What is a dividend withholding tax?

One of the core rules of investing is to diversify as much as we can. Never put all of your eggs in the same basket. Most people know that.

There is something I learned that not many knows. If you are not careful, you may pay a price you can avoid.

A key recommendation for diversification is to buy assets from different investment class, industries, and even countries to try to protect your wealth. When buying an asset that pays dividends or interests from outside of your resident country, you may be subject to something we call withholding tax.

In the case of dividends between Canada and the US, as a Canadian, if I buy a stock that pays dividends from the United-States, they will keep a 15% withholding tax from it because the money is exiting the country. This is not just for the US, every country has their own different rules. The same thing is applied to Americans buying dividend-paying stocks from Canada.

What can we do about it?

That is a good question, with a bit of knowledge, there is something we can do to help ourselves. The United States and Canada signed an agreement called the income tax treaty, which you can find here: https://www.irs.gov/pub/irs-trty/canada.pdf

The benefit of this treaty for us, the investors, is that the 15% withholding tax on dividends and interests is not applied when the assets are held in a registered retirement saving plan account (RSP). This means we must be careful where to hold specific types of assets. If you have a TFSA and an RSP account, and you have the choice to hold two stocks, a growth-focused stock, and a dividend-paying stock, by holding the dividend-paying stocks in your RSP you would avoid the withholding tax on those dividends. You can then hold your growth stock allocation in your TFSA and not worry about taxes on this asset.

I would encourage you to look into your taxes with a tax expert, every personal finance situations are different. Taxation may be very complex depending on our situations.

 

I hope this post helped you understand a bit more on the subject, potentially helping you to avoid paying withholding taxes when you can. 🙂

Enjoy!