Reference Guide: Foreign Withholding Taxes on ETFs for Canadian Investors
While it is true that you can't avoid paying taxes, when it comes to echange traded funds, there are some strategies available to help minimize the withholding tax that you are subject to.
By fully understanding how ETFs are taxed, you can ensure you are choosing the most tax-efficient investment solution available to you. First Asset Exchange Traded Funds offer a variety of tax-efficient ETF solutions to include in your portfolio.
ETF Structures and Withholding Taxes
When investing in an Exchange Traded Fund (ETF), you should be familiar with how the ETF obtains exposure to international markets. An ETF's structure and the type of account used to hold it could significantly affect how much withholding tax an investor is subject to. Once you understand the impact of foreign withholding taxes on ETFs, you will be better equipped to make investment choices that will maximize your after-tax returns.
ETF Structures - common structure examples
There are three common ETF structures available to Canadian investors that provide access to international markets. First Asset's international ETFs employ the most tax-efficient structure by investing directly in portfolios of international stocks (see Structure 3).
U.S.-LISTED ETF THAT INVESTS DIRECTLY IN INTERNATIONAL STOCKS
INVESTOR HAS DIRECT EXPOSURE TO INTERNATIONAL MARKETS
With this first structure, there are two levels of withholding tax a Canadian investor may be exposed to. First, an investor is subject to the taxes levied by the country in which each foreign stock is based. Second, the U.S. government may levy an additional withholding tax, up to 15%, on certain distributions made by the U.S. ETF to a Canadian investor's account. The amount of taxation depends on local jurisdictional tax legislation, as well as any respective income tax treaties.
CANADIAN-LISTED ETF HOLDING A U.S.-LISTED ETF THAT INVESTS IN A PORTFOLIO OF INTERNATIONAL STOCKS
INVESTOR HAS INDIRECT EXPOSURE TO INTERNATIONAL MARKETS
Also known in Canada as a "wrapped" ETF, within this structure a dividend paid by a foreign company may be subject to withholding taxes since the payments are sent to the U.S. ETF. Distributions by the U.S. ETF may then be subject to an additional U.S. withholding tax as they are distributed to the Canadian ETF.
CANADIAN-LISTED ETF THAT INVESTS DIRECTLY IN A PORTFOLIO OF INTERNATIONAL STOCKS
INVESTOR HAS DIRECT EXPOSURE TO INTERNATIONAL MARKETS
This is the most tax-efficient ETF available to Canadian investors. Withholding tax only applies to the Canadian investor according to the country where the foreign stock is domiciled. A dividend paid by a foreign company may be subject to one level of withholding tax as the payments are made to the Canadian ETF.
Withholding Tax Levels by Account Type
RRSP, TFSA, RESP & TAXABLE ACCOUNTS
Investors should consider the account type that the ETF is held in, as this also impacts the amount of withholding tax an investor is subject to. The chart below illustrates what levels of withholding tax a Canadian investor would be subject to depending on the account type the investment is held in.
Tax I: Withholding taxes levied by the country where the underlying stocks/holdings are domiciled
Tax II: Additional withholding tax (15%) levied by the virtue of being a U.S.-listed ETF
NOTES ON THIS CHART
- "Creditable" means that foreign tax credits are available to the taxable Canadian-resident investor or ETF (to the extent that the Canadian recipient is taxable), to be claimed against the foreign income/distribution received.
- Most countries impose a tax on income when paid to foreign investors. The U.S. levies a 30% withholding tax (reduced by any respective income tax treaties) on certain income distributions to foreign residents.
Investors will want to keep in mind other considerations that may impact their overall investment return:
- Cost of currency conversion: The spread paid to convert currency may reduce or eliminate the advantage of owning U.S.-listed ETFs with lower management expense ratios (MERs).
- U.S. estate taxes: Wealthy Canadians may be subject to estate taxes if they have large holdings in U.S.-listed ETFs. These investors may be better off holding Canadian-listed ETFs, even if exposed to certain withholding taxes.
First Asset International ETF Solutions
STRUCTURED FOR TAX-EFFICIENCY
First Asset ETFs are Canadian-listed and invest directly in U.S. and international securities. Our ETF products are structured to ensure that Canadian investors are only subject to one level of withholding tax, making our ETFs more tax-efficient than investing in fund-of-fund structures.
From a tax perspective, Canadian investors are best served when investing in international equities directly through Canadian-listed ETFs.
The information herein is not intended to provide specific financial, investment, tax, legal or accounting advice, and should not be relied upon in that regard. Individuals should seek the advice of professionals, as appropriate, and read an ETF Fund's prospectus prior to investing. Investments in ETF Funds may not be suitable for all investors. Some conditions apply. Copies of the prospectus may be obtained from your investment advisor, First Asset or at www.sedar.com. Commissions, trailing commissions, management fees and expenses all may be associated with an investment in ETF Funds. ETF Funds are not guaranteed, their values change frequently and past performance may not be repeated. The opinions contained in this article are solely those of First Asset and are subject to change without notice. First Asset assumes no responsibility for any losses or damages, whether direct or indirect, which arise from the use of this information and expressly disclaims liability for any errors or omissions in this information. This document may contain forward looking statements which are based on expectations, estimates and projections at the time the statements are made that involve a number of risks and uncertainties which could cause actual results or events to differ materially from those presently anticipated. Other events which were not taken into account may occur and may significantly affect the returns or performance of an ETF Fund. First Asset does not undertake any obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise, except as expressly required by law. The First Asset ETF Funds are managed by First Asset Investment Management Inc.
Morningstar® is trademarks of Morningstar, Inc. and has been licensed for use for certain purposes by First Asset. The First Asset ETF Funds are not sponsored, endorsed, sold or promoted by Morningstar or any of its affiliates (collectively, "Morningstar"), and Morningstar makes no representation regarding the advisability of investing in these ETF Funds. MSCI is a trademark of MSCI Inc. The MSCI indexes have been licensed for use for certain purposes by First Asset. The funds or securities referred to herein are not sponsored, endorsed, or promoted by MSCI, and MSCI bears no liability with respect to any such funds or securities or any index on which such funds or securities are based. The prospectus of the funds contains a more detailed description of the limited relationship MSCI has with First Asset and any related funds.
Important information about each First Asset ETF Fund is contained in its respective prospectus. Individuals should seek the advice of professionals, as appropriate, prior to investing. This investment may not be suitable for all investors. Some conditions apply. Copies of the prospectus may be obtained from your investment advisor, First Asset or at www.sedar.com. Commissions, trailing commissions, management fees and expenses all may be associated with mutual fund investments. ETFs are not guaranteed, their values change frequently and past performance may not be repeated.
The commentaries presented are prepared as a general source of information. They are not intended to provide specific individual advice including, without limitation, investment, financial, legal, accounting or tax. The opinions contained in this document are solely those of First Asset and are subject to change without notice. First Asset assumes no responsibility for any losses or damages, whether direct or indirect, which arise from the use of this information and expressly disclaims liability for any errors or omissions in this information. First Asset is under no obligation to update the information contained herein.