I have received a number of questions lately asking if withholding tax applies to foreign stocks held in the TFSA. The following explains how foreign withholding taxes are applied in the TFSA (and the RRSP & RRIF).
To understand the how this works, you first need to understand what withholding taxes are and how they are applied.
Most foreign countries apply a withholding tax on distributions of interest and dividends from countries located in their jurisdiction. In other words, the withholding tax has nothing to do with the exchange the shares are traded on.
Canada-U.S. Tax Treaty
The 5th protocol of the Canada-U.S. income tax treaty (or convention) contains provisions that reduce the withholding tax on interest to zero and dividends to 15%, when the recipient is one of the counties.
If a U.S. company pays a dividend to a person in Canada, the withholding tax is reduced to 15% from 30% and interest is not subject to U.S. withholding taxes.
Canada has treaties with many countries that also reduce the withholding tax.
Special Treatment For RRSP’s and RRIF’s
Under the Canada-U.S. tax treaty, interest and dividends received by an RRSP, RRIF, or other pension trust will not be subject to withholding tax by the U.S. However, don’t assume that every country Canada has a treaty with has the same provision!
Warning About ADR’s
If you decide to buy an American Depository Receipt (ADR) you are actually buying a stock or bond from a country that is NOT the U.S. As a result, withholding tax probably will apply to the investment income received by your registered account.
Furthermore, since your RRSP or RRIF is a tax-deferred account, you cannot claim the foreign tax credit.
No Mention of The TFSA
The TFSA is not a considered a pension trust under Canada’s treaty with the U.S. and therefore foreign dividends and interest would be subject to the normal withholding taxes under those treaties.
In addition, since the TFSA is a tax free account in Canada the foreign tax credit cannot be claimed for withholding tax applied to interest and dividends subjected to non-resident withholding taxes.
Still Hold U.S. Stocks In The TFSA
Even though, the dividends from your U.S. stocks will be reduced by 15% when received in your TFSA, it still make sense for you to hold them in the TFSA. Here is why.
The U.S. dividend will be reduced only 15%. If your combined federal-provincial marginal tax rate is more than withholding tax then the TFSA is the best place to hold this investment.