Do you pay withholding tax on US ETFs?
US ETF Withholding Tax for Canadians
U.S. equity markets accounted for approximately 46% of global equity markets market capitalization in the third quarter of 2022. The total return of the S&P 500 in Canadian dollars over the past 50 years as of December 31, 2021 was 2.1% higher than the compound total return of the S&P/TSX for the same period (11.7% vs. 9.6%). It makes sense that Canadian investors have an allocation to US equities.
One problem with owning US stocks is withholding tax. To answer your question directly, Neil, buying a US stock domiciled in Canada exchange traded fund (ETFs) will generally not avoid US withholding tax. Under the tax treaty between Canada and the United Statesthere is a 15% withholding tax on dividends paid by a “resident company” of one country to a resident of the other.
A Canadian-domiciled ETF, meaning an ETF that trades on the Toronto Stock Exchange, for example, is considered a Canadian resident. So if a Canadian-listed ETF receives a dividend from a US stock, as would a Canadian-domiciled US equity ETF, there is a 15% withholding tax.
Registered or unregistered account: Does it matter?
If this investment is held in a non-registered account, the 15% withholding tax would likely not matter. In effect, it can be claimed as a foreign tax credit that reduces Canadian tax otherwise payable. This avoids double taxation. Even on low incomes, Canadian taxpayers generally pay between 20% and 25% in tax at a minimum. Thus, this first 15% only reduces the ultimate tax payable.
If you hold a Canadian-domiciled U.S. equity ETF in a registered retirement savings plan (RRSP), tax-free savings account (TFSA), Where registered education savings plan (RESP), the withholding tax of 15% is not recoverable. The S&P 500 has a dividend yield of about 1.7% currently, suggesting a yield reduction of about 0.25%. Beware, this might be a small price to pay for diversificationgiven the difficulty of accessing sectors such as technology and healthcare for an investor investing solely in Canada.
Withholding tax on RRSP investments
Interestingly, Neil, there may be a way around this withholding tax for an investor in their RRSP. US stocks and US-domiciled US stock ETFs are not subject to withholding tax for a Canadian investor who holds them in their RRSP, registered retirement income fund (RRIF) or similar retirement accounts. Buying US stocks and US-listed stock ETFs can therefore increase returns for a Canadian investor, by 0.25% per year for a typical S&P 500 or S&P 500 ETF. Plus the dividend higher, the greater the profit, Neil.
However, to buy investments domiciled in the United States, a Canadian investor must deal with foreign exchange costs. These can vary from 1.5% to 2% to buy US dollars with Canadian dollars in a brokerage account depending on the exchange rate provided. These exchange costs can be reduced using a strategy commonly referred to as Norbert’s bet, in which ETFs or stocks are bought in one currency and sold in another currency. In this case, the cost can be as low as brokerage commissions to buy and sell.
The withholding tax exemption for RRSPs does not apply to TFSAs or RESPs, Neil.