The Fine Print Most Canadians Miss When Holding U.S. Stocks in a TFSA

Maximize your investment opportunities in US stocks with a TFSA while being aware of the tax implications of dividends.

Puja Tayal

Author Bio

Puja Tayal grew up in a small-business family where dinner conversations often centred on working capital and savings. Her early experiences with investing, particularly during the 2008 financial crisis, shaped her approach to understanding markets and evaluating investment opportunities. She began her career at a mutual fund company before moving into investor education and financial writing for asset and wealth management firms. Before joining The Motley Fool, Puja wrote for Market Realist, where she extensively covered the semiconductor industry. Her published work has also appeared in The Indian Express. Puja believes every stock has a story that can help investors understand its potential returns. She combines business analysis with different investing approaches to help investors make informed decisions and align their portfolios with their long-term financial goals. Outside of finance, Puja enjoys long drives, catching up with friends, watching superhero and science-fiction movies, and managing her family portfolio. She also has a keen interest in artificial intelligence and its potential to reshape the world.

Education

Bachelor's degree in Accounting and Finance, University of Mumbai (2007)
CFA Level I

Areas of Expertise

Qualitative company analysis, management strategy, risk assessment, long-term investing, portfolio diversification and rebalancing, dividend reinvestment, cyclical growth opportunities, compounding strategies, growth stocks, and dividend stocks.

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Favorite Investment Quote

"Risk comes from not knowing what you're doing." — Warren Buffett

Published June 30, 8:45 pm EDT

The U.S. is the world’s biggest stock market where many attractive dividend and growth stocks trade. From Micron Technology to Pfizer, you can get exposure to global leaders of various profit-making sectors. The Canada Revenue Agency (CRA) allows Canadians to buy US stocks trading on the Nasdaq and NYSE through the Tax-Free Savings Account (TFSA) and Registered Retirement Savings Plan (RRSP). However, the tax benefits of a TFSA come with fine print when holding US stocks.

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The fine print of holding U.S. stocks in a TFSA

You can earn from a stock through capital appreciation or dividends. Both fall under different tax brackets. The Internal Revenue Service (IRS) taxes dividends as “Income from Other Sources”. When a non-resident American earns this income, the IRS imposes a 30% withholding tax before crediting the dividend to the beneficiary’s account. Thanks to the US-Canada tax treaty, Canadians face a 15% withholding tax provided they submit the necessary forms with their broker and claim the benefit.

The capital appreciation falls under capital gains tax. This tax is paid by the non-resident in their resident country. In Canada, TFSA investments are allowed to grow tax-free. Thus, if you hold US stocks in a TFSA, you are subject to the IRS’s 15% withholding tax on dividends but benefit from the CRA’s tax-free capital gain.

However, the IRS allows dividends to grow tax-free in an RRSP, as it is a retirement account.

The TFSA only accepts Canadian dollar values

Another fine print point to note for a TFSA holding US stocks is that all values have to be converted into Canadian dollars. The CRA determines TFSA contribution room in Canadian dollars, and even if you invest in US stocks, you have to ensure the investment does not exceed the Canadian dollar limit.

Non-residents cannot invest in a TFSA

Now, if you work in the United States and become a non-resident in Canada, because you stayed 183 days or more out of Canada in a tax year, you cannot invest in a TFSA. The TFSA benefit is only for Canadians. Any contributions made as a non-resident would attract a penalty of 1% per month. As a non-resident, you can’t even accrue new contribution room.

So be careful where you invest in US stocks and know your tax residency before investing through a TFSA.

How to get exposure to US stocks through a TFSA in a tax-efficient manner?

Navigating the fine print, a tax-efficient way to get exposure to US stocks in a TFSA is to buy Canadian Depository Receipts (CDRs) of US stocks. With CDRs, you can buy fractional shares of global tech companies on Canadian exchanges in Canadian dollars. CDRs remove the hassle of currency conversion and hedge your exposure to exchange rate fluctuations. Companies like Micron, SpaceX, and Broadcom have their CDRs listed on the TSX.

Another tax-efficient way to get US stock exposure is through US ETFs trading on the TSX and currency hedged. The iShares NASDAQ 100 Index ETF (CAD-Hedged) (TSX: XQQ) replicates the Nasdaq 100 Index and charges a minimal management fee of 0.35% annually. It calculates the fee on your total investment, irrespective of the performance. If you invest $10,000 in the first year, $35 is charged. If your investment grows to $20,000 in the third year, $70 is charged. This fee is not charged separately but is adjusted to your net asset value.

However, the XQQ ETF’s 39% year-to-date return and 20% average annual return in 10 years make the fee a drop in the ocean. In fact, it is a cost-efficient way to benefit from the artificial intelligence (AI) sector. All AI players trade on the Nasdaq, from AI chipmakers to AI application developers, and AI infrastructure providers. Nasdaq will not only capture the AI revolution but all future tech revolutions like self-driving cars, space travel, and robotics.

Investing tip

The TFSA is a great investment tool as it lets your money grow tax-free. A stock that can grow multiple-fold and help with wealth creation is best placed in a TFSA, as it can save you a significant amount in tax, especially if you fall under a higher tax bracket.