The potential benefits of foreign equity investing are numerous, including the ability to access world-leading companies and create greater diversity within an equity portfolio. However, the taxation of foreign dividends can significantly reduce the after-tax returns of foreign equity holdings, and can create the additional headache of having to complete T1135 Foreign Income Verification Statements (T1135 forms) when filing tax returns.
The Horizons Total Return Index (TRI) ETFs which track foreign indices, can help reduce the tax burden associated with those applicable foreign securities by deferring the taxation of foreign income and mitigating the risk of a potential U.S. estate tax liability. As an added benefit, investors would not need to submit T1135 forms in relation to their position in these ETFs. Horizons’ TRI ETFs also provide the following benefits:
• No distributions, so no foreign withholding taxes
• Canadian property; therefore not subject to inclusion for U.S. estate tax purposes
• Low management fees
Horizons ETFs offers TRI Index ETFs that provide exposure to popular foreign equity index benchmarks such as the S&P 500®, the NASDAQ-100® and the EURO STOXX 50®. If an investor obtains their exposure to a foreign index or asset class through investment in a foreign mutual fund, ETF or other security (and the total cost of all their foreign property exceeds $100,000), they will be required to complete a form T1135 and report such holdings along with their tax return.
None of the Horizons TRI ETFs have ever made a taxable distribution to their unitholders. All of our TRI ETFs track the total return versions of their respective indices. This means that 100% of the value of any distributions from the index constituents is automatically and immediately (without any reinvestment cost) reflected in the Net Asset Value (NAV) of the ETF when these distributions occur. It is similar to a distribution reinvestment plan, except that no distributions are received by the ETF, and therefore there are no distributions to be taxed at the unitholder level.
For investors, one of the benefits of being invested in this type of ETF is tax efficiency, since a tax liability is only expected to occur when the ETF is sold if the investor realizes a capital gain.
Taxation on Foreign Equity ETFs
All distributions from foreign-listed securities are taxed in Canada at the full marginal tax rate of a Canadian resident investor if held outside of a registered account. Canadian residents who receive dividends and interest from foreign (non-U.S.) sources are subject to various rates of non-resident withholding tax (depending on the country of origin and type of income) ranging from 0 to 35%, even if the security is held within a registered account. In addition, Canadian investors who receive dividends from U.S.-listed securities are also subject to a 15% withholding tax on those distributions if they hold the securities in a Tax Free Savings Account (TFSA) or a non-registered account.
Where foreign non-resident tax has been withheld from a distribution to a Canadian investor (other than to a registered account), the investor may also be entitled to a foreign tax credit for all or a portion of the foreign tax withheld.
The following illustrative example highlights the expected after-tax performance benefits of holding the Horizons S&P 500® Index ETF (“HXS”) versus another Canadian-domiciled physically replicated U.S. equity ETF in a non-registered account, assuming both ETFs earned a net 2% dividend and track the exact same universe of stocks (in the same proportions). This example does not take into account any fees or expenses of the ETFs, or any commissions, fees or expenses that would be associated with the purchase or sale of the ETF units. Both ETFs are held by an Ontario resident investor in the fourth highest tax bracket, who would have had a marginal income tax rate of 46.41% in 2016. The example does not contemplate the sale of the ETF units or any tax liability that would result. It also assumes no change in the market value of the index constituents.
|Market Return (0%)||0%||0%|
|Net Dividends of Constituents||$2,000||$2,000|
|Pre-Tax Total Portfolio Value||$102,000||$102,000|
|Foreign Withholding Tax (15%)*||$300||$0|
|Taxes on Dividends (46.41%) **||$928.20||$0|
|Total Tax Payable||$1,228.20||$0|
|Total After Tax Portfolio Return||$100,771.80||$102,000|
|Difference in Return||-$1,228.20||$1,228.20|
|Return Lost to Tax on Distributions||-1.23%||0%|
*Where a Canadian ETF holds U.S. securities, non-resident taxes will be withheld from payments that are subject to U.S. withholding taxes (such as most dividends). Depending on the ETF, some Foreign Tax Credit may be passed on to certain unitholders. No Foreign Tax Credit is contemplated in this example.
**Based on combined provincial and federal rates, as disclosed for the 2016 tax year. This rate does not contemplate any non-resident withholding tax that may be withheld by the relevant foreign jurisdiction(s) or any resulting foreign tax credits.
The compounded value of reinvested tax savings should help to generate higher compounded returns. This advantage should increase the longer the ETF is held. On an after-tax basis, we would expect our TRI ETFs to deliver higher after-tax returns than traditional physically replicated ETFs that track the same index.
Say goodbye to T1135 forms and hello to a more tax-efficient way to get exposure to foreign equities!
Four Ways to Get Tax-Efficient Exposure to Foreign Equities:
|HXS||Horizons S&P 500® Index ETF||0.1%||2.09%|
|HSH||Horizons S&P 500 CAD Hedged Index ETF||0.1%||2.09%|
|HXQ||Horizons NASDAQ-100® Index ETF||0.25%||1.23%|
|HXX||Horizons EURO STOXX 50® Index ETF||0.17%||3.60%|
|1 Month||3 Months||6 Months||YTD||1 Year||3 Years||5 Years||Since Inception
*As at December 31, 2016.
The indicated rates of return are the historical annual compounded total returns including changes in per unit value and reinvestment of all dividends or distributions and do not take into account sales, redemption, distribution or optional charges or income taxes payable by any security holder that would have reduced returns. The rates of return shown in the table are not intended to reflect future values of the ETF or returns on investment in the ETF.
1 Plus applicable sales taxes.
2 Sum of the weighted dividend indicated yields of all index constituent securities. The dividend Indicated yield is defined as the most recently announced dividend amount, annualized based on the dividend frequency, then divided by the market price as at the close of the last business day of the last month end. Gross or net dividend amount is used based on market convention as at December 31, 2016.
3 Mutual fund regulations restrict the presentation of performance figures until a fund reaches its one-year anniversary.
The information contained herein reflects general tax rules only and does not constitute, and should not be construed as, tax advice. Investors situations may differ from those illustrated, Investors should consult with their tax advisors before making any investment decisions.
“Standard & Poor’s®” and “S&P®” are registered trademarks of Standard & Poor’s Financial Services LLC (“S&P”) and “TSX®” is a registered trademark of the TSX Inc. (“TSX”). These marks have been licensed for use by Horizons ETFs Management (Canada) Inc. The ETFs are not sponsored, endorsed, sold, or promoted by the S&P, TSX or their affiliated companies and none of these parties make any representation, warranty or condition regarding the advisability of buying, selling or holding units/shares of the ETFs. Complete trademark and service-mark information is available at https://horizonsetfs.com/legal/trademarks.
The EURO STOXX 50® Futures Roll Index (Total Return) is the intellectual property (including registered trademarks) of STOXX Limited, Zurich, Switzerland (“STOXX”), Deutsche Börse Group or their licensors, which is used under license. Horizons EURO STOXX 50® Index ETF is neither sponsored nor promoted, distributed or in any manner supported by STOXX, Deutsche Börse Group or their licensors, research partners or data providers and STOXX, Deutsche Börse Group and their licensors, research partners or data providers do not give any warranty, and exclude any liability (whether in negligence or otherwise) with respect thereto generally or specifically in relation to any errors, omissions or interruptions in the EURO STOXX 50® Futures Roll Index (Total Return) or its data.
Certain statements may constitute a forward looking statement, including those identified by the expression “expect” and similar expressions (including grammatical variations thereof). The forward-looking statements are not historical facts but reflect the author’s current expectations regarding future results or events. These forward-looking statements are subject to a number of risks and uncertainties that could cause actual results or events to differ materially from current expectations. These and other factors should be considered carefully and readers should not place undue reliance on such forward looking statements. These forward-looking statements are made as of the date hereof and the authors do not undertake to update any forward-looking statement that is contained herein, whether as a result of new information, future events or otherwise, unless required by applicable law.