As a result of I’ve written loads concerning the Greatest Canadian ETFs and the highest dividend ETFs, I are likely to get a variety of questions and feedback asking me concerning the MER and taxes on ETFs that maintain equities from different international locations.
Clearly if you’re asking these varieties of in-depth questions you already perceive the worth of index investing, and on the spot diversification. Personally, I wish to stability my love of Canadian dividend shares, with non-Canadian ETFs to get super-convenient worldwide publicity.
I might say that at this level, I’ve acquired a good quantity of hard-earned experience in the case of the most important Canadian dividend payers. That experience requires hours of studying each quarter although, to make it possible for I keep on prime of earnings, debt ranges, administration methods, and so forth.
Frankly, I don’t have the time to develop into an skilled on the huge universe of worldwide shares as nicely. However whereas I don’t have the time and data to choose worldwide shares, I do have the time to analysis simply how essential worldwide diversification is in my general portfolio. Consequently, I do know that I need publicity to far more than the three% of the world financial system that Canada presents.
Non-Canadian index funds are the simplest means to do that. My spouse and I every have worldwide ETFs in our RRSPs, my spouse’s LIRA, and in our youngsters’s RESPs. With a purpose to profit from worldwide shares you’ll be able to both decide to prioritize comfort and use a Canadian all-in-one ETF, or you’ll be able to prioritize optimization of taxes and MERs with particular person worldwide ETFs. If you happen to go for the second path, you want to concentrate on ETF withholding taxes in Canada, and the way taxes on ETFs differ between dividends and capital good points.
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Do Canadians Pay Tax on ETFs?
Earlier than we get into the gritty particulars of overseas withholding taxes, let’s take a step again and take a look at the broader image of paying taxes on ETF funding good points.
As with different investments, ETFs could make you cash in 3 ways:
1) Capital good points (you purchase low the ETF low, promote excessive, the distinction is a capital achieve).
2) Dividends (the businesses within an ETF pay dividends, which then receives a commission to you – normally each three months or as soon as per yr).
3) Curiosity (you’ll get curiosity earnings from money ETFs or bond ETFs).
Every of a lot of these earnings will get taxed in another way.
It’s additionally essential to level out that in case your ETFs are in an RRSP, TFSA, or RESP (amongst different registered accounts) you don’t pay any taxes to the Canadian authorities.
In fact, in case your ETFs are saved in a non-registered account, then the Canadian authorities goes to cost you taxes on the dividends and curiosity that you just earn every year. The tax charge that you just pay on these ETFs will rely upon the remainder of your private tax state of affairs for that yr. Capital good points in your ETF would solely happen in case you determined to promote some items of your ETF. For extra particulars try my article on investing taxes in Canada.
However there may be additionally a complete different degree of taxation at work in the case of worldwide ETFs. If you happen to solely put money into ETFs that maintain Canadian belongings AND are listed on a Canadian inventory change (nearly all the time the Toronto inventory change) then you definately don’t have to fret about different international locations taxing your investments. But when your ETF tracks belongings within the USA or in different international locations, then it’s in all probability that you just’re going to be paying one thing referred to as a overseas withholding tax in your dividend earnings earlier than that cash ever hits your brokerage account.
What’s Overseas Withholding Tax?
Once you purchase U.S dividend shares in a taxable account, you might discover that the dividend may have 15% withheld. That’s 15% offering you might have stuffed out a W-8BEN, in any other case you’re a 30% clawback of your US-based dividend earnings. Once you see cash popping out of your dividend cost, that cash is getting used to offset your taxes owing on that dividend if you file your tax return.
What about US dividend shares inside an RRSP? For RRSPs, there’s a tax settlement between Canada and the US that eliminates the 15% withholding tax on US dividends. Whereas that is nice, the settlement doesn’t lengthen to TFSAs, so US dividends inside a TFSA will face a non-recoverable 15% tax. This settlement means that there’s a small-but-measurable enhance if you just be sure you have your US-based investments within your RRSP.
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Overseas Withholding Tax on ETFs?
So what about paying overseas withholding tax on US and worldwide ETFs?
That is the place it will get difficult!
Whereas holding US shares immediately in an RRSP will get preferential tax therapy, do you know that a Canadian ETF that holds an underlying USA ETF doesn’t qualify for the tax exemption? So primarily with the extra embedded tax, you’re paying the next MER than you assume!
Worldwide equities from international locations outdoors of Canada and the USA can be topic to withholding tax in an RRSP/TFSA, and will get even bigger if the worldwide ETF holds underlying ETFs. The brilliant aspect is that the extra well-liked worldwide fairness ETFs like iShares XEF and Vanguard VIU maintain particular person shares, which leads to just one degree of withholding tax.
An Instance
For instance, one in every of my favourite methods to get US publicity in my RRSP is thru the iShares XUU due to the diversification and due to the extraordinarily low MER of 0.07%.
Nevertheless, since XUU holds underlying ETFs, it might face overseas withholding tax to the tune of 0.26%. This leads to a complete MER of 0.33% when held in an RRSP/TFSA.
As one other instance, one in every of my favourite worldwide fairness ETFs inside my RRSP is proudly owning iShares XEF. This ETF has a MER of 0.22%, however because it holds shares immediately (and never different ETFs), the ensuing withholding tax is 0.27%. When holding in an RRSP/TFSA, the ensuing MER/Tax mixture is 0.49%.
Calculating Withholding Tax on Canadian ETFs
Justin Bender, from Canadian Portfolio Supervisor weblog, does an ideal job explaining ETF withholding tax and has even created a nifty calculator that actually helps simplify the idea.
With out entering into the main points of methods to calculate the withholding tax, let’s get into the great things and present the entire MER together with withholding tax in every account sort of some well-liked ETFs.
U.S Fairness ETFs
| ETF | TFSA | RRSP |
| XUU (CAD) | 0.26% | 0.26% |
| VUN (CAD) | 0.26% | 0.26% |
| ITOT (USD) | 0.26% | 0.00% |
| VTI (USD) | 0.26% | 0.00% |
Worldwide Fairness ETFs
| ETF | TFSA | RRSP |
| XEF (CAD) | 0.27% | 0.27% |
| VIU (CAD) | 0.29% | 0.29% |
| IEFA (USD) | 0.67% | 0.25% |
World Fairness and All-in-One ETFs
| ETF | TFSA | RRSP |
| XAW (CAD) | 0.31% | 0.31% |
| VXC (CAD) | 0.31% | 0.31% |
| VGRO (CAD) | 0.19% | 0.19% |
| XGRO (CAD) | 0.17% | 0.17% |
| VBAL (CAD) | 0.17% | 0.17% |
| XBAL (CAD) | 0.13% | 0.13% |
*Observe that dividends obtained from non-Canadian corporations in non-reg accounts are taxed like curiosity (ie. added to your marginal tax charge). Additionally word the price of overseas forex change from CAD to USD.
Tax Environment friendly ETFs in Canada: Horizon Swap ETFs
One method to beat the overseas withholding taxes on ETFs that offer you American and worldwide publicity is to try the Horizon swap ETFs. These ETFs “swap” dividends for capital good points, and consequently remove the necessity for overseas withholding taxes to be paid in any respect.
However after all you don’t get something totally free on this world. In change for the immediate elimination of 1 layer of ETF taxes, it’s a must to take into account the next commerce offs.
- You’re going to pay a buying and selling payment along with your MER charges. This payment can mainly offset the entire overseas withholding taxes that you’d be saving.
- The complexity of constructing certain that you’ve got HXS in the fitting allocation quantity – inside the fitting accounts – is considerably extra work than simply shopping for an multi function ETF.
- There’s a slight elevated danger when utilizing HXS as a result of counterparty publicity. That mentioned, Nationwide Financial institution (the counterparty) isn’t going wherever anytime quickly.
If you wish to defer taxes from if you’re in a excessive tax bracket, to a time if you’re in a a lot decrease one, then HXS and its capital good points magic is price consideration. If you happen to’re solely searching for a method to keep away from overseas withholding taxes then I might argue the juice isn’t well worth the squeeze right here. For extra particulars on the way in which this ETF capabilities, see my article on Horizons swap primarily based ETFs.
Is Minimizing Taxes on ETFs in Canada Value It?
Look – there’s a danger right here that in the case of Canadian ETF taxes, DIY buyers can shortly lose the forest by observing a single tree.
It’s essential to emphasise that overseas withholding taxes solely apply to the dividends of ETFs – not the general return. So in case your overseas ETF has a complete return of 10%, and dividends are accountable for 2% of that return, then your .3% overseas withholding tax charge would solely lead to .60% being subtracted out of your 10% return.
It’s actually essential to know that the elevated withholding tax charge doesn’t apply to capital good points (that are prone to be the majority of your returns on worldwide fairness ETFs over the long run).
Consequently, if you wish to perceive if chopping taxes on ETFs proper to the minimal is price it for you, then it’s a must to put a worth by yourself time. If you happen to completely perceive on how taxes on USA ETFs work (together with methods to decrease forex conversion charges), and methods to optimize your TFSA vs RRSP vs non-registered accounts, then you’ll be able to in all probability minimize someplace round .10% to .30% of your whole tax/payment drag from the non-Canadian a part of your portfolio. You may get extra particulars on these tax optimization methods right here.
Over the long run that .10% to .30% financial savings will compound to a good chunk of cash – BUT – it’s fairly a bit of labor to maintain rebalancing all of those completely different funds over separate accounts, and deal with the forex conversion logistics in a means that minimizes charges.
That’s why most folk would go for the comfort of a Canadian portfolio ETF, because it’s simply a lot simpler to deal with, and the value is a comparatively low one to pay for not having to pour over a number of account balances every quarter with a purpose to be sure that you’re general asset allocation technique stays in tune along with your overseas withholding tax minimization technique.
