My friend Chris was irate. "My broker just
ripped me off!" he pouted. "Royal Dutch (NYSE: RDS-A) said
in a press release they would pay $0.84 a share, but instead
my broker gave me $0.714 a share."
I tried to explain to Chris that it's not his broker's
fault. The broker doesn't withhold the amount. Royal Dutch
is a foreign company. It's based in the Netherlands. It's
required to withhold the tax he owes on the dividend.
"But I pay taxes in the U.S.," Chris insisted. "The U.S.
government will get 15% of my dividend. It's not fair that I
pay some foreign government taxes, too."
I agreed with him it doesn't seem fair. But I asked him to
look at it in another way. The foreign government is just
trying to recoup millions of dollars in lost taxes it incurs
when a company pays dividends or interest to foreign
taxpayers outside their country.
The United States does the same thing. Just about every
country does. Greece withholds 30% to U.S. taxpayers, the
Philippines take off 25%, and South Korea shaves 16.5% off
the top. Most other countries take 15% off the dividends to
U.S. taxpayers and, in turn, the U.S. takes 15% of their
country's dividends payments. Interest and royalty payments
are also taxed, but the rates tend to vary depending on the
country. For a handy list of foreign withholding taxes,
check out the
Deloitte & Touche website.
Foreign withholding taxes would be even greater if the U.S.
didn't have tax treaties to promote mutual investment with
many countries. For instance, the statutory withholding tax
for the Netherlands is 25%. But the tax treaty brings the
statutory rate down to 15%. That's why Chris got 85% of the
declared dividend, or $0.714 per share.
Generally, the higher yields you can get from foreign
equities can make up the difference. For example, Royal
Dutch's nearly 7% yield is more than twice that of
Texas-based Exxon Mobil (NYSE: XOM), and the yields on
Canadian royalty trusts such as Pengrowth (NYSE: PGH) are
Also, you can claim credit or take a tax deduction for the
foreign tax withheld by filing
IRS Form 1116. But when the foreign security is an ADR
that's held in a tax-deferred IRA or 401(k) type of account,
you generally can't recoup the tax. However, since you're
not dinged with the 15% U.S. dividend tax in this account,
the taxes you pay to a foreign country are equivalent to
what you pay Uncle Sam in a taxable brokerage account, so
it's a wash.
Besides, there are exceptions.
Germany, for one, exempts IRAs from the German withholding
tax under a revised treaty with the U.S. Germany withholds
15% of the dividend from your taxable account, but refunds
the withholding tax on German dividend-paying corporations
held in an IRA or other qualified U.S. pension fund.
Canada recently revised its tax treaty with the U.S. as
well. As of 2009, Canadian corporate dividends and interest
income are exempt from the 15% withholding tax if they are
held in an IRA or 401(k). That means you should now be able
to hold converted income trusts in an IRA without being
dinged the 15% withholding tax.
But the best news is there are about a dozen
major equity markets around the world where the withholding
tax on qualifying dividends is zilch. You pay no withholding
tax and you get to pocket every penny of the dividend. To
the right is a list of some of these foreign tax havens.
Some of these countries also offer compelling yields, making
them exceptionally attractive as a destination spot for
income investors. For instance, in
International, I've loaded my model portfolios
with such high-yielding, high-performance equities as
Ireland's Babcock & Brown (NYSE: FLY), which yields over 7%
and has returned more than +60%.
And without the foreign withholding taxes, the after-tax
returns are that much sweeter.
Carla Pasternak's Dividend Opportunities
P.S. -- Based on the info above, I was keen to find an
income investment for
High-Yield International from
the U.K., one of a select group of countries where U.S.
taxpayers pay 0% withholding tax on either dividends,
interest income, or royalties.
I was delighted, therefore, to discover an exchange-traded
note for my June issue now yielding close to 7% that also trades on the NYSE.
To learn more about this find, I invite you to try a
risk-free subscription to High-Yield International.
Visit this link to learn more.