U.S. stocks have been outperforming those of Canada and many other parts of the world. Theconsensus outlook among leading equity analysts suggests this trend will continue as theU.S. economy continues to recover from the depth of the 2008-2009 credit crisis. So it's not surprising that many Canadian investors, after years of focusing on the domestic market, have been looking southward to give their portfolios a new edge.
The Standard & Poor's 500 Composite Index, the broadest U.S. equity measure, gained 18.1% (in Canadian-dollar terms) during the three years ended Aug. 31, far ahead of its Canadian counterpart, the S&P/TSX Composite Index, which rose just 5%. Among small-cap stocks, the gap is even greater; the Russell 2000 Index jumped 20.1%, versus a negligible 0.4% for the S&P/TSX Small Cap Index. During the past year, U.S. stocks' outperformance has been even greater.
Many Canadian investment dealers are registered to trade U.S. securities, so this market is very accessible. In addition, most Canadian mutual-fund companies have a variety of U.S. equity funds. But while there's no denying the U.S. market's current attraction, there are tax issues to contend with that, in some cases, can dull the lustre -- not to mention the usual concerns about the relative values of the Canadian and U.S. dollars.
How and where to buy Many Canadian investment dealers are registered to trade stocks and other equity securities on major U.S. stock exchanges, including the New York, American and NASDAQ stock exchanges, as well as to buy and sell U.S. bonds. So many Canadians need look no farther than their existing investment advisor to invest in U.S. securities. What's more, investing via U.S. markets provides access to many overseas companies who issue American Depositary Receipts (ADRs), which are proxies for stocks listed on exchanges in these companies' home countries. Most ADRs are listed on the New York Stock Exchange. You also gain access to U.S. and global exchange-traded funds (ETFs), such as "Spyders" (SPDRs, or Standard & Poor's Depositary receipts, which are based on a wide range of U.S. indices) and WEBs (World Equity Benchmark Series, which are based on various global Morgan Stanley indices). Both types of ETFs are traded on the American Stock Exchange. Unfortunately, you cannot invest in U.S.-domiciled mutual funds through a Canadian-based trading account. This can only be done through an account at a U.S.-based dealer. And in most cases, you must be a U.S. resident to open such an account. While some brokerages, suchas Charles Schwab, will open accounts for investors who reside outside the United States, this requires an application for a registration number with the Internal Revenue Service -- a process that has become more complicated due to tightening up on regulations during the post-9/11 era. What's more, the full amount of capital gains realized from a U.S.-based mutual fund held by a Canadian investor may be taxed at the investor's marginal tax rate. Capital gains from Canadian-based funds qualify for the 50% inclusion rate under Canadian taxation laws. In most cases, there is no cost-saving advantage to having a U.S.-based investment account, as trading fees are similar on both sides of the border. Typically discount or online brokers in either country will levy a minimum fee of approximately $30 for a self-serve trade. |
The currency climate has changed, with our dollar having slipped to below par and economists predicting further erosion in the coming years. While the prospect of a falling loonie might add to the argument to buy in the United States now, regardless of attractive opportunities related to the exchange rate, the difference in the dollars' values is an extra layer of complexity and potential worry that many investors may wish to avoid.
Tax-wise, the only real deterrent to investing in the United States is of an administrative nature, as the tax treaty between the two countries prevents double taxation in most cases. In most cases, a Canadian who lives in Canada will not have to deal directly with the U.S. Internal Revenue Service. Nonetheless, there is added complexity when doing Canadian income-tax returns, including reclaiming tax on U.S.-source income withheld by the IRS. Here's a brief summary of tax issues to consider when investing in U.S. securities:
Currency exchange: All income amounts reported on your Canadian tax return must be in Canadian dollars. This includes interest, dividends and capital gains or losses. The conversion must be done using theBank of Canada exchange rate in effect the day an amount was paid out to you.
It's worth noting that, if you have a significant amount of U.S. cash in an account, fluctuations in currency exchange could produce a gain or loss. However, income or losses of up to C$200 on a U.S. cash balance during a taxation year that are the result of changes in the exchange rate are tax-exempt.
Withholding tax: The IRS normally will not withhold any tax on interest received from a U.S. source. However, dividend income received from a U.S. corporation is subject to withholding tax of up to 15% of the income paid out to you. (In some cases, this withholding could be as high as 30%; to avoid this greater withholding, you may have to file Form W-8BEN with the IRS.) You are able to recover tax withheld by the IRS through a foreign tax credit (Form T2209) when you file your Canadian tax return.
Capital gains: Profits and losses from a U.S. investment are taxed in the same manner as those from Canadian investments. Thus one-half of gains or losses from a U.S. investment are subject to tax at your Canadian marginal tax rate. However, the amount of the gain or loss must be converted to Canadian dollars as of the transaction date. The adjusted cost base (acquisition cost) of an investment also must be stated in Canadian dollars. The good news is most Canadian investment dealers' client statements report information on foreign investments in Canadian-dollar terms.
LLCs: Investing in a U.S. limited-liability company (LLC) can be expensive tax-wise for Canadians. An LLC is taxed as a partnership in the United States, which means all income is flowed through to shareholders, and taxed in their hands. The CRA treats a U.S. LLC as a corporation, and thus taxes only distributions from these entities. However, according to accounting firm KPMG, "the different tax treatments in Canada and the U.S. result in a combined Canadian and U.S. effective tax rate of 60% or more on income from LLCs."
Registered plan eligibility: While most U.S. investments qualify for a registered retirement savings plan, registered retirement income fund, tax-free savings account or registered education savings plan, the rules for U.S. tax withholding vary. U.S. tax is not withheld on income from an RRSP and RRIF. However, income from a TSFA or RESP is subject to withholding tax, as these are not considered to be pension-related investments.
