A Hold on Withholding Taxes

Sometimes in finance, authors take ownership of certain topics. This is what my colleagues Justin Bender and Dan Bortolotti have done with their white paper Foreign Withholding Taxes.

Many investors are not aware of it, but foreign governments take a bite of their returns in the form of a levy on their dividends even before they are paid out. For ETF investors, the extent of these levies is determined by the structure of the ETF you hold and the type of account it is held in (RRSP, TFSA, taxable account). There are even some cases where governments double-dip into dividends without investors knowing! Bottom line, the paper documents a potential saving of 0.43% between the most expensive and the most affordable ETF in certain categories. In an environment where five-year Government of Canada bonds hardly yield 0.50%, this is a major value added!

Here are three reasons to read Justin and Dan’s paper:

1. The colonel’s recipe: In contrast with most papers published by the financial industry, the authors share a detailed explanation of how to figure out which ETFs are lighter on withholding taxes, rather than the usual cursory review of the issue.
2. A short cut: If you don’t want to do the whole exercise of selecting your own ETFs, the paper provides comparative data on withholding tax costs for four comparable ETFs in three categories: U.S. equity, Developed Markets equity and Emerging Markets equity.
3. Context: Instead of discussing foreign withholding taxes (FWTs) in isolation, the paper provides a discussion of the reasons why you may or may not elect in favor of the lowest available FWT cost. These factors will include currency conversion costs, sampling error and, of course, expense ratios.

Most ETF investors pay attention only to management expense ratios (MERs) to determine costs, but picking the wrong ETF can cost more in FWTs than MERs. Investors should learn as much as possible about this issue.