Foreign Withholding Tax: Which Fund Goes Where?

By Dan Bortolotti on September 20, 2012
Estimated reading time: 4 minutes

My previous post on foreign withholding taxes included a lot of information for investors to puzzle over. But unless you’re an accountant, you probably don’t care too deeply about the finer details. Most investors just want to answer a simple question: which fund should I put in which account? Recall from the earlier post that [...]

A. Canadian mutual fund or ETF that holds US or international stocks directly. B. US-listed ETF that holds US stocks. C. US-listed ETF that holds international stocks. D. Canadian ETF that holds a US-listed ETF of US stocks. E. Canadian ETF that holds a US-listed ETF of international stocks.

To help you make the most tax-efficient choice for each type of account, see the tables below. I’ve specified which of the above fund categories are the most tax-efficient, and which ones carry the largest withholding tax burden. Then I’ve included some comparisons of specific funds. In each case, the pairs track the same index and use the same currency hedging strategy. Once again, a big thanks to Justin Bender at PWL Capital for helping me sort through these details. An important note before you make your decision: foreign withholding taxes are just one of many costs of investing, so they should not be the only factor in your fund choices. Management expense ratios are just as important: it makes no sense to pay an extra 0.50% in MER to save 0.30% in withholding taxes. Similarly, a US-listed ETF may be more tax-efficient than a Canadian one, but your overall cost will still be higher if you’re paying 1.5% in currency exchange fees. Make sure you’ve thought this through before making any changes to your portfolio. Even more important, you need to consider your income tax situation when deciding where to hold your fund. While holding foreign equities in a non-registered account (as opposed to an RRSP) allows you to claim the foreign tax credit, the dividends are taxed at your full marginal rate, and any capital gains are also taxable. In an RRSP, these taxes can be deferred until retirement. Justin illustrates this idea with a dramatic example on his blog.

US Equities

For non-registered accounts choose A, B or D.

TD U.S. Index (TDB902)	is equal to	iShares S&P 500 (IVV)
TD U.S. Index Currency Neutral (TDB904)	is equal to	iShares S&P 500 CAD-Hedged (XSP)
BMO S&P 500 Hedged to CAD (ZUE)	is equal to	iShares S&P 500 CAD-Hedged (XSP)
iShares US Fundamental (CLU.C)	is equal to	PowerShares FTSE RAFI 1000 (PRF)

For RRSPs choose B. Avoid A and D.

iShares S&P 500 (IVV)	is more tax-efficient than	TD U.S. Index (TDB902)
iShares S&P 500 CAD-Hedged (XSP)	is equal to	TD U.S. Index Currency Neutral (TDB904)
BMO S&P 500 Hedged to CAD (ZUE)	is equal to	iShares S&P 500 CAD-Hedged (XSP)
PowerShares FTSE RAFI 1000 (PRF)	is more tax-efficient than	iShares US Fundamental (CLU.C)

International equities

For non-registered accounts choose A. Avoid C and E.

TD International Index (TDB911)	is more tax-efficient than	Vanguard MSCI EAFE (VEA)
TD International Index Currency Neutral (TDB905)	is more tax-efficient than	iShares MSCI EAFE CAD-Hedged (XIN)
iShares International Fundamental (CIE)	is more tax-efficient than	PowerShares FTSE RAFI Developed Mrkts ex-U.S. (PXF)
Vanguard MSCI Emerging Markets (VWO)	is equal to	Vanguard MSCI Emerging Markets (VEE)

For RRSPs choose A or C. Avoid E.

TD International Index (TDB911)	is equal to	Vanguard MSCI EAFE (VEA)
TD International Index Currency Neutral (TDB905)	is more tax-efficient than	iShares MSCI EAFE CAD-Hedged (XIN)
iShares International Fundamental (CIE)	is equal to	PowerShares FTSE RAFI Developed Mrkts ex-U.S. (PXF)
Vanguard MSCI Emerging Markets (VWO)	is more tax-efficient than	Vanguard MSCI Emerging Markets (VEE)