Justin Bender and I have just completed the second edition of our popular white paper, Foreign Withholding Taxes: How to estimate the hidden tax drag on US and international equity ETFs.
Originally published in 2014, the paper explains how many countries impose a tax on dividends paid to foreign investors—most notably a 15% levy on US stocks held by Canadians. When the first edition appeared, foreign withholding taxes were not well understood by many investors and advisors, and even the ETF providers rarely discussed them. In the two years since, the issue seems to be getting more recognition. Both Vanguard and iShares, for example, have made changes to their international equity ETFs to make them more tax-efficient. That’s great news, though it also made the first version of our paper somewhat dated.
In this new edition, we’ve made some significant changes. First, we’ve removed corporate accounts from the discussion and focused on personal accounts only. We’ve also used some different ETFs in our examples, including the Vanguard U.S. Total Market (VUN), the Vanguard FTSE Developed All Cap ex U.S. (VDU) and the iShares Core MSCI EAFE IMI (XEF). Finally, we’ve added some additional commentary to help investors make better decisions.
The takeaways
We invite you to dive into the paper for all the details, but if you’re looking for a summary of the important points, here they are:
- In an RRSP, using US-listed ETFs for foreign equity holdings can bring a significant tax advantage. That’s because these securities are exempt from the usual 15% withholding tax on dividends imposed by the US government. Assuming a 2% yield on US stocks, the tax savings amounts to 0.30%.
. - In taxable accounts, Canadian-listed ETFs are generally a better choice. US-listed ETFs offer little or no tax advantage, and in cases where there would be a small benefit it’s likely to be outweighed by other considerations, including currency conversion costs and additional record-keeping—more on this below.
. - In a TFSA or RESP, you should always use Canadian-listed ETFs for foreign equities. US-listed ETFs offer no tax advantage whatsoever, and in some cases they’re significantly less tax-efficient.
. - Finally, if you use Canadian-listed ETFs for international equities, look for funds that hold the stocks directly rather than through an underlying US-listed ETF. The “wrap” structure imposes a second level of foreign withholding tax that is not recoverable. To review the example we use in the paper, XEF holds its stocks directly, and Justin estimated its tax drag at 0.26% in an RRSP or TFSA. By comparison, VDU gets its exposure via an underlying US-listed ETF, resulting in foreign withholding taxes of 0.59%. (Note that Vanguard’s newer international equity fund, VIU, holds its stocks directly, so its tax drag should be similar to that of XEF.)
Understanding the trade-offs
US-listed ETFs have long been popular with Canadian investors because of their low fees, and if you’ve read through our paper you’ll understand they can also have significant tax benefits. With our clients, we regularly use US-listed ETFs in RRSPs and other retirement accounts for these reasons. But with DIY investors we usually don’t recommend this, unless you can be sure you understand the trade-offs. As for taxable accounts, the case for using US-listed ETFs is even weaker. Here’s why:
The cost of currency conversion. Any benefits from the lower fees and taxes on US-listed ETFs will be reduced or even eliminated if you fail to avoid the potentially high cost of converting currency before purchasing them. In most cases you should have a source of USD income or be comfortable using Norbert’s gambit—otherwise, stick with Canadian ETFs.
Here’s a bit of good news from our findings, which Justin explained in more detail in a recent blog. It turns out that in an RRSP, the foreign withholding taxes on XEF, a Canadian-listed ETF, are almost exactly the same as those of its US-listed equivalent, the iShares Core MSCI EAFE (IEFA). So this is one place where you really don’t need to use a US-listed fund.
Record-keeping and reporting. In taxable accounts, tracking the adjusted cost base of US-listed ETFs is significantly more difficult, because you will need to look up the exchange rate on the settlement date of every transaction. This adds an additional cost, especially if you pay a tax preparer to do it for you.
US-listed ETFs are also considered foreign property by the Canada Revenue Agency, and non-registered holdings with a book value of $100,000 CAD or more must be reported annually using the T1135 form. Additional reporting is required when the total cost of your US-listed ETFs is over $250,000 CAD.
US estate taxes. Granted, this isn’t a problem for most of us. But wealthy Canadians may be subject to US estate taxes if they have significant holdings in US-listed ETFs, even if these are held in an RRSP.
@Dan Wow, thank you for your quick response!!
Yes, the relatively slower growth of bond ETFs was definitely a concern and why I originally put them in my RRSP. Right now, my remaining RRSP room and my entire TFSA are for equity ETFs, without worrying about putting more US/Intl/CAD ETFs in one or the other. They’re all CAD-listed.
If I’m understanding correctly, if one is comfortable with doing Norbert’s gambit regularly and dealing with some additional complexity, then it can incur relatively high cost savings in the long run. In my case, I am estimating I can retire half a year earlier which would be quite a nice option to have! This of course assumes that the US-CAD dollar doesn’t go completely crazy for a long period of time when I’m about to retire.
However, if I strive for having the same portfolio mix in my RRSP and TFSA while optimizing my RRSP for FWT, I need to be more mindful.
1 – I would need to keep track of the exchange rate when balancing my overall accounts, to ensure my overall portfolio mix is on target
2 – I essentially would go from 5 CAD-listed ETFs to 5 CAD-listed ETFS + 3 US-listed ETFs, so on paper / spreadsheet this might look more complicated
3 – A bit of additional risk of highly fluctuating exchange rates when I’m close to retirement
4 – Anything else?
Norbert’s Gambit is no problem, I’ve done it a few times and have helped a couple of friends figure their way around it as well. I’ve also found that balancing every quarter is about the right cadence for me, and I don’t fuss about the markets in between. My spreadsheet is set up to tell me what to do automatically, and I get a sense of satisfaction when I’m done. I find it fun in a weird way :)
Hello Dan,
My son is buying VGRO in his TFSA account. He can only small amounts weekly in questrade. Will he have more difficult time during tax season with keeping small purchases organized for the foreign withholding tax? I might be confusing what you are saying about the paperwork headache in taxable acccounts.
@Miwo: You don’t have to worry about any tax reporting in a TFSA, so there’s nothing to be concerned about. VGRO is a great choice in a TFSA.
Hello Dan,
Just to show what a newbie I am, how does CRA take its withholding tax from VGRO in the TFSA? Is it taken only if we sell? Will Vanguard be sending us some reporting slip?
@Miwo: CRA does not deduct foreign withholding taxes. They are deducted at the fund level, like fees. In a TFSA there is nothing to report. In a taxable account, the amount for FWT deducted will appear on your T-slip and you can claim the foreign tax credit on that amount to receiver it.
Hi Dan,
I am having trouble understanding foreign withholding tax. I am new to investing as of this fall and in RRSP I have 45k split evenly between VCE and VSP. In TFSA I have 17k in VAB. I contribute 2500 / month and I want to have a 80/20 aggressive portfolio. In one year I will have maxed contributed to TFSA and RRSP and will start contributing to a taxable account. In 8 years I will want to live off of the dividends of my portfolio. Can you please advise me on your suggested holdings and their respective locations? I am grateful for all of the info I gather from your site and look forward to reading your reply.
Thanks
@DP: Your question is more complicated that it may appear on the surface, and FWT is just one small piece of the puzzle. FWT is only relevant in your RRSP, and to avoid it you would have to use a US-listed ETF in place of VSP, which you may not want to do. As long as you are using only an RRSP and a TFSA, then it makes sense to keep the bonds in the RRSP. Otherwise, there are just too many factors to consider in the decision.
Hi Dan,
Thx v much for all the great insight you are sharing. I have read the paper but have found conflicting/confusing information elsewhere so I figured I’d ask..
I have a few index funds covering US equities (TDB902, TDB908), international equities (TDB911) and emerging mkts (CIB519), all of which in both RRSP, LIRA, RESP and TFSA.
What I think I understand is that for US equities within the RRSP/LIRA, no tax withholding applies. However, it looks like it would within the RESP and TFSA. Is that the case even with these mutual funds I mentioned or is it only for funds listed in the US?
Thanks so much for sharing your brain with us!
LC
@LC: Foreign withholding taxes will always apply if you hold mutual funds. There is no exemption in an RRSP (or LIRA) unless you use US-listed ETFs.
I have found this article quite helpful. However, I have a very basic, perhaps rather naïve question. Why do some ETFs not hold their stocks directly? I own some iShares which hold other US listed iShares instead of the US stocks. Why is that?
@David: The wrap structure allows for economies of scale. Since many of the US ETFs have enormous assets under management, the smaller Canadian ETFs can piggyback on them. Using an underlying US-listed ETF is much more efficient than buying the hundreds or thousands of stocks individually. In the past, some index ETFs would use “representative sampling” for large indexes. That is, instead of buying all the stocks they would buy a subset of them hoping to capture similar performance with fewer trades. But this proved to be unreliable compared with the wrap structure.
This blog is very informative. Thank you for providing us with so many valuable articles. May you please answer my one question.
May you comment on the withholding tax on fund?
U.S. Dividend Appreciation Index ETF (VGG) vs U.S. Dividend Appreciation Index ETF (CAD-hedged) (VGH). Because these funds are Canada based, does it mean that there wont be any tax to be paid on the dividends? What would be the difference between these two funds if we consider it for our tfsa account?
Thanks
@Jashan: Both of the funds you mention are what we call Type B funds in the white paper: Canadian ETFs that hold US-listed ETFs of US stocks. In a TFSA, 15% withholding tax applies on dividends and this is not recoverable.
Thank you Dan and Justin for this very informative paper (and all that I have learned at Couch Potato)!
My question is about the fluctuation of CAD vs USD. Wouldn’t this whole tax saving by using US-traded ETF in RRSP just be wiped out if the Canadian dollar is strong (stronger than today) when I finally decide to cash out? I recognize this is a big IF and we will never be able to predict what way the CAD vs USD conversion will go. However, at the current $1CAD hoovering around 75 cents US it seems quite realistic that even if I cashed out at $1CAD= 80 cents US that tax savings of 0.3% (on assumed 2% yields) would be wiped out and then I also lose some because a stronger CAD. Norbert’s Gambit is a doable and efficient low-cost way of converting currencies but it doesn’t change the fact that there is fluctuation in the CAD vs USD.
@Albert: The key point here is that if you hold US equities using a Canadian-listed ETF you have exactly the same currency exposure as a US-listed ETF. (Unless you specifically use a Canadian ETF that employs currency hedging, which I don’t recommend.)
This idea is not very intuitive, and it trips up many investors. But it’s important to understand that whether you use VTI (US-listed) or VUN (Canadian-listed), for example, you have the exact same exposure to the US dollar.
https://canadiancouchpotato.com/2014/01/13/how-a-falling-loonie-affects-us-equity-etfs/
Hi Dan,
I just received confirmation from ishares Canada that XEF uses an underlying US-listed ETF in combination with individually-listed stocks. It’s also the largest holding. Would you still recommend it?
@Linda: Many ETFs do this for cash management: they hold a small amount in an ETF to maintain exposure to the index until they have a sufficient amount to buy up the individual stocks cost-efficiently. This might be 3% to 4% of the ETF’s assets on some days, but as of November 8, it was 0.02% of the XEF. It’s a trivial concern for investors in the fund.
Hi Dan,
Great info. Have you looked at how foreign withholding taxes work for US ETFs that are essentially “funds-of-funds”?
For example:
1. US-listed ETF composed of other US-listed ETFs, that in turn hold US Equities
2. US-listed ETF composed of other US-listed ETFs, that in turn hold Developed Market Equities
3. US-listed ETF composed of other US-listed ETFs, that in turn hold Emerging Market Equities
Thanks!
@gocanada: In example 1 there would be no effect. In the other two there would presumably be Level 1 FWT, but these would be based on the tax treaties between the US and the overseas countries. But this all sounds hypothetical: there is no reason for Canadians to use ETFs with this structure when there are plenty of alternatives that hold the stocks directly.
Hi Dan,
I understand the advantages of US listed ETF for US stocks but what would you recommend between XEF and IEFA or VEE and IEMG for Canadian investors? Is there any good reasons to go US listed for those two? Thank you, as always, for all the useful information!
@Sophie: This is explained in the white paper. A fund like XEF, which holds its stocks directly, eliminates the second layer of foreign withholding tax. Funds like VEE, which hold an underlying US-listed ETF, may result in a second layer of unrecoverable FWT.
Hi Dan
I am wondering if one decides to hold the US part of his portfolio in a RRSP to avoid witholding tax, how is he supposed to rebalance the asset allocation since the money in the RRSP doesn’t have the same value because it will be taxed when withdrawing..? Would you be ignoring that fact or would put a certain percentage amount more by projecting an estimate of the taxable rate at the time of withdrawal?
I am now beginning investing in a tfsa and just figured out two of my funds (XUS and XEC) are subject to the two levels of witholding taxes… Would you have a recommendation of etf for s&p 500 and emerging markets that would be more tax efficient to hold in a TFSA besides HXS ?
Thanks a lot
Yan
@Yan: Whether you should consider your RRSP assets on a pre-tax or post-tax basis when rebalancing is a complicated issue. It is theoretically correct to consider them on a post-tax basis, built it makes portfolio management very complicated (especially since you don’t know what your tax rate upon withdrawal will be). If you want to dive into this issue, this may help:
https://www.canadianportfoliomanagerblog.com/asset-location-in-a-post-tax-world-tfsas-vs-rrsps/
There is no way to avoid foreign withholding taxes in a TFSA, so you are fine with XUS (which has only one layer of withholding tax) and XEC.
I was wondering if there is such a thing as a type E ETF for the emerging market (i.e. holding the stocks directly)? I’m looking for a more tax efficient alternative to XEC or IEMG for a TFSA.
@Julien: The BMO MSCI Emerging Markets Index ETF (ZEM) comes closest: it still has some underlying ETFs but mostly holds the stocks directly.
Hi Dan – A couple of questions.
Lets say I buy a Canadian listed ETF that either holds US equities directly, or holds an underlying US ETF that holds the US equities. Lets also assume the ETF is designed for accumulation rather than income, and that even though the underlying equities pay a dividend to the fund, the fund pays no dividends to the holders. I will hold the ETF in an unregistered account. Will I still get issued a T slip with the withholding taxes even though the taxable dividends are paid to the holding fund and not directly to me? And in order to claim the foreign tax credit is it absolutely necessary to have recieved a T slip anyway?
Thanks!
@Andrew: If the holdings within the fund pay dividends, then you will receive a T-slip itemizing those dividends (and any foreign withholding taxes), whether or not they are paid out to you in cash. ETFs and mutual funds are required to pass along all distributions to their unitholders for tax purposes, even if those distributions were reinvested in the fund.
Hi Dan,
A question about dealing with the withholding tax in a TFSA in a situation where one also has a corporation (taxable) account. If one holds only Canadian equities in their TFSA and then adjusts the holdings in the corporation with less canadian equities and more US and international equities (to maintain an overall portfolio balance) would this be more tax efficient? I don’t think I’d go this route at my point of DIY investing because it adds another level of complexity and behavioural risks for a beginner DIYer like me. But just wondering if this is the concept?
@LK: Thanks for the comment. It would reduce the amount of foreign withholding taxes, but it could easily increase the overall amount of tax you pay, since Canadian dividends are taxed more favourably in corporations than dividends from US and international equities.
HI Dan,
I am enjoying your articles and podcast. Thank you.
By the way, similar to above Julien’s question, I noticed that your paper hasn’t mentioned a Canadian-listed ETF for emerging market
equivalent to Type E (I was able to find BMO ZEM & ZLE). My question is, are these type of ETF such as ZEM & ZLE tax efficient than Type F or Type G for TFSA or RESP? By basic thinking is that it should be as Type E in TFSA or RESP is tax efficient than Type C or Type D.
@Rody: ZEM is now a hybrid, holding a combination of underlying ETFs and stocks. Yes, it would be somewhat more tax-efficient in an RRSP than a fund that got all of its exposure through underlying ETFs.
Regarding ZLE, this fund has quite a different strategy and a much higher fee, so I would not choose this option simply for its perceived tax-efficiency.
Hi Dan,
Just wanted to confirm.
There are no withholding taxes for having VXC in TFSA?
Thanks
@Ale: Unrecoverable foreign withholding taxes do apply on VXC when held in a TFSA. There is no way to avoid these taxes if you hold foreign equities in TFSA.
Hi Dan,
Thank you for the informative article.
Can you please clarify whether the foreign withholding tax only applies on dividends and not capital gains, for a foreign equity?
If one were to invest in a non-dividend US equity and sells a few years down the road at a profit, would they have been better off holding the funds in a RRSP vs. TFSA or would the gains/outcome be the same in either account by virtue of no dividends being paid?
@Wally: Foreign withholding taxes apply on dividends only, not on capital gains you realize from selling ETF shares. In this respect, there would be no difference between realizing gains in a TFSA or RRSP: in both cases, no tax is payable.
How does one adjust the etf trailing returns on morningstar.ca for fwt?
@Alan: This should help:
https://canadiancouchpotato.com/2016/07/18/how-foreign-withholding-taxes-affect-returns/
I have a Individual RESP for my 1 yr old son. I want to invest in 100% Equities. In the future when the child grows older I will be looking to add fixed income. I also will be trying to invest upto $2500/year. Should I invest in VEQT or individual ETF’s? If Individual ETF’s should I go with Option 1) VCN, VUN, VIU, VEE or Option 2) XAW, VCN? I don’t mind rebalancing if need be and I am using Questrade so buying ETF is free. Also is investing in a lump sum better or monthly contributions?
@Massoud: I think the one-ETF solution with annual contributions would be best. If you are prepared to hold all equities for a few years, this would allow you to manage the portfolio with virtually no effort. No need to overcomplicate things with a small RESP. When it comes time to reduce the risk, you can add a bond ETF and/or cash.
Thanks for all the articles, great advice. :)
I have a question. My wife is an American citizen and she wants to buy US-listed ETFs (or mutual funds) to avoid US taxes.
How can she find such US-listed ETFs or funds in Canada?
Would the options provided by say, TD (e-Series or not), or RBC that mentions “US” in the name be considered US-listed?
Thank you in advance for your help.
PS: Sorry if there is already an article with such information, I don’t seem to find it.
@Guilherme: A US-listed fund is traded on a US exchange: it cannot simply be a Canadian ETF that holds US stocks, such as the products offered by TD and RBC.
The good news is that all Canadian brokerages allow you to purchase ETFs on US exchanges.
Hi Dan, can I ask, what’s the best US Equity ETF, say the SP500, to hold in a Canadian RESP, TFSA, and RRSP account? Do you recommend the same one for all 3 or is there a different one for each account that would be more tax efficient? Thanks!
Hi Dan, a few years ago, I started investing in ETF’s (VAB, VCN, VUN, XEF and XEC) following one of your model portfolio’s.
I hold these ETF’s in a TFSA and RESP (as well as in an RRSP but that seems less of an issue). I now came to realize that some of these ETF’s hold US and foreign stock that pay dividends. I’m wondering now if I have to do anything during tax season? Are taxes on dividends of US and foreign stock withheld automatically or do I need to report anything to the CRA for these ETFs being held in an TFSA and RESP? And what about if I rebalance these accounts and sell some of these ETFs that hold US and foreign stock? Do I need to report that to the CRA?
Not sure if you can provide any guidance here. Thanks.
@Koen: No tax reporting is necessary for an RESP, TFSA or RRSP. If withholding taxes apply, they are taken at the fund level, before the dividends are paid to you. No worries, you don’t need to do anything.
Hello CCP,
Just a little background; I’ve read through all of MMM blog posts and read JLcollins stock series twice. I must say I learned quite a lot from doing so. However, both sources of information pertain to US citizens (Both recommend VTSAX as a one fund solution). As you know, things get somewhat complicated trying to follow this as a Canadian due not being able to purchase VTSAX and taxes on VTI etc.
But then I finally came across your blog after being smart enough to google Canadian investing lol. Everything you say relates perfectly with no translation necessary. YES!
So, I read through your getting started page. I then found the model portfolio page with option #1 (Vanguard ETFS) and option #2 (TD e-series).
This eliminated my most likely foolish idea of trying to mimic VTSAX by choosing to fund VUN.to in my TFSA and VTI in my RRSP through Questrade.
Anyway, I’m seriously considering investing in VEQT for both RRSP and TFSA. (You already answered my first question in the last comment: I now know that I dont need to worry about withholding taxes for either accounts because they’re already taken out automatically). So I dont need to file any forms or anything right??
BUT my second question is how do the dividend payouts compare to say investing in VEQT (or any vanguard asset allocation etf) versus TD e-series?
Is either even close to the nearly 2% that VTSAX provides?
Is it going to be the same return over time? I’m really just looking for something similar to VTSAX since that seems to be the answer for Americans. (After reading through all the MMM and JLcollins articles, I kind of wish I was American at this point for the sake of simplicity.)
I’d like to be able to live off the dividend payments at some point in the future. I’m just not sure which fund offers this kind of dream (option #1 or option #2?)
Anyway, sorry for the long message. I hope all this rambling makes sense to you and you are able to clear things up for me.
Are units that are in usd like xdu.u us listed? Or is it only ETFs that are mainly listed on the us stock exchange?
Hello Dan, i am newbie in investing. I recently bought VFV EFT for my non registered fund. Will I need to pay witholding tax and what implications come tax season?
@Karen: Withholding taxes are taken at the fund level before the dividends are paid to you. When you receive your T3 slip at tax time, the amount of foreign tax paid will appear on the slip, and you will receive a tax credit for that amount when you file your return.
Thanks Dan for answering my question. I appreciate. Please continue with all helpful articles. Lot’s of people learn from it. Be bless!
Hi Dan, I know your site is ETF focused but can you provide any insights for withholding taxes for owning ADRs of foreign stocks? Can these be treated like an ETF that holds a stock directly?