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By Larry MacDonald
Globe Investor Magazine Online, September 16, 2008
Diversifying your portfolio by investing abroad is a good idea, but tax traps lurk for many investors.
Before you fork dollars over to foreign governments, take a look at the checklist below. It covers dividend income, interest income, capital gains, and estate taxes in the U.S., which is by far the most popular investment destination outside Canada.
1. Dividends from U.S.-listed stocks do not qualify for the Canadian dividend-tax credit.
2. Dividend income must be converted to Canadian dollars for tax calculations. It can be converted using the exchange rates on the dates your foreign dividend income is received, or using the Bank of Canada's average annual exchange rate for all the dividends received in the year.
3. Dividends from U.S. stocks will be subject to a 15 per cent withholding tax if held in a non-registered account, as long as you have submitted a W8-BEN form to indicate that you are a Canadian resident. Otherwise, the withholding tax rate will be 30 per cent. Many brokerages submit the W8-BEN form for their customers but some customers do "slip through the cracks," observes Ram Balakrishnan, author of the Canadian Capitalist blog.
4. The withholding tax can be reclaimed via Canada's foreign non-business tax credit. If it totals more than $200, it has to be calculated separately for every country involved.
5. Dividends from U.S. stocks will not be subject to withholding tax if held in a registered account, such as a registered retirement savings plan. If you notice a withholding tax is being applied to dividends received in a registered account, it could be because the trustee failed to file the appropriate documentation with the U.S. company paying the dividend.
6. If you receive U.S. dividends through a Canadian-domiciled mutual fund or exchange-traded fund, it will likely have paid the withholding tax prior to distributions even if you hold the fund in a registered account.
Dividends received through a U.S-domiciled ETF will not have paid withholding tax, and a Canadian investor holding the U.S. ETF in a registered account will not be subject to withholding tax.
7. American Depositary Receipts (ADRs) trading on U.S. exchanges may withhold taxes at different rates, even for registered accounts, depending on the tax treaty with the country from which the company issuing the ADR originates. Tax treaties between the U.S. and foreign countries are available at www.irs.gov/businesses/international/article/0,,id=96739,00.html.
8. Interest income earned on bonds and other vehicles is withheld at 10 per cent, except for U.S. bank deposits, where it is usually tax free. The Canada-U.S. tax treaty was amended in 2007 to eliminate the withholding tax and will come into effect when the two countries ratify the agreement. In addition, interest is included in Canadians' income, where it is taxed again, with the withheld tax reclaimable via the foreign non-business tax credit.
Capital gains/losses on U.S. securities and cash
9. Currency gains or losses from cash in a U.S.-dollar account are taxable if they exceed $200, notes Dean Smith, a chartered accountant with Grant Thornton LLP.
10. Capital gains or losses on U.S. securities held by Canadians are taxed in Canada. There usually is a gain or loss related to currency fluctuations. If the currency gains/losses are less than $200, they don't have to be reported.
U.S. estate tax
11. On death, Canadians' holdings of U.S. shares are subject to U.S. estate tax, at the fair market value, but only if the value of the worldwide gross estate is at least $2 million (U.S).
12. The exemption level rises to $3.5 million in 2009, according to Smart Tax Tips by Karen Yull of Grant Thornton LLP. Pending further legislative action by the U.S. Congress, there will be no estate tax in 2010, and a reintroduction of the tax in 2011 with $1-million exclusion.
13. Estates above the threshold can obtain a tax credit of up to $780,000 pro-rated by the proportion of total holdings comprising U.S. assets. Thus, if 10 per cent of a Canadian's estate is in the U.S., they are entitled to a $78,000 credit ($780,000 x 0.10). If the assets are left to a spouse, an additional credit of up to $780,000 is available.
14. If U.S. estate tax paid is paid, it will be eligible in Canada for foreign dividend credits that can be used to reduce Canadian tax bills in the year of death.
15. There are several strategies for minimizing U.S. estate taxes, including: Holding U.S. assets in a corporation, sharing ownership with someone else, and securing non-recourse loans to U.S. assets. Tim Cestnick's guide, 101 Tax Secrets for Canadians (2008 edition) has more details.
For more reading, go to:
- Karen Yull, Smart Tax Tips (Updated for 2008), Grant Thornton LLP
- Dean Smith, Chartered Accountant, Grant Thornton LLP
- Tim Cestnick, 101 Tax Secrets for Canadians (2008 edition)
- Ram Balakrishnan, Canadian Capitalist blog.
Note: The above checklist was compiled with the assistance of tax experts but you should always consult an expert.
Special to The Globe and Mail
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