Tax implications For Canadian Traders Shopping for U.S. Shares

Up to date on August twenty eighth, 2024 by Bob Ciura

For Canadian traders, having publicity to america inventory market is essential. There are a selection of explanation why.

First, america is the biggest inventory market on the planet. So as to keep away from residence nation bias and have a globally diversified funding portfolio, publicity to American shares is required.

Second, there are specific sectors which might be underrepresented within the Canadian inventory market. Examples embrace healthcare, know-how, and client staples. Apparently, these sectors are among the many strongest within the U.S. market.

To put money into shares from america, Canadian traders want to know how it will impression their tax payments.

This text will focus on the tax implications for Canadians that put money into U.S. shares, together with examples of dividend- and non-dividend-paying shares held in each taxable accounts and nontaxable accounts.

Desk of Contents

Whereas we suggest studying this text in its entirety, you possibly can skip to a specific part of this text utilizing the desk of contents beneath:

Capital Features Tax

There are two sorts of investing taxes that Canadian traders pays if they’re investing outdoors of a tax-free retirement account. The primary is capital good points tax, which might be mentioned first.

A capital achieve happens when a safety is bought for greater than its buy worth. Conversely, a capital loss comes from promoting a safety for lower than it was bought for.

Canadian traders are pressured to pay capital good points tax on 50% of their realized capital good points. The tax fee for these transactions is equivalent to the person’s marginal tax fee.

Marginal tax charges are composed of a federal part (which is paid in the identical quantity by all Canadians) and a provincial part (which varies relying on which province you reside in).

Based on the Canada Income Company, present federal tax charges by tax bracket are:

15% on the primary $50,197 of taxable earnings, +
20.5% on the subsequent $50,195 of taxable earnings (on the portion of taxable earnings over $50,197 as much as $100,392), +
26% on the subsequent $55,233 of taxable earnings (on the portion of taxable earnings over $100,392 as much as $155,625), +
29.38% on the subsequent $66,083 of taxable earnings (on the portion of taxable earnings over $155,625 as much as $221,708), +
33% of taxable earnings over $221,708.

As talked about, provincial tax charges fluctuate by province. Examples on this article will use Ontario’s tax charges, as it’s Canada’s most highly-populated province. Ontario tax charges by tax bracket are proven beneath:

5.05% on the primary $46,226 of taxable earnings, +
9.15% on the subsequent $46,228, +
11.16% on the subsequent $57,546, +
12.16% on the subsequent $70,000, +
13.16% on the quantity over $220,000

So how do capital good points taxes fluctuate for holders of U.S. shares?

Thankfully, the capital good points tax paid on investments in U.S. shares is equivalent to the capital good points paid on Canadian securities. The one minor distinction is that capital good points have to be expressed in Canadian {dollars} for the aim of calculating an investor’s tax legal responsibility.

An instance will help us perceive capital good points tax from U.S. shares within the context of those Canadian tax brackets. Let’s assume that you’re a Canadian investor who has executed the next trades:

Bought 100 shares Johnson & Johnson (JNJ) for US$100 at a time when the USD to CAD change fee was 1.25
Bought your Johnson & Johnson shares for US$125 at a time when the USD to CAD change fee was 1.15

You’ll pay capital good points on the distinction between your buy worth and your sale worth, expressed in Canadian {dollars}. The next desk will help us to know the correct method to calculate the CAD-denominated capital achieve. Though in a roundabout way calculated within the picture above, the capital achieve for this transaction – expressed in U.S. {dollars} – is US$2,500. Nonetheless, that’s irrelevant for the aim of calculating capital good points tax as a result of capital good points tax is predicated on transaction costs expressed in Canadian {dollars}. What actually issues is the CAD$1,875 capital achieve proven within the backside proper cell of the desk.

That is the quantity used to calculate capital good points. As talked about beforehand, half of this quantity could be taxed on the investor’s marginal tax fee. We’ll assume for simplicity’s sake that the investor is within the highest tax bracket, which is 46.16% for Ontario residents.

The next desk breaks down the capital good points tax calculation for this hypothetical funding in Johnson & Johnson (JNJ).

This calculation was fairly concerned and demonstrates how sophisticated the calculation of capital good points tax might be for Canadians.

Thankfully, capital good points tax might be averted totally if U.S. shares (or shares from some other nation) are held in Canadian retirement accounts. We focus on the 2 sorts of Canadian retirement accounts (TFSAs and RRSPs) in a later part of this text.

For now, we’ll transfer on to discussing the taxation of dividends paid to Canadian traders from U.S. companies.

Dividend Tax

Not like capital good points taxes (that are calculated in the identical manner for U.S. shares and Canadian shares), the taxes that Canadian traders pay on worldwide inventory dividends are completely different than the taxes they pay on home dividends.

This is because of a particular kind of dividend tax known as “withholding tax.” Not like different taxes paid by Canadian traders, these taxes are withheld at supply (by the corporate that pays the dividend) and remitted to their very own tax authority – which, for United States corporations, is the Inside Income Service (IRS).

Dividend withholding taxes meaningfully scale back the earnings that Canadian traders are capable of generate from U.S. shares. Thankfully, this impact is partially offset by a particular tax treaty between america and Canada (known as the Conference Between Canada and america of America). The U.S. withholding tax fee charged to international traders on U.S. dividends is often 30% however is diminished to fifteen% for Canadians as a consequence of this treaty.

How does this evaluate to the typical withholding tax of nations throughout the globe?

Even after accounting for the particular tax treaty, the U.S. continues to be an unfavorable marketplace for Canadian traders from the attitude of tax effectivity. Based on Blackrock, the weighted common international withholding tax on worldwide inventory dividends is 12%. Even after accounting for the tax treaty, Canadians nonetheless pay a 15% withholding tax — 25% increased than the weighted common dividend withholding tax around the globe.

Canadian traders might be blissful to listen to that this international withholding tax is ready to be reclaimed come tax time. The Canada Income Company means that you can declare a international tax credit score for the withholding tax paid on United States dividends. This prevents traders from paying tax twice on their dividend earnings.

Nonetheless, U.S. dividends are usually not as tax environment friendly as their Canadian counterparts. The explanation why is considerably sophisticated and is said to a Canadian taxation precept known as the “dividend tax credit score.” The dividend tax credit score meaningfully reduces the taxes that Canadians pay on dividends, and causes dividend earnings to be the one most tax-efficient type of earnings obtainable to Canadians.

Based on MoneySense:

When a non-resident invests in U.S shares or U.S.-listed change traded funds (ETFs), the usual withholding tax on dividends is 30%. A Canadian resident is entitled to a decrease withholding fee of 15% beneath a treaty between the 2 nations if they’ve filed a type W-8 BEN with the brokerage the place they maintain the investments.

Our suggestion for Canadian traders on the lookout for publicity to U.S. shares is to carry their U.S. shares in retirement accounts, which concurrently reduces their tax burden and dramatically reduces the tax complexity of their funding portfolios. We focus on dividend taxes in retirement accounts within the subsequent part of this text.

Dividend Tax in Retirement Accounts

One of the simplest ways for Canadian traders to achieve publicity to U.S. shares is thru retirement accounts.

There are two main retirement accounts obtainable for Canadian traders:

Each provide tax-advantaged alternatives for Canadians to deploy their capital into monetary property. With that stated, there are vital variations as to how every account features.

The Tax-Free Financial savings Account (TFSA) permits traders to contribute after-tax earnings into the account. Funding good points and dividends held throughout the account are topic to no tax and no tax is incurred upon withdrawal from the account. TFSAs are functionally much like Roth IRAs in america.

The opposite kind of retirement account in Canada is the Registered Retirement Financial savings Plan (RRSP). These accounts enable Canadian traders to contribute pre-tax earnings, which is then deducted from their gross earnings for the aim of calculating annually’s earnings tax. Earnings tax is paid later, upon withdrawals from the RRSP. RRSPs are functionally equal to 401(ok)s inside america.

Each of those retirement accounts are very engaging as a result of they permit traders to deploy their capital in a really tax-efficient method. Basically, no tax is paid on each capital good points or dividends as long as the shares are held inside retirement accounts.

Sadly, there’s one exception to this rule. The withholding tax paid to the IRS on dividends from United States companies continues to be paid inside TFSAs. Because of this, U.S. shares shouldn’t be held inside a TFSA if attainable.

As a substitute, the RRSP is the perfect place to carry U.S. shares (not MLPs, REITs, and many others.) as a result of the dividend withholding tax is waived. The truth is, no tax is paid in any respect on U.S. shares held inside RRSPs.

Because of this Canadian traders ought to maintain all dividend-paying U.S. shares inside their RRSPs if they’ve adequate contribution room. U.S. shares that don’t pay dividends needs to be held in a TFSA.

Lastly, Canadian shares needs to be held in non-registered accounts to reap the benefits of the dividend tax credit score.

Last Ideas

This text started by discussing a number of the advantages of proudly owning U.S. shares for Canadian traders earlier than elaborating on the tax penalties of implementing such a method. After describing the tax traits of U.S. shares for Canadians, we concluded that the perfect practices are to:

Maintain dividend-paying U.S. shares inside an RRSP
Maintain non-dividend-paying U.S. shares inside a TFSA
Maintain Canadian shares in a taxable account — particularly dividend-paying Canadian shares, to reap the benefits of the dividend tax credit score

If you’re a Canadian dividend investor and are thinking about exploring the U.S. inventory market, the next Certain Dividend databases comprise a number of the most high-quality dividend shares in our funding universe:

The Dividend Aristocrats: S&P 500 shares with 25+ years of consecutive dividend will increase
The Dividend Achievers: dividend shares with 10+ years of consecutive dividend will increase
The Dividend Kings: thought-about to be the best-of-the-best on the subject of dividend development, the Dividend Kings are an elite group of dividend shares with 50+ years of consecutive dividend will increase

Alternatively, chances are you’ll be seeking to tailor a really particular group of dividend shares to fulfill sure yield and payout traits. If that is certainly the case, you can be within the following databases from Certain Dividend:

One other method to method the U.S. inventory market is by setting up your portfolio in order that it owns corporations in every sector of the inventory market. Because of this, Certain Dividend maintains 10 databases of shares from every sector of the market. you possibly can entry these databases beneath.