How to avoid Non-resident Tax Onforeign Dividends: Investment motive determines how to hold global equities

National Post

2007-01-06



Although much ink has been devoted over the past year to the tax treatment of
tax-advantaged Canadian-eligible dividends, global investors have been virtually
ignored as they try to manage their foreign holdings in themost tax-efficient
manner.

With the repeal of the 30% foreign property rule, the choice of where to hold
foreign investments is a more complex tax decision.

To determine the optimal allocation, you should begin by reviewing what your
primary investment objective is: income or capital appreciation.

If it's income, then, as with Canadian fixed-income securities, foreign bonds
should be held in registered accounts so as to shelter all foreign interest
income, which is fully taxable at your marginal tax rate, from current Canadian
tax until withdrawal.

On the other hand, if growth through capital appreciation is your objective,
global equities should generally be held in a nonregistered account as any
capital gains realized will be only 50% taxable. In an RRSP or RRIF, any capital
growth is effectively taxed as straight income at full marginal rates when
withdrawn.

Unlike their Canadian counterparts, dividends received from global stocks are
not eligible for the dividend tax credit and as a result are simply taxed as
ordinary income at marginal rates.

The added wrinkle, common to both global stocks and bonds, is the potential
imposition of nonresident withholding tax on the foreign dividends or foreign
interest income before it's paid to you in Canada.

Withholding rates vary from country to country and may also be reduced under
the terms of a tax treaty between Canada and the foreign jurisdiction.

If the bond or stock is held in a non-registered account, then you can
generally claim a foreign tax credit for the non-resident tax withheld, which
can be applied against Canadian taxes payable.

Say you made $100 in foreign dividends, but you received just $85 due to a
15% withholding tax. In a 40% tax bracket, you would report the full $100 on
your Canadian return but claim a foreign tax credit for the $15 withheld, paying
only $25 here.

Where the asset allocation decision becomes tricky, however, is when the
foreign dividend-paying stock or bond is held in an RRSP or RRIF. Unless a
specific exemption from withholding tax is available (as with the U.S., for
example), no foreign tax credit is available and this becomes an absolute cost
to your RRSP.

In other words, if the same $85 net dividend (after withholding tax) was paid
to your registered plan, and subsequently withdrawn, you would pay 40% on the
$85 RRSP income or $34. Your after-tax cash yield on $100 of foreign dividends
has been reduced from $60 in a non-registered account ($85 minus $25) down to
$51 ($85 minus $34). This strengthens the case for holding global equities
outside of registered plans, where no withholding tax exemption is applicable.

jamie.golombek@aimtrimark.com

- Jamie Golombek, CA, CPA, CFP, CLU, TEP is vice-president, Taxation & Estate
Planning, at AIM Trimark Investments in Toronto.