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

Appendix

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