Are you a Canadian investor holding U.S. stocks?
If so, congratulations! You are average!
While investors in all countries suffer from “home field bias” to some extent, few investors outright ignore the world’s biggest equity market, the good ol’ USA.
In Canada, it’s quite common for investors to hold U.S. stocks, especially blue chip tech stocks and index funds. Many Canadians hold U.S. stocks through their Canadian dollar-hedged equivalents (which aim to reduce exchange rate risk), as well as TSX-listed funds of U.S. stocks.
So, you are in good company holding U.S. stocks. Nevertheless, if you hold those stocks in a tax-free savings account (TFSA), there are some small print rules that influence how they are treated. In this article, I explore one small-print TFSA rule that affects your U.S. stocks in a very negative way!
Source: Getty Images
U.S. dividend stocks are taxable inside a TFSA
One of the main fineprint TFSA rules you’ll need to be aware of is that U.S. dividend stocks are taxable within your TFSA. Taxable by the IRS, that is! While the Canadian government tends to honour the TFSA’s tax-exempt status (barring rule violations), the U.S. government is a whole other can of worms. Countries have the right to tax dividends that their companies pay, no matter where their holders are located. The U.S. imposes 15% withholding taxes on dividends paid by U.S. companies.
Let’s imagine that you’re holding Fortis Inc (TSX:FTS) stock in a TFSA. Fortis is a dividend stock that pays $0.64 in quarterly dividends, or $2.56 in annual dividends. The stock’s price is $78.15; so, the dividend yield is 3.27%. If you invest $50,000 into Fortis stock, you get $1,638 back in annual dividends. Here’s a table showing the numbers on that:
| COMPANY | RECENT PRICE | NUMBER OF SHARES | DIVIDEND | TOTAL PAYOUT | FREQUENCY |
| Fortis | $78.15 | 640 | $0.64 per quarter ($2.56 per year) | $409.60 per quarter ($1,638.40 per year) | Quarterly |
In a TFSA, you would pay zero dollars in taxes on all that income, because the TFSA completely shelters Canadian stocks from taxation. Easy peasy.
With U.S. stocks it’s different.
Let’s imagine a U.S. stock that’s identical to Fortis, apart from its country of origin. In Canadian dollar terms, its price is $78.15, and its annual dividends are $2.56. If you held this hypothetical stock, your pre-tax dividend income on a $50,000 position would be identical to that which you’d earn from Fortis: $1,638. The after-tax amount would be different, though. The U.S. charges a 15% withholding tax on all U.S. dividends received by Canadian holders. The TFSA does not spare you this tax. So, your after-tax dividends on the hypothetical U.S. stock would be $1,392.64. That is, $1,638.40 minus a 15% tax ($245.76).
A parting thought
As I showed above, U.S. dividend withholding taxes can be substantial, even if you hold U.S. dividend stocks in a TFSA. If this matter is a concern to you, you might want to hold your U.S. stocks in a registered retirement savings plan (RRSP) instead of a TFSA. Thanks to a tax treaty between Canada and the United States, U.S. stocks held in RRSPs are spared the withholding tax. Just something to think about when you contemplate whether to hold investments in an RRSP or TFSA.
