In today’s post, I’ll try and answer a question on the new Tax-Free Savings Account that were sent to the Personal Finance Clinic. You may also want to check out Money Gardener and Triaging my way to Financial Success, who have also been fielding questions that were sent to the Clinic.

Maxime writes:

I have opened a TFSA with BMO InvestorLine and purchased shares of Microsoft. When I received my first dividend I was surprised to see that they took the usual 15% of taxes as in a regular [taxable] account.

I called BMO to ask about it because I was sure that there would be no income taxes and they told me that this rule in TFSA applies only on Canadian investments.

Is it the same for you guys?

The TFSA is a true tax-free account. There are no taxes on interest, dividends or capital gains on investments held in the account. However, if Canadian residents purchase US-based securities (such as Microsoft) in a TFSA, a 15% withholding tax applies. The withholding tax has nothing to do with the Canada Revenue Agency. It is charged by US tax authorities on US investments held by foreigners, including Canadian residents. Withholding tax also applies to other tax-deferred vehicles such as RESPs.

RRSPs, on the other hand, receive special treatment under the Canada-US Tax Treaty because they are “operated exclusively to provide pension, retirement or employee benefits”. However, if you hold non-US foreign investments inside a RRSP, you may pay a withholding tax. For instance, I used to own Nokia (NOK), which is based in Finland, within my RRSP and was subject to a withholding tax.

As US investments held in a TFSA are subject to a withholding tax, it is best to hold these securities within a RRSP. The TFSA is an ideal location for Canadian bonds, Canadian stocks and Canadian income trusts, including REITs.

This article has 30 comments

  1. Can you file a US tax return and reclaim the withholding tax? Is there any other way to reclaim it?

    • Canadian Capitalist

      @Aolis: Not to my knowledge. A withholding tax isn’t a problem in taxable accounts as you get a credit when filing taxes with the CRA but since a TFSA is a tax-free account in the eyes of the CRA, nothing can be done about the taxes withheld.

    • I think it works this way – there is at tax time a statement of foreign investment income and taxes paid on these investment and I’m pretty sure you can use this as a credit on your Canadian taxes which means taxes are paid to the US inside TFSA or RESP and credit is made outside. i would appreciate comments.

  2. Thank you for this information! I didn’t even realize this was an issue, so I’m glad I read this post and became aware of it!

  3. Pingback: witholding tax in tfsa — award tour

  4. Good information. I figured this would be the case because RESPs are treated this way.

    The withholding tax isn’t so bad compared to the tax that the Canadian government will charge on that income. At least an RRSP prevents the tax, or a taxable account can be planned for and potentially recouped. If your RRSPs are maxed out and you aren’t doing any tax planning then at least the TFSA protects you from some of the taxes charged on foreign investments.

  5. CC have you ever applied for that credit when filing taxes with the CRA for taxable accounts? Any idea of what form you should use for this?

    • Canadian Capitalist

      @Remus: I don’t think there is a special form. The T5 form sent by the broker has a box for “Foreign Income” and “Foreign Tax Paid”. Tax software adjusts the Canadian tax payable with the withholding tax already paid.

      Apparently, investors who are below the 15% tax bracket can get a refund on the withholding tax from the CRA. Canadian Financial DIY wrote about this but I’m not in that situation.

  6. @Remus, the problem with applying for a credit that you are not sure you deserve is that you will likely get it. Our tax system is mostly honor based, so if your forms are later reviewed and they decide you shouldn’t have received it then you get a fine and a late payment fee and you owe the money back.

    The tax treaties that exist between most nations can be summarized thusly: You (citizen) will pay no more taxes than the higher of the withholding tax or the taxes imposed by your home country.

    This basically means that if the withholding taxes are greater than the taxes to be charged you will only pay the withholding taxes.

    Someday Canada may open negotiations with the US on adding the RESP and TFSA to the tax exemptions. This will likely require Canada to add some US accounts to this list as well. Canada will have to give up far more US withholding taxes than the US will (most likey, based upon population sizes). Essentially this would end up being a bad deal for the Country and a good deal for the citizens, unlikely to happen unless Canada comes up with a new way of taxing people.

  7. Maybe I have the tendency to over simplify things but I really don’t think it could be that complicated. In my view it should work like this: you have a taxable account and in there you have US dividend paying companies. They pay 1000 USD in dividends in year 2009. In real terms you get 850 USD in your account. So they withhold 15% correct?
    The rule says you are entitled to apply for a credit for this correct? You know you lost 150$ so that is the amount.
    I would imagine it is up to CRA to determine if you are entitled to a refund or not, and do the math per how much you should have paid in Canada if they wouldn’t have withheld them in US etc etc etc.
    And you put this in some kind of form (which by the way is the one I am trying to find out which one it is and if anybody in here ever completed one; that way they can share some info on the process).
    Am I wrong?

  8. Ugh. What a nasty subject debated over many times with my peers…

    I personally prefer to only put fixed income securities in my TFSA. The reason being that interest income is the most heavily taxed form of distribution and hence that category has the most to be gained from sitting inside a TFSA. But with stocks having been recently pounded into a pulp, it is undeniably VERY tempting to put equities into a TFSA account. Here’s my argument for leaving equities out of a TFSA:

    1. Capital losses cannot be written off in a TFSA account.
    2. It is unclear whether the interest paid on a leveraged purchase of an income investment inside a TFSA would qualify for a tax deduction. I am erring on safe side with CRA and assuming that the answer is NO.
    3. If you manage to get a large capital gain in a fully taxable cash account, that capital gain is tax advantaged already. You don’t pay tax on 100% of the capital gain AND you can offset the gain with any losses from a “dog” you might have accidentally purchased. See point #1.
    4. The maximum annual TFSA contribution is $5K. If your brokerage charges you $29 per transaction (since your balance is only $5K, well below most brokerages’ thresholds to get the lower commission rate), then on a RELATIVE basis the commissions are quite high.
    5. It is difficult to buy exactly $5000 of a stock. Whatever leftover dollars in your TFSA account are sitting around doing nothing waiting until next year’s contribution. So if you buy 100 shares of XYZ for $48 a share, then in many cases you will have about $200 of cash collecting no interest until next year when you add another $5K to make it $5200 to invest. In contrast, you can put exactly $5K in a GIC.

  9. Does anyone know if Canadian based mutual funds (invested in US equities) are subject to the US withholding tax?

    Will you have to pay US tax if you hold the e-Series funds in your TFSA?

  10. @Chris, withholding taxes are exactly that. Taxes withheld at the source. AKA money NOT paid to you. Every single foreign investment is subject to that (there are a few countries that don’t charge such). Heck an RRSP withdrawl is also subject to withholding taxes.

    If tax is withheld you should receive a tax receipt stating such. Then you can claim it back on your taxes. If your in a non-taxable account, you are pretty much screwed. If you don’t receive a tax receipt at the end of the year it means you were not subject to the taxes or the Mutual fund ate the cost and packed it into the MER.

  11. I’m curious how this works in mutual funds and index funds. If a fund
    holds an us equity and that equity pays a dividend, does the fund
    manager have to determine who pays the withholding tax and who doesn’t
    in the case where the fund is held inside an RRSP?

  12. @ Aolis: You cannot file a US Tax Return and recover withholding taxes from the TFSA unless you are a US citizen or have US tax filing obligations.

    @ Shane: Mutual funds that have foreign investments are subject to withholding tax. The fund manager pays the withholding tax and passes your portion along to you. The withholding tax will be reported on Box 16 of the T3.

    I have a similar article on my site. Click on my name to view.

  13. What about Vanguard ETFs such as VEA (Europe Pacific) and VTI (entire US market, MSCI index)?

  14. Excellent post CC!

    Does anyone know if there are withholding taxes for RSP LIRAs? (Locked-In Retirement Accounts)?

    I would like to hold U.S. dividend-paying stocks in my RSP LIRA (stocks like Johnson & Johnson), but I do not want to be penalized for holding those U.S. stocks there by paying any withholding tax.

    I have my LIRA because I contributed to a pension at my former employer.

  15. Can anyone provide insight on the following.

    I got stocks from my work, even tho I have a W8-BEN on file, they took 47% Withholding at source (US).
    The documents my brokers sent me clearly indicates the taxes were sent to the Ontario government.
    -is this possible ? Should i chase the Ont Gov for the credit ? Should i simply claim a Foreign Tax Credit ?
    It’s my understanding that I cannot recover the withholding tax ?? But only get credit for it ??
    Thanks.

  16. @Phil S:
    “2. It is unclear whether the interest paid on a leveraged purchase of an income investment inside a TFSA would qualify for a tax deduction. I am erring on safe side with CRA and assuming that the answer is NO.”

    There’s nothing unclear about it.
    Money contributed to an RRSP is *pre-income-taxed* money and you get back the income tax you paid on it. Because of that, the tax deduction that normally applies to interest on money borrowed to earn investment income is negated.
    Money contributed to a TFSA is post-income-taxed money, so there’s no special negation of the tax deduction, so it applies as normal.

    “4. The maximum annual TFSA contribution is $5K. If your brokerage charges you $29 per transaction (since your balance is only $5K, well below most brokerages’ thresholds to get the lower commission rate), then on a RELATIVE basis the commissions are quite high.”

    Phil S’s post is 3 years old, so that ($29 trades for less than $5k balances) may have been true then, but it certainly isn’t now. Even so, $29 on $5k is 0.58%. That’s less than very nearly all the MERs out there. It’s certainly not a barricade to holding equity in your TFSA.

    “5. It is difficult to buy exactly $5000 of a stock. Whatever leftover dollars in your TFSA account are sitting around doing nothing waiting until next year’s contribution. So if you buy 100 shares of XYZ for $48 a share, then in many cases you will have about $200 of cash collecting no interest until next year when you add another $5K to make it $5200 to invest.”

    You can take that $200 back out and do something else with it, until next year when you can add $5200 instead of $5000 to give you $5200 to invest.

  17. Here is another version of this issue:
    Blackstone (symbol BX) is an LP(limited Partnership. Their 8% distributions are neither dividends nor interest payments, their distributions are called “effectively connected income” (business income). The exemption on withholding tax in registered accounts only applies to dividends and interest.
    The Witholding tax is 40%.
    Ouch, and ideas greatly appreciated.

  18. 1 – Where the article says “non-US foreign investments” does that mean only capital gains from securities sold on overseas exchanges or does it include any stocks that are based overseas? If all of those are included that seems like a very large and sneaky tax grab. For example, if I buy an ETF that tracks the S&P 500 do I pay tax for the portion of my gains that come from every foreign entity (Nokia, Toyota, etc)?

    2 – The article says the tax rate is 15%. Why do some posts have examples of much higher rates? Are those from other countries? If so, can someone tell me where I can find a listing of withholding tax rates for ALL countries?

    3 – Some articles on this topic say you must file a tax form with your broker to reduce the US tax rate from 30% to 15% but others like this one make no mention of it. Is this necessary or not?

    • @JC2:

      1. The withholding tax in TFSA is only charged on *dividends* from stocks or ETFs listed in the US. If you hold a stock such as Nokia in a TFSA or RRSP, you will be charged a withholding tax at a rate applicable to that country. In either case, you will not have taxes withheld on capital gains.

      2. Yes, the 15 percent withholding tax rate is for Canadian residents holding US stocks or ETFs. The rate may be higher or lower for other countries. For example, if I recall correctly, you’ll pay a 30 percent withholding tax if you hold NYSE listed Nokia whether you hold the ADR in taxable or RRSP or TFSA account.

      3. Check with your broker whether they need a W8-BEN form. Some brokers may require that you have to submit this form for the correct tax rate to be applied on US stocks (15 percent for TFSA, taxable accounts, 0 percent for RRSP accounts).

      Hope this helps.

      • Phew! It certainly does, thank you so much! I have some big gains right now all from foreign markets so I was in a panic there!

        However, I think in the article when you write one sentence naming capital, interest, and dividend returns and then in the next sentence say there are taxes from other countries – it is implied to most readers that the tax will apply on all of the above.

        “There are no taxes on interest, dividends or capital gains on investments held in the account. However, if Canadian residents purchase US-based securities (such as Microsoft) in a TFSA, a 15% withholding tax applies.”

        Nonetheless, I am a huge fan, keep up the great work! Thanks again.

  19. Why is the Withholding Tax such a big deal? As I understand it, you pay 15% on the dividend the stock pays out. On a typical stock, that average dividend yield might be what, somewhere between 5 or 10%? Any stocks like Microsoft, Google, et. al., if they pay out dividends, I assume they probably pay out in that range?

    Which means you are paying a 15% tax on the 5 or 10% dividend yield only, not the capital gains. Which should theoretically be minimal anyway. Can anyone please provide me a sample calculation on a typical tech sector stock for this?

  20. I have a question I can’t seem to find any answer for. What if we are buying CANADIAN companies/securities but on a US exchange?

    An example of why someone would do that: I’d like to buy NYSE listed CAD, which is a bond etf made up entirely of Canadian gov’t bonds. Obviously the income generated will be from Canadian sources, in Canadian dollars. Will that be subject to a witholding tax as well?

    Or another example, let’s say you buy a US listed ETF that holds 50% Canadian companies and 50% US. Is the witholding tax applied to only the 50% of the US companies? Or is it applied to all since the ETF is US listed?

    Thanks.

    • Canadian Capitalist

      @Rob: If you are buying Canadian companies listed on the US exchange (any of our banks or resource companies), there will be no withholding tax for Canadian investors.

      ETFs are different. If you buy US-listed ETFs that hold Canadian securities, the fund itself will pay withholding taxes to CRA. Then, the IRS will charge a withholding tax for TFSAs, RESPs and taxable accounts. RRSPs/RRIFs/LIRAs will not be charged the second withholding tax.

  21. Hi was reading online about this withholding tax as I have recently opened my TFSA with TD waterhouse and I purchased some US equity mutual funds , so will I get charged withholding tax on dividends from those mutual funds?? examples of funds are TDB218 (TD Dow jone industrial Index US$) , TDB981 ( TD Nasdaq index -I ) . so will I pay withholding tax on these TD mutual funds??

    • @jai: The TD Mutual Funds are Canadian mutual funds, therefore there is no direct withholding tax. However, since these funds hold US-domiciled assets, the fund itself pays a 15 percent withholding tax. In a non-registered account, the fund company will issue you a T5 and you’ll get a foreign tax credit for the taxes paid by the mutual fund. In a TFSA account, there is no Canadian tax implication but effectively, you are paying a withholding tax. Note that if you had held a US-listed stock or ETF, you’ll be charged a withholding tax directly.

      I think you should try and hold assets in the best location possible to minimize the tax hit. That would mean holding US equities in your RRSP as much as possible.

  22. If a buy blackstone LP and put it in my RRSP I don’t have to pay any withholding taxes from the IRS because they are tax sheltered and also the treaty that was developed between the two countries.

Leave a comment

Your email address will not be published. Required fields are marked *

*

You may use these HTML tags and attributes: <a href="" title=""> <abbr title=""> <acronym title=""> <b> <blockquote cite=""> <cite> <code> <del datetime=""> <em> <i> <q cite=""> <strike> <strong>