Will buying a Canadian-domiciled U.S. index ETF result in U.S. withholding tax on dividend income like a U.S.-domiciled ETF or U.S. stock paying a dividend?
—Neil
Withholding tax on U.S. ETFs for Canadians
U.S. equities make up a large share of global markets — roughly 46% of world equity market capitalization as of the third quarter of 2022. Historically, the S&P 500 has outperformed the Canadian market over long periods: over the 50 years ending Dec. 31, 2021, the S&P 500 total return in Canadian dollars was about 11.7% annually versus 9.6% for the S&X/TSX Composite, a difference of 2.1 percentage points. For that reason, it’s common and reasonable for Canadian investors to include U.S. stocks in their portfolios.
One important consideration when holding U.S. equities is U.S. withholding tax on dividends. To answer your question plainly: buying a Canadian-domiciled ETF that holds U.S. stocks will generally not avoid U.S. withholding tax. Under the Canada–U.S. tax treaty, dividends paid by a company resident in one country to a resident of the other are subject to a 15% withholding tax.
A Canadian-domiciled ETF — for example, one that trades on the Toronto Stock Exchange — is treated as a Canadian resident for tax purposes. When that Canadian-listed ETF receives dividends from U.S. corporations, those dividends are typically subject to the 15% U.S. withholding tax, even though the ETF itself is listed in Canada.
Registered or non-registered account: Does it matter?
Where you hold the investment does affect the after-tax outcome. If the ETF sits in a non-registered (taxable) account, the 15% withholding tax is generally claimable as a foreign tax credit on your Canadian tax return. The foreign tax credit prevents double taxation by offsetting Canadian tax otherwise owed on that income. Since many Canadian taxpayers face a minimum effective tax rate in the 20%–25% range, the 15% U.S. withholding often serves mainly to reduce, rather than multiply, total tax on dividend income.
However, if a Canadian-domiciled U.S. equity ETF is held inside registered accounts such as an RRSP, TFSA, or RESP, the 15% U.S. withholding tax cannot typically be recovered. With the S&P 500 yielding roughly 1.7% at the time of writing, a 15% withholding on that yield equates to roughly a 0.25% drag on total return. For many investors, that small hit may be acceptable given the diversification benefits of U.S. exposure, particularly to sectors like technology and health care that are harder to access through Canadian-only holdings.
Withholding tax on RRSP investments
There is a useful exception for RRSPs and similar registered retirement accounts. U.S. dividends paid to U.S.-domiciled stocks or U.S.-listed ETFs held inside an RRSP or RRIF are generally exempt from U.S. withholding tax under the Canada–U.S. treaty. That means a Canadian investor who holds U.S.-listed ETFs or direct U.S. equities inside an RRSP can avoid the 15% withholding, which can boost net returns — for an S&P 500 exposure the benefit is on the order of 0.25% per year, and it increases with higher dividend yields.
Buying U.S.-listed ETFs or stocks does introduce foreign exchange costs, since you must convert Canadian dollars to U.S. dollars. Typical retail FX markups in brokerage accounts are often in the 1.5%–2% range. Many investors reduce those costs using a technique called Norbert’s Gambit, which involves buying and selling an interlisted ETF or stock to switch currency at near-brokerage fees rather than paying the currency spread. When executed well, Norbert’s Gambit can cut the conversion cost down to only the trading commissions.
Note that the RRSP withholding exemption does not apply to accounts such as TFSAs or RESPs, where U.S. dividends paid to U.S.-domiciled securities remain subject to the 15% withholding.
Consider incremental taxation
Be mindful of potential extra layers of tax when you own ETFs that hold other ETFs. For example, a Canadian ETF that itself holds a U.S.-domiciled ETF or a foreign ETF could face two layers of withholding: first on dividends at the level of the underlying foreign stock, and then again when U.S. dividends flow from the U.S.-domiciled fund to the Canadian fund. For international exposure, many Canadian investors find it preferable to choose Canadian-domiciled ETFs that hold foreign stocks directly, avoiding that double pass-through of withholding taxes. It’s always worthwhile to look “under the hood” of any ETF you buy to understand where dividends originate and how they’re taxed.
Some products are designed to mitigate U.S. dividend withholding. A well-known option for Canadian investors seeking U.S. equity exposure is a swap-based ETF, such as the Horizons S&P 500 Index ETF. Swap-based ETFs replicate index returns synthetically through derivatives and typically do not take ownership of the underlying shares, meaning they do not directly receive dividends. As a result, they can avoid the U.S. withholding tax that applies to physically held shares. These funds usually provide the index’s total return through changes in unit price rather than taxable distributions.
Final thoughts
In short, a Canadian-domiciled ETF that holds U.S. equities will generally be subject to 15% U.S. withholding tax on dividends, though a swap-based ETF is a common exception because it does not receive physical dividends. You can avoid withholding in an RRSP by holding U.S.-listed securities directly, but TFSAs and RESPs do not share that exemption. For taxable accounts, the foreign tax credit often offsets the U.S. withholding, reducing the practical impact. Finally, be careful about multi-layered fund structures that can introduce extra withholding at several points; review an ETF’s holdings to understand the true tax exposure before you invest.
Jason Heath is a fee-only, advice-only Certified Financial Planner (CFP) at Objective Financial Partners Inc. in Toronto. He does not sell any financial products whatsoever.
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