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moneysense.ca, 16/06/09
Withholding tax & TFSA Investments
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.
moneysense.ca, 16/06/09
Can you file a US tax return and reclaim the withholding tax? Is there any other way to reclaim it?
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!
@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.
[...] Withholding Tax on US Stocks Held in a Tax-Free Savings Account | Canadian Capitalist. good tip about why you should hold dividend-paying US stocks in an RRSP over TFSA. [...]
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.
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?
@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.
@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.
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?
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.
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?
@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.
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?
@ 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.
What about Vanguard ETFs such as VEA (Europe Pacific) and VTI (entire US market, MSCI index)?