My friend Chris was irate. "My broker just ripped me off!" he
Royal Dutch Shell (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 Shell is a foreign
company. It's based in the Netherlands and is required to withhold
the tax Chris owes on the dividend .
"But I pay taxes in the United States," 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 a
Generally, the higher yields you can get from foreign equities can
make up the difference. For example, Royal Dutch Shell's nearly 7%
yield is more than twice that of Texas-based
Exxon Mobil (
, and the yields on Canadian royalty trusts such as
are even higher.
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 American Depository Receipt (
) 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 United States. 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 United States 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
Action to Take -->
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
, I've loaded my model portfolios with such high-yielding,
high-performance equities as Ireland's
Babcock & Brown (
, which yields over 7% and has returned more than +60%.
And without the foreign withholding taxes, the after-tax returns
are that much sweeter.
Editor: High-Yield Investing, High-Yield International, Dividend
Disclosure: Carla Pasternak does not own shares of any security
mentioned in this article.
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