Tax implications For Canadian Investors Buying U.S. Stocks

Up to date on September 2nd, 2024 by Kay Ng

For Canadian buyers, having publicity to the USA inventory market is essential. There are a selection of explanation why.

First, the USA is the most important inventory market on this planet. So as to keep away from house nation bias and have a globally diversified funding portfolio, publicity to American shares is required.

Second, there are particular sectors which might be underrepresented within the Canadian inventory market. Examples embody healthcare, expertise, and shopper staples. Curiously, these sectors are among the many strongest within the U.S. market.

To put money into shares from the USA, Canadian buyers want to know how it will influence 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 non-taxable accounts.

Desk of Contents

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

Capital Positive aspects Tax

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

A capital acquire 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 buyers should pay capital good points tax on not less than 50% of their realized capital good points. The 2024 Federal Finances introduced a rise within the capital good points inclusion fee from 50% to 2 thirds on the portion of capital good points realized within the yr that exceed $250,000 for people, for capital good points realized on or after June 25, 2024. The $250,000 threshold applies to capital good points realized by a person web of any capital losses realized within the present yr or carried ahead from prior years. The tax fee for capital good points is similar 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).

In line with the Canada Income Company, present federal tax charges by tax bracket are:

15% on the primary $55,867 of taxable earnings, +
20.5% on the following $55,866 of taxable earnings (on the portion of taxable earnings over $55,867 as much as $111,733), +
26% on the following $61,472 of taxable earnings (on the portion of taxable earnings over $111,733 as much as $173,205), +
29% on the following $73,547 of taxable earnings (on the portion of taxable earnings over $173,205 as much as $246,752), +
33% of taxable earnings over $246,752.

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 following $46,228, +
11.16% on the following $57,546, +
12.16% on the following $70,000, +
13.16% on the quantity over $220,000

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

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

An instance may also 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 alternate fee was 1.25
Offered your Johnson & Johnson shares for US$125 at a time when the USD to CAD alternate 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 may also help us to know the correct solution to calculate the CAD-denominated capital acquire. Though in a roundabout way calculated within the picture above, the capital acquire 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 relies on transaction costs expressed in Canadian {dollars}. What actually issues is the CAD$1,875 capital acquire proven within the backside proper cell of the desk.

That is the quantity used to calculate capital good points. As talked about beforehand, not less than half of this quantity could be taxed on the investor’s marginal tax fee. We are going to 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). So, the capital good points tax could be not less than $432.75.

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

Fortuitously, capital good points tax will be tax-free or tax-deferred if U.S. shares (or shares from every 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 buyers from U.S. companies.

Dividend Tax

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

This is because of a particular kind of dividend tax referred to as “withholding tax.” Not like different taxes paid by Canadian buyers, 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 firms, is the Inner Income Service (IRS).

Dividend withholding taxes meaningfully scale back the earnings that Canadian buyers are capable of generate from U.S. shares. Fortuitously, this impact is partially offset by a particular tax treaty between the USA and Canada (referred to as the Conference Between Canada and the USA of America). The U.S. withholding tax fee charged to international buyers on U.S. dividends is generally 30% however is lowered to fifteen% for Canadians as a result of this treaty.

How does this examine to the common withholding tax of nations throughout the globe?

Even after accounting for the particular tax treaty, the U.S. remains to be an unfavorable marketplace for Canadian buyers from the attitude of tax effectivity. In line with 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 all over the world.

Canadian buyers 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 buyers from paying tax twice on their dividend earnings.

Nonetheless, U.S. dividends should not as tax environment friendly as their Canadian counterparts. The explanation why is considerably difficult and is expounded to a Canadian taxation precept referred to 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 only most tax-efficient type of earnings out there to Canadians.

In line with MoneySense:

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

Our suggestion for Canadian buyers searching 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 buyers to realize publicity to U.S. shares is thru retirement accounts.

There are two main retirement accounts out there for Canadian buyers:

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

The Tax-Free Financial savings Account (TFSA) permits buyers 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 the USA.

The opposite kind of retirement account in Canada is the Registered Retirement Financial savings Plan (RRSP). These accounts permit Canadian buyers to contribute pre-tax earnings, which is then deducted from their gross earnings for the aim of calculating annually’s earnings tax. Revenue tax is paid later, upon withdrawals from the RRSP. RRSPs are functionally equal to 401(okay)s inside the USA. In different phrases, earnings earned in RRSPs at tax-deferred.

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

Sadly, there may be one exception to this rule. The withholding tax paid to the IRS on dividends from United States companies remains to be paid inside TFSAs. Because of this, U.S. shares that pay out massive dividends shouldn’t be held inside a TFSA if potential.

As a substitute, the RRSP is the very best place to carry U.S. dividend shares (however not MLPs, REITs, and so forth.) as a result of the dividend withholding tax is waived. Actually, no tax is paid in any respect on U.S. shares held inside RRSPs.

Which means that Canadian buyers ought to maintain all dividend-paying U.S. shares inside their RRSPs if they’ve enough contribution room. U.S. shares that don’t pay dividends will be held in a TFSA.

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

Ultimate Ideas

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

Maintain dividend-paying U.S. shares inside an RRSP
Maintain non-dividend-paying or low-yielding U.S. shares (which might be anticipated to have increased development prospects) inside a TFSA
Maintain Canadian shares in a taxable account — particularly dividend-paying Canadian shares, to make the most of the dividend tax credit score

In case you are a Canadian dividend investor and are fascinated by exploring the U.S. inventory market, the next Positive Dividend databases include 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 of to be the best-of-the-best in the case 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 satisfy sure yield and payout traits. If that is certainly the case, you’ll be within the following databases from Positive Dividend:

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