Vanguard.com, it is exactly how much I received in dividends therefore no withholding taxes. Is that correct or am I missing anything? Or the international W/H tax is not shown?

Please advise. Thanks
 
  26/06/2013 9:47:14 AM
Justin Bender
@Matt:

Question #1: All of these securities would have similar foreign withholding taxes. VXUS would be cheaper, but if you don't want to convert currency every time you need to invest new cash or rebalance, a combination of XEC/XEF would be an excellent choice as well.
Question #2: I normally use VEU as the replacement for VXUS. Other iShares alternatives you could consider would be IXUS or ACWX. As these all trade in US dollars, there is no need to convert currencies (like you would have to do if you sold VXUS and purchased XEF/XEC).
There is always the risk that CRA could disallow any of these losses - however, I have never heard of an instance where they have (as long as the underlying index was different). Please ensure that your shares of VXUS are held on the USD side of your corporate account before engaging in tax loss harvesting (to avoid forced currency conversion. You may want to also speak to your accountant beforehand to ensure that they are not planning on paying a non-taxable dividend out of your corporation's capital dividend account (CDA).

Hope this helps!

J
 
  24/06/2013 12:34:18 AM
Matt
Hi Justin,

A little late to this thread, but it's right up my alley.

I hold VXUS in my taxable corporate account, having maxed out my RRSP/TFSA contribution room with the other elements of my couch potato portfolio. I can't pull cash out of the corporation to use a personal non-registered account without paying a significant amount of tax.

With the recent market down turn, I have what I believe to be a reasonable tax-loss harvest opportunity with VXUS.

I have two questions I wonder if you can address.

First, is it more tax efficient to hold a combination of XEF/XEC in place of VXUS? It gets a bit confusing when talking about ETFs of ETFs. From your post of Feb 11, it appears VXUS is not particularly tax efficient given that I can only recover 26% of the 15% withheld tax...just not sure how funds like XEF/XEC would differ with a corporate taxable account.

Second, and you may not be able to give a definitive answer, but do you think the combination of XEF/XEC is dissimilar enough from VXUS to avoid the tax loss being disallowed under superficial loss rules, if I were to go that way?

Thanks for any help, and a great article.
 
  12/03/2013 5:18:48 AM
CanadianInvestor
Arrgghhh! Another important nuance that can make a difference. A while back I made a chart of the general pattern of withholding tax effects in different types of accounts - http://howtoinvestonline.blogspot.co.uk/2011/05/pros-and-cons-of-cross-border-shopping.html but it looks like it needs an asterisk. A post in SeekingAlpha shows all the withholding rates for US investors - http://seekingalpha.com/article/248039-withholding-tax-rates-by-country-for-foreign-stock-dividends. Given the variety of rates across countries it looks like the effect will be on a case by case basis, depending which mix of countries is in a particular ETF. Major developed countries look to be among the highest withholders - France 30%, Germany 26.4%, Italy 27%, though the UK is 0% and Japan 10%. But those rates apply to US residents. The Canada-France tax treaty applies a 15% rate (the same as what Canada applies) - see http://www.ambafrance-us.org/spip.php?article755. Bottom line - looks like it is necessary to check the annual accounts, as you did, to see the ETF's withholding tax track record.
 
  30/01/2013 9:54:23 AM
Justin Bender
@Kevin Wacker - it would generally be true for all US-listed ETFs. TDB911 would technically be more tax-efficient than VEA when held in a corporate taxable account, but I would expect the difference after MER to be negligible.
 
  29/01/2013 7:04:12 PM
Kevin Wacker
Thank you for the reply and the information. I was not aware of the unfavourable taxation of a ETF like VEA in a corporate account. Is this true for all U.S. ETF's ?(only able to recover 26% of the 15% withholding tax) I look forward to the possibility of a future blog review on this subject
What would be the best way to get international exposure in a taxable corporate account? TDB911?
 
  29/01/2013 9:52:43 AM
Justin Bender
@Kevin Wacker - if
- you can find a US-listed ETF that is significantly cheaper than TDB911 - the Vanguard MSCI EAFE ETF (VEA) comes to mind with an MER of 0.12% relative to TDB911 at 0.51%
- you can convert currencies cheaply like you said (using DLR/DLR.U)
- you are not making regular contributions
- you do not have any US estate issues to worry about
- both they track their respective index just as well after-fees
...then I would say that the advantages of the lower MER of VEA could slightly outweigh the beneficial structure of TDB911.
 
  29/01/2013 9:36:08 AM
Justin Bender
@Kevin Wacker - if
- you can find a US-listed ETF that is significantly cheaper than TDB911 - the Vanguard MSCI EAFE ETF (VEA) comes to mind with an MER of 0.12% relative to TDB911 at 0.51%
- you can convert currencies cheaply like you said (using DLR/DLR.U)
- you are not making regular contributions
- you do not have any US estate issues to worry about
- both they track their respective index just as well after-fees
...then I would say that the advantages of the lower MER of VEA could slightly outweigh the beneficial structure of TDB911.
 
  29/01/2013 9:24:27 AM
Justin Bender
@MK - Generally TFSAs are best suited for Canadian-domiciled investments (from a foreign withholding tax perspective). I tend to use RRSPs in my examples because most investors have a large allocation to this type of account (so these account decisions will have a greater impact than those of a TFSA).
 
  29/01/2013 9:20:54 AM
Justin Bender
@Jamie Brown - No worries - this is a complicated topic that takes awhile to get your head wrapped around! if you hold a US-listed ETF that holds the underlying international stocks in your non-registered account (like VXUS or VEU), you'll lose one level of foreign withholding tax (about 8%) but you'll be able to recover the second level of 15% US withholding tax (unless you hold the fund in a corporate account, and then generally you would only be able to recover about 26% of the 15%...this is a more complicated topic - I'll try to address it in an upcoming blog).
 
  29/01/2013 8:43:40 AM
Jamie Brown
Hi Justin,
Thanks for this article. Can you describe briefly the withholding tax implications for international investments held in a non-registered account, and how they compare with the above ? (I'm sure you've explained this to me before but I honestly can't remember!).
 
  29/01/2013 12:51:20 AM
Kevin Wacker
Am I correct in assuming that TDB911 would overall be the best choice from a tax perspective in a taxable account.? (Even though foreign counties are holding 3% more when held in a Canadian dominciled ETF or mutual fund as compared the 1st or 3rd structures )
Or is it ultimately better to use a U.S. international ETF in a taxable account if one uses Norbert's gambit to keep conversion costs to a minimum and have a lower MER -despite the higher taxes involved? (Again thinking of a taxable account in the highest tax bracket)
 
  29/01/2013 12:29:12 AM
MK
Hi Justin,

Thanks for your reply. In your articles and various articles on other sites, RRSP is discussed a lot in terms of holding foreign equities because of tax treaties and such. Are Canadian income/dividend producing equities the only thing that is advantageous for TFSA in terms of tax efficiency?
Thanks again.
 
  28/01/2013 9:14:23 PM
Jamie Brown
Hi Justin,
Thanks for this article. Can you describe briefly the withholding tax implications for international investments held in a non-registered account, and how they compare with the above ? (I'm sure you've explained this to me before but I honestly can't remember!).
 
  28/01/2013 1:02:17 PM
Justin Bender
@MK - if you hold a US-listed ETF that holds the underlying stocks in your TFSA, you will lose the first level of withholding (approx. 8%) and you will also lose the US withholding tax (approx. 15%).
If you hold a Canadian-domiciled mutual fund that holds the underlying international stocks directly, you'll lose about 11% overall (a bit more tax efficient).
Neither is a great option...if possible, I wouldn't hold international equities in a TFSA.
 
  27/01/2013 2:52:28 AM
MK
Are there any particular structures that would be more efficient when held in a TFSA? Or should we only keep international equities in non-registered or RRSP?
 



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