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Foreign Withholding Taxes in International Equity ETFs (Revisited)

June 2, 2016 - 7 comments

In August 2014, BlackRock Canada announced that they were changing the investment strategy of the iShares Core MSCI EAFE IMI Index ETF (XEF) in order to reduce the overall amount of foreign withholding tax levied on the fund.  XEF would no longer gain its international stock exposure by holding the iShares Core MSCI EAFE ETF (IEFA) (a US-listed ETF) – it would instead hold the underlying stocks directly.  

Lately, I’ve spoken to numerous investors who feel that holding US-listed international equity ETFs, such as IEFA, is still the way to go (especially in RRSP accounts), due to the lower foreign withholding taxes levied.  In order to dispel this myth, let’s compare the foreign withholding tax cost of our two similar funds, IEFA and XEF.

(Note:  For this analysis, I’ve used the methodology from our white paper, Foreign Withholding Taxes, and summarized the results in the chart below).

Tax-Free and Taxable Accounts

The foreign withholding tax drag is higher in the tax-free (TFSA) accounts (0.69% vs. 0.26%) and taxable accounts (0.25% vs. 0.00%) for IEFA relative to XEF.  Although IEFA has a lower expense ratio than XEF (0.12% vs. 0.22%) the 10 basis point advantage can’t compete with XEF’s more tax-efficient structure.  Converting currencies in these accounts to purchase IEFA would also add additional cost and complexity to the portfolio.  I think it’s safe to say that XEF is a slam-dunk for these types of accounts.

Tax-Deferred Accounts

These next results were what really stood out to me.  IEFA and XEF had almost the exact same foreign withholding tax cost (0.25% vs. 0.26%) when held in tax-deferred accounts (such as RRSPs or LIRAs).  The only advantage of holding IEFA over XEF would be the slightly lower expense ratio (0.12% vs. 0.22%).

We’ll call this one a draw.  Although IEFA is slightly cheaper before considering currency conversion costs, a few currency conversion errors can quickly tilt the analysis in favour of XEF.  If you’re still debating which ETF to purchase in your RRSP account, please follow this simple advice:

  • If you have no idea what ‘Norbert’s gambit’ is, and have no desire to learn, hold XEF

Estimated Foreign Withholding Tax by Account Type

Account Type iShares Core MSCI EAFE IMI ETF (IEFA) iShares Core MSCI EAFE IMI Index ETF (XEF)
Tax-Free 0.69% 0.26%
Taxable 0.25% 0.00%
Tax-Deferred 0.25% 0.26%

Sources: 2015 BlackRock Annual Reports, MSCI Index Fact Sheets as of April 29, 2016


  iShares Core MSCI EAFE IMI ETF (IEFA) iShares Core MSCI EAFE IMI Index ETF (XEF)
Net Dividends (A) $131,417,349 $10,187,883
Foreign Withholding Tax (B) $11,048,732 $890,763
Gross Dividends (A + B) $142,466,081 $11,078,646
Foreign Withholding Tax Level 1 (%) = [B ÷ (A + B)] 7.76% 8.04%
Foreign Withholding Tax Level 2 (%) (if applicable) 15.00% 0.00%
Gross Dividend Index Yield (as of April 29, 2016) 3.27% 3.27%
MER (%) 0.12% 0.22%

Sources: 2015 BlackRock Annual Reports, MSCI Index Fact Sheets as of April 29, 2016

By: Justin Bender with 7 comments.
  15/05/2017 2:02:12 AM
Brian C
Hi Justin - questions re holding type B and G ETFs in an RRSP.

1. Is it possible to file a US non-resident tax return to recover the US tax withheld, since the funds are ultimately being paid to an RRSP account exempt from US tax?
2. Upon request, will the bank issue you a US 1042-S to reflect the US tax withheld? (for the purposes of filing the above)
  03/05/2017 1:18:18 PM
Justin Bender
@Jonathan: I was informed by Vanguard that they charge the fund expenses (ER or MER) first, and then remit the withholding taxes to the government. So the withholding taxes would be on the dividend amount after fees.
  02/05/2017 9:11:39 PM
Mr. Bender,

In your white paper "Foreign Withholding Taxes" you have subtracted the MER from the dividend yield before applying the withholding tax rate. Why?

For example for 'Type A' ETFs - US Listed ETF of US Stocks - you calculated the withholding tax for the Vanguard ETF VTI when held in a TFSA or RESP as:

15% x (2.07% - 0.05%)

15% = US Withholding Tax Rate
2.07% = Dividend Yield
0.05% = MER
  03/02/2017 1:59:11 PM
Justin Bender
@Emmanuel N: I would suggest contacting a company like KPMG or EY to see if they have any additional insight into your specific withholding tax issues.
  03/02/2017 1:21:53 PM
Emmanuel N
I am an individual who own stocks of corporation from many countries outside North America. My stockbroker is inapt when it comes to ensure the adequate foreign withholding tax on dividends is applied. The general problem is:

1-My stockbroker does not want to handle neither the Claim of Tax Treaty Benefits nor the Tax Refund Claim forms.
2-The country where the company is located (for instance Korea) keeps telling me to go to my broker as they are suppose to handle it.
3-My domestic country does not want to be involved and their tax agents have no clue.

This seems to be a problem many investors face. I do not want to get too much into the specifics of my case at this point since it could be easy to get lost into the details.

Questions 1- Is there a way for me to ensure I get the refund for the excessive foreign withholding tax, meaning above the tax treaty rate?

Questions 2-Is anyone aware of a global stockbroker which will handle the paperwork as in #1, as opposed to simply give their customers the brush off.

  06/06/2016 10:31:04 AM
Justin Bender
@Anne - yes, ZEA has a similar structure as XEF (it holds the underlying stocks directly). Vanguard Canada's new ETF, VIU, is another example of this type of structure.
  06/06/2016 7:54:51 AM
Would the comments for XEF also apply to ZEA?

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