The trouble with foreign withholding taxes

By Justin Bender and Dan Bortolotti | May 16, 2014 | Last updated on September 15, 2023
6 min read

Canadian investors get an enormous benefit from diversifying their portfolios with U.S. and international stocks. But this benefit carries a cost: foreign withholding taxes.

Many countries impose a tax on dividends paid to foreign investors: for example, the U.S. government levies a 15% tax on dividends paid to Canadians. Since these taxes are withheld before dividends are paid in cash, they often go unnoticed. But their impact can be far greater than that of management fees, which get much more attention.

The withholding tax on U.S. dividends paid to Canadians is technically 30%, but this can be reduced to 15% if clients fill out the Internal Revenue Service’s W-8BEN form.

Read: Foreign withholding taxes: How to estimate the hidden tax drag on U.S. and international equity index funds and ETFs

The amount of foreign withholding tax payable depends on two important factors. The first is the structure of the ETF or mutual fund that holds the stocks. Canadian index investors can get exposure to U.S. and international stocks in three ways:

  • through a U.S.-listed ETF;
  • through a Canadian-listed ETF that holds a U.S.-listed ETF; or
  • through a Canadian-listed ETF or mutual fund that holds the stocks directly.

In all of these cases, clients are potentially subject to withholding taxes levied by the countries where the stocks are domiciled, whether that is the U.S., developed markets outside North America (western Europe, Japan, Australia), or emerging markets (China, Brazil, Taiwan). We refer to this as Level I withholding tax.

When international stocks are held indirectly via a Canadian-listed ETF that holds a U.S.-listed ETF, clients may also be subject to what we’ve called Level II withholding tax. This is an additional 15% withheld by the U.S. government before the U.S.-listed ETF pays the dividends to Canadian investors.

Think of Level I foreign withholding tax like a departure tax your client pays when taking a direct flight to Canada from a foreign country (including the U.S.). Level II tax is like a second departure tax she pays when an overseas flight to Canada has a layover in the U.S.

The second key factor is the type of account used to hold the ETF or mutual fund.

Different account types— RRSPs, personal taxable accounts, corporate accounts and TFSAs—are vulnerable to foreign withholding taxes in different ways, as in the following examples:

  • When U.S.-listed ETFs are held directly in an RRSP (or other registered retirement account, such as a RRIF or a locked-in RRSP), investors are exempt from withholding tax from the U.S. (but not from overseas countries).
  • This exemption does not apply to TFSAs or RESPs.
  • If clients hold foreign equities in a personal taxable account, they will receive an annual T3 or T5 slip indicating the amount of foreign tax paid. This amount can generally be recovered by claiming the foreign tax credit on Line 405 of their returns. (Since no tax slips are issued for dividends received in a registered account, any foreign withholding taxes incurred are not recoverable.)
  • Holding foreign equities in taxable corporate accounts is generally less tax-efficient than holding them in taxable personal accounts. A full explanation is beyond the scope of this article. However, to make our cost comparisons more relevant, we have assumed the taxation of foreign income in a corporation has a similar effect to recovering approximately 50% of the final level of foreign withholding tax. (Throughout the article, we refer to this tax as “partially recoverable.”)

Read: Pros and cons of foreign dividends

In this article, we discuss two of eight different fund structures ( will have an analysis of all eight and allow you to earn CE credits). For each structure and account type, we estimate the total cost of a representative fund by adding the fund’s fee to the foreign withholding taxes that apply.

1. U.S.-listed ETF of U.S. stocks

When Canadians hold a U.S.-listed ETF of U.S. stocks, they face only Level I foreign withholding taxes. This is exempted in RRSPs and recoverable in taxable personal accounts, making Type A ETFs extremely tax-efficient:

  • In an RRSP, Level I withholding taxes do not apply.
  • In a taxable account, Level I withholding taxes apply, but are recoverable.
  • In a corporate account, Level I withholding taxes apply, but are partially recoverable.
  • In a TFSA or RESP, Level I withholding taxes apply and are not recoverable.

2. Canadian-listed ETF that holds a U.S.-listed ETF of U.S. stocks

Canadian ETF providers, such as Vanguard and iShares, often take advantage of economies of scale by getting their exposure to U.S. markets simply by holding a U.S.-listed ETF.

On the iShares website, you can identify Type B funds by clicking the “Holdings” tab on the ETF’s web page. The U.S.-listed ETF will be named near the top of the page, followed by a list of the “Aggregate Underlying Holdings” (i.e., the individual stocks in that ETF).

These funds can also be identified by looking at the Statement of Investments section in the fund’s annual report. The annual report for the Vanguard S&P 500 Index ETF (VFV) reveals its primary holding is the U.S.-listed Vanguard S&P 500 ETF (VOO).

Read: Different ways to construct ETF portfolios

Since the underlying stocks are domiciled in the U.S., only Level I withholding tax applies. Unlike with Type A funds, there is no exemption from this withholding tax when Type B funds are held in an RRSP:

  • In an RRSP, TFSA or RESP, Level I withholding taxes apply and are not recoverable.
  • In a taxable account, U.S. withholding taxes apply, but are recoverable.
  • In a corporate account, Level I withholding taxes apply, but are partially recoverable.

For deeper analysis and the other six fund structures, go to to take this course. It has been submitted to IIROC, FPSC and The Institute for accreditation.

The true cost of investing

Foreign withholding taxes are just one of many costs of investing. Before choosing the right funds and account locations, consider the following factors as well:

Currency conversion. In a large RRSP, it may be significantly more cost-effective to hold U.S.-listed ETFs for your clients’ foreign equity exposure. However, this is only true if they can avoid paying large spreads to convert currency before purchasing the ETFs.

In taxable accounts, U.S.-listed equity ETFs are not more tax-efficient than Canadian-listed ETFs that use U.S.-listed equity ETFs. It may therefore make sense for investors to use Canadian-listed ETFs in their taxable accounts—even though their MERs are slightly higher—to avoid the cost of currency conversion.

Income tax situation. While holding foreign equities in a taxable account allows clients to recover at least some of the foreign withholding tax, the dividends are taxed at the full marginal rate, and they’ll face additional taxes on capital gains. For an investor in a high tax bracket, it is likely better to pay a 15% withholding tax on dividends in an TFSA (if they have available contribution room) if the alternative is paying 46% income tax on dividends and 23% on capital gains.

U.S. estate taxes. Wealthy Canadians may be subject to U.S. estate taxes if they have significant holdings in U.S.-listed ETFs. These investors may be better off holding Canadian-domiciled funds to avoid this risk, even if it means incurring foreign withholding taxes.

Justin Bender, CFA, CFP, B.Comm., is a portfolio manager at PWL Capital in Toronto.

Dan Bortolotti is an award-winning financial journalist and financial planning consultant at PWL Advisors in Toronto.

Justin Bender and Dan Bortolotti