The tax issue created by Canadian ETFs that simply hold ETFs trading in the US is seldom discussed but the additional tax drag is worth highlighting. Take for instance, the iShares CDN MSCI EAFE ETF (XIN), which holds the iShares MSCI EAFE Index Fund (EFA). EFA holds foreign stocks that trade in the UK, Japan, Germany, Australia etc. but the fund itself is located in the US. Therefore, EFA pays a withholding tax on dividends according to the tax treaty between the US and whichever country the company paying the dividend is resident of. Since, XIN simply holds EFA but is listed in Canada, XIN will pay a further 15% withholding tax to the IRS before paying the dividends to Canadian investors. In taxable accounts, this is not a problem because the dividends received through XIN are taxable anyway and Canadian taxpayers will receive a credit for foreign taxes paid.

There is a problem, however, with holding XIN within a RRSP account. The withholding tax paid to the IRS by XIN is not recoverable and creates an additional tax drag. If we assume a 3% dividend yield on EFA, the 15% withholding tax creates an extra tag drag of 0.45% for holding XIN over EFA within a RRSP.

The extra tax drag is not limited to Canadian ETFs that hold US-listed ETFs that hold foreign stocks. It also applies to Canadian ETFs that hold US-listed ETFs that hold US stocks such as the iShares CDN S&P 500 ETF (XSP). Another example is the recently launched Claymore Emerging Markets ETF (CWO), which simply holds the Vanguard Emerging Markets ETF (VWO). It is probably cheaper for ETF vendors to structure Canadian ETFs to hold US ETFs but the withholding tax creates an additional tax drag that is borne by the investor.

Bottom line: If a Canadian ETF simply holds a US-listed ETF, an additional tax drag is created due to withholding taxes that are not recoverable when the ETF is held within a RRSP account. It may be cheaper, instead, to simply hold the US-listed ETF directly.

This article has 19 comments

  1. I wasn’t aware of these tax differences between investment products.

    I buy Vanguard ETFs for any non-Canadian equity holdings. I’m not sure exactly why iShares would be preferable even without the tax issue.

  2. Is the withholding tax even recoverable at all? It was my understanding that a withholding tax paid by an entity other than yourself is not recoverable by you.

    Wouldn’t that mean that the withholding tax paid by yourself on the US ETF would be recoverable, but one paid by a Canadian ETF holding a US ETF wouldn’t be (the tax is part of the MER expense)?

    • Canadian Capitalist

      I don’t own XIN or XSP in a taxable account but the distribution history of these ETFs indicates that Foreign Taxes paid is listed in the tax breakdown. ETFs and mutual funds simply flow through the taxes to investors, so I think that the withholding taxes are recoverable in taxable accounts.

      I don’t think there will be any difference between XSP and IVV from the withholding tax point of view in taxable accounts. The investor pays the withholding tax for IVV directly through their brokerage. iShares pays the withholding tax for XSP but issues a tax receipt for foreign taxes paid. Taxpayers get a credit for both when filing their taxes. Does anyone know different?

  3. “I can confirm there is no U.S withholding tax on dividends paid by US based ETFs in an RRSP. I just got a dividend payment from an Ishares ETF I own (DVY) at the end of March. The full U.S. dividend amount (converted to Canadian dollars) was paid into my RRSP accountl.”

    • Canadian Capitalist

      @Vlad: I personally hold VTI, VEA, VWO and owned US stocks in RRSP accounts. There is no withholding tax on dividends due to the special treatment that RRSPs receive in the Canada US Tax Treaty. Thanks for confirming this.

  4. Thats good news for RRSP’s. I expect that this would still be an issue for TFSA’s?

  5. Yet, another follower of your blog CC…
    Is it safe to assume that it’s advisable to hold my U.S. or foreign stocks in RRSP and put my Canadian dividend paying stocks outside my RRSP so I can claim the Canadian dividend tax credit?

  6. with respect to US ETFs any US 15% wt is not fully recovered by Canadians through the foreign tax credit system – it’s prorated in proportion to your foreign income/can income..I think.

  7. What about the currency exchange rate spread?
    If you pay >1% each time you buy or sell a $US ETF, rebalancing becomes really expensive compared to the MER difference.

  8. I raised this issue with my financial advisor and got the following response: “.BUT I phoned the fund company…currently XSP and XIN will be same withholding tax whether held in an RSP and NON RSP and because the withholding tax is at a fund level instead of an individual level, you will not see any withholding tax being broken down in an RSP or a non RSP as the fund withholds it from a fund level in an RSP and NOn RSP thus unlike an individual stock since we would not mail you out(nor would any be produced) what the withholding tax is in a NON RSP you could not claim any back…thus as Barclays told me there is no difference on which account its held at”

  9. Does the US Withholding Tax apply to dividend payments only, or does it apply to capital gains generated through active trading too? For instance, if I buy a stock at $10 and sell at $15, is there any tax withheld on the $5 profit (if no dividend is paid)?


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  14. Is the tax issue the same if a Cdn ETF holds US stocks, and in an rrsp…or is it only an issue if a Cdn ETF holds a US ETF?…ie is the issue that a Cdn ETF is holding anything US/foreign, or is the issue that a CDn ETF is holding a US ETF (that is holding US/foreign assets). Thx.

  15. I found a new article written by Dimensional fund advisors that explains quite nicely the withholding tax problem with foreign ETFs:

    Foreign Withholding Taxes

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