The following post is written by Brian So, a financial advisor and blogger at www.aafsinsurance.com.
Hi everyone, this is my first of hopefully many posts on the Dividend Ninja. Allow me to introduce myself. My name is Brian So and I have been working with my dad in the financial industry for about 2 years, and helping people with their financial goals. I’ve found my work to be very rewarding and I want to share some of my knowledge with more people. What better way to do this than to guest post on the Dividend Ninja with such a loyal and dedicated following.
Now that the intro is out of the way, let me get into the topic on hand: the implications of having US dividend stocks in your RRSP and TFSA. First off, because there are plenty of posts on the internet about what RRSPs and TFSAs are and how to use them, I am going in another direction with my posts to try to delve a bit deeper into the lesser known facts of these savings vehicles.
Generally, the type of investments you can put in a TFSA is similar to the type of investments you can put in a RRSP. These are known as qualified investments and include:
- Mutual funds
- Securities listed on a designated stock exchange
- Bonds and other debt obligations
- Shares of small business corporation
- Annuity contracts
- Warrants, rights, and options
Generally, the list of qualified investments is similar in the TFSA and the RRSP and so are the rules that govern the tax-sheltering of these investments. The difference occurs when US stocks and US-listed ETFs holding US stocks that pay dividends are held within each account.
The Federal Foreign Tax Credit
Because of treaties between Canada and the United States, dividends paid from American companies are subject to a 15% withholding tax. For non-registered accounts, this is not a problem since the dividend was paid to you directly and you can claim the foreign tax credit (FTC) on your tax return to recover this amount. The treaties also allows for the withholding tax to be waived in accounts used for retirement savings, such as the RRSP.
Because the TFSA can be used for many purposes besides retirement, it is not considered a retirement savings account and the withholding tax will apply accordingly. You cannot claim the FTC on registered accounts. Therefore, the implications of this for TFSA is that 15% of dividends paid from U.S. stocks and U.S.-listed ETFs holding US stocks will be withheld and lost forever.
(The following was added Feb. 24th, 2014)
The rules are slightly different with regards to distributions paid out of Master Limited Partnerships (MLPs). These distributions are not the same as dividends traditionally paid by US companies. As such, treatment of the withholding tax is not reduced by the tax treaty. Distributions are charged a withholding tax of 35% for all accounts. Although this can be recovered in non-registered accounts via the FTC, withheld amounts from MLPs in RRSPs and TFSAs will not be recoverable. More information about MLPs and their taxation can be found in MLP Taxation in Canadian Accounts.
Canadian ETFs Holding U.S. Stocks
If all of that seems pretty straight forward, good, because the rules are different for Canadian-listed ETFs holding US stocks. These seem to be most popular among Canadian investors who want exposure to American companies. In a non-registered account, nothing changes and you can claim the foreign tax credit to recover the withholding tax.
However, tax will be withheld on dividends payable in both a RRSP and TFSA. Withholding tax will not be waived for RRSP containing Canadian-listed ETFs holding US stocks, since the withholding tax was paid by the fund and not directly by you. As a result, in both the RRSP and TFSA, the 15% withholding tax will not be recoverable.
Table-1 below summarizes the differences between US stocks and US-listed ETFs holding US stocks (A) and Canadian-listed ETFs holding US stocks (B) in a non-registered account, RRSP and TFSA.
How the Dividends Are Taxed
|Dividend income received||$100||$100||$100||$100||$100||$100|
|Tax withheld||$15||$15||$0 (waived)||$15||$15||$15|
|Claim with foreign tax credit||$15||$15||$0||$0||$0||$0|
|Net income (before tax)||$100||$100||$100||$85||$85||$85|
As you can see from Table-2, from a withholding tax perspective, it is more advantageous to put categories A and B in non-registered accounts and just category A in a RRSP. But it is important to take a look at the big picture. Foreign dividends do not benefit from the dividend tax credit and is treated like income when it comes to taxation in a non-registered account. RRSPs and TFSAs still benefit from tax-sheltering of distributions which can be reinvested automatically. Don’t base your decision on one factor when there are other more important points to consider.
While this post provides general information on situations involving withholding tax of foreign investments, it does not provide tax advice. Please seek a tax professional regarding your tax obligations.
Brian So is a financial advisor and blogger at www.aafsinsurance.com. His areas of expertise include retirement planning, tax savings and insurance advice. If you want to hear his thoughts about the world of personal finance, follow him on Twitter.