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It’s a first among bank-owned discount brokers in Canada. With more banks likely to follow RBC's lead, what should Canadians be thinking about?
RBC Direct Investing recently became the only Canadian bank-owned discount brokerage to allow self-directed investors to buy securities trading internationally on several non-North American stock exchanges. It’s not the only option in Canada for investors, though. Interactive Brokers Canada, for example, provides access to more than 150 global markets.
Regardless, the move by Royal Bank is sure to introduce international stock trading to the mainstream, as other banks will likely follow suit. So, what is RBC Direct Investing’s offering, and what are the considerations for investors?
Online investors with RBC Direct Investing can now trade in Hong Kong, London, Paris and Frankfurt. Investors can also trade in Japan, Singapore, Australia and some smaller European markets by phone.
You can also now hold foreign currencies, including the British pound, euro, Swiss franc and Japanese yen, as well as Singapore, Australian, New Zealand and Hong Kong dollars, in non-registered accounts.
Foreign currencies other than U.S. dollars can’t be held in registered accounts, such as registered retirement savings plans (RRSPs) and tax-free savings accounts (TFSAs). However, you can hold foreign securities in both registered and non-registered accounts. This means Canadian dollars or U.S. dollars are converted to foreign currency by RBC Direct Investing to buy investments, and foreign dividends are converted to Canadian dollars as they are received and deposited to your account.
Canadians used to be restricted by a limit on foreign assets in some registered plans. Between 1971 and 2005, there was a limit on foreign investments in RRSPs, registered retirement income funds (RRIFs) and pension plans, ranging from 10% to 30%.
Some older investors still remember this rule and may not be sure if there are still restrictions. The foreign limit was eliminated in 2005, and currently, there are no restrictions to owning foreign stocks in Canada. There are, however, tax considerations.
When you buy foreign stocks in a registered account like an RRSP or a TFSA, the dividends are generally subject to withholding tax.
Most countries apply withholding tax on dividends at a rate of between 15% and 25%. The rate can vary depending on the terms of the tax treaty between Canada and the other country—if there is one.
Under the tax treaty between Canada and the U.S., U.S. stock dividends are exempt from withholding tax inside an RRSP. Inside a TFSA, U.S. dividends are subject to 15% withholding tax.
Withholding tax in a registered account cannot be claimed on your Canadian tax return. So, this is a cost of diversifying into foreign stocks.
If you buy foreign stocks in a taxable non-registered account, the income must be reported on your Canadian tax return, because Canadian residents are taxable on their worldwide income. The foreign tax withheld can also be claimed as a foreign tax credit in order to avoid double taxation.
Foreign countries do not generally charge foreign capital gains tax to investors who buy securities in those countries. It is common for countries to tax residents on the sale of real estate that is physically in that other country, but not so much with stocks. The U.S. is one exception. A U.S. citizen or green card holder—even while not a U.S. resident—is required to report their worldwide income on a U.S. tax return.
If you own certain foreign investments with a cost of more than CAD$100,000, you need to file form T1135 Foreign Income Verification Statement when you file your tax return. This is a disclosure form that must be filed annually with the Canada Revenue Agency (CRA), to avoid penalties. Foreign investments held in an RRSP or a TFSA are exempt from reporting.
When you complete your tax return, your foreign income needs to be converted into Canadian dollars. This applies to dividends, interest and capital gains, as well as other income.
You should typically use the foreign exchange rate on the date the income is earned, but the CRA will also accept recognized foreign exchange sources like the Bank of Canada. If the currency does not fluctuate significantly, the average exchange rate for the year may also be acceptable.
Keep in mind when you buy and sell foreign investments, it’s the Canadian-dollar purchase and sale prices that matter. You need to convert the purchase to Canadian dollars and the sale price to Canadian dollars based on the foreign exchange rate at the time of the transactions. This can lead to a foreign exchange gain or loss that enhances or reduces the foreign currency capital gain or loss.
The financial services world is becoming smaller thanks to advances in technology. Though RBC Direct Investing is the first bank-owned discount brokerage to introduce international trading, Canadians can expect to have more access to investment opportunities abroad in the future.
Foreign investments are a good way to diversify a portfolio. The entire S&P 500 represents about 51% of global stock market capitalization, whereas Canada accounts for just about 3%, so investing south of the border is a start. However, buying a few U.S. technology stocks and thinking you are diversified may not cut it. Non-S&P 500 stocks represent 8% of global stock market capitalization, and the rest of the world another 38%.
Buying internationally may come with costs, including higher commissions, foreign exchange costs and taxes, which reduce an investor’s return. So, it’s important to understand these costs and plan for them.
Even though you can buy international stocks, there may be simpler ways to invest globally using exchange-traded funds (ETFs) or mutual funds. While more investment options are a good thing, make sure you consider alternatives to trading foreign stocks directly.
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