As the year 2022 heads into its second act, the themes of value and dividend investing are expected to remain popular. With inflation and interest rates yet to show a definitive peak, growth stocks remain out of fashion. While there are no investments that can truly be “recession-proof”, dividend and value investing traditionally hold up better during these volatile periods as their relatively muted valuations and steady cash flows provide a degree of support for investors.
As one includes more dividend paying stocks into their portfolio, the portfolio yields will increase. With that, investors should be aware of the tax implications from dividend investing.
For some Canadian investors, the investment opportunities in the U.S. are attractive and allow for one to better diversify their portfolio. Before investing, it is advisable to learn the tax differences that Canadians face on foreign dividends compared to those received by Canadian companies. For domestic dividends, a dividend tax credit will meaningfully reduce the taxes owed, making dividend income more tax-efficient for Canadians. On the flipside, there is no dividend tax credit when dividends are received from a U.S. company. Rather, dividends are taxed equally to interest income, which are taxed at one’s marginal tax rate. Furthermore, Canadians will be subject to a non-resident withholding tax. The U.S. withholding tax rate for foreign investors is 30%, however, due to the current tax treaty between our countries, the withholding tax is reduced to 15%.
Fortunately, there are some simple strategies that can help reduce the tax impact from US dividends. The best accounts for Canadians to hold their US dividend paying positions may be in registered retirement accounts. In these accounts, the 15% withholding tax is waived. Under a Canada-US Treaty, there is an exemption from US withholding tax on dividend income earned through a trust that is set up exclusively for the purpose of providing retirement income. These trusts include RRSPs, RRIFs, LIRAs, LIFs and LRIFs. Unfortunately, the withholding tax is not waived for the TFSA and RESP accounts. Still, for all registered accounts, the gains and income earned are tax deferred or tax exempt which further reduces the annual tax impact from US dividends that would otherwise be treated as interest income in non-registered accounts.
The non-registered account may be the most appropriate place to hold Canadian dividend stocks so that one can make use of the Canadian dividend tax credit. Some investors may even feel that growth stocks will benefit from being held in non-registered accounts as one has the opportunity to harvest capital losses if needed. This may be particularly valuable in a volatile market.
When investing in foreign securities, there are many things to consider. It is important to consider after-tax returns and the potential added complexity of cross-border investing. Speak to your advisor on how to best position your investments within the myriad of account types and structures.