Non-resident withholding taxes generate a lot of questions and misunderstandings among investors. Knowing how withholding taxes work and when they apply will help you figure out the best way to invest in foreign stocks.
What Is A Non-Resident Withholding Tax?
Withholding taxes may be applied to interest, dividends or other income you receive from foreign investments. The withholding tax is not applied by Canada but is applied by a foreign country.
Lets say you own shares of Bayer AG. The dividends are subject to a 15% non-resident withholding tax. This 15% tax is paid to the government of Germany because Bayer AG is a German company.
The Foreign Tax Credit
If you hold your foreign investments outside of an RRSP, RRIF or TFSA (collectively called non-registered accounts), you may be able recover all or part of the foreign tax withheld by way of the foreign tax credit.
If you hold foreign investments inside registered accounts, you cannot claim the foreign tax credit. Continue reading!
How Do Withholding Taxes Affect RRSP’s & RRIF’s?
Under the Canada-U.S. Income Tax Treaty, there is no withholding tax applied to interest or dividends received on investments inside of an RRSP or RRIF (see below for the TFSA). If you have non-U.S. investments inside of your RRSP or RRIF, withholding taxes may be applied at varying rates. These withholding taxes are not recoverable and the foreign tax credit cannot be claimed!
How Do Withholding Taxes Affect The TFSA?
Dividends from U.S. companies received inside the TFSA are subject to U.S. withholding tax and are not recoverable nor is the foreign tax credit available. Interest, on the other hand, is not subject to withholding (whether it is received in your TFSA or outside of your TFSA).
Foreign Investments (Non-U.S.) may still be subject to withholding taxes depending on the country of origin.
Arrange Your investments To Maximize Returns?
Interest and foreign dividend income is fully taxed at your marginal tax rate. Generally, you should hold your interest generating investments and U.S. stocks inside of your RRSP or RRIF as these would be fully exempt.
Other foreign investments may be held inside of your RRSP, RRIF or TFSA if the withholding tax that would be applied is less than your marginal tax rate. For example, you would still be better off holding a foreign stock subject to a 15% withholding tax inside of your registered account if your marginal tax rate is 20%. Here is why:
- A $100 dividend received outside of your registered account would be effectively taxed at 20% and you would have $80 left over, after tax.
- If the same $100 was received in your registered account, you would have $85.
Knowing when and how withholding taxes will be applied and the rate that will be applied will help you determine the best type of account to hold your foreign investments.