Overseas Dividends and Taxation

I go through all of the portfolios individually and track all the transactions in order to create the spreadsheets that you can see on the sidebar.  One of the items I noted a while back is that if you receive a dividend on an ADR from an overseas company, your broker will withhold taxes and you won’t receive your entire dividend in cash.

A little background – an ADR is an instrument that trades on a US stock exchange that moves along with the underlying stock on a foreign exchange.  These ADR’s allow you to get stock exposure to overseas markets on an individual stock basis without having to purchase them through an international exchange, which brings additional procedural and processing headaches.  Generally only very large and liquid overseas stocks have US based ADR’s.

For instance Portfolio One, our longest tenured portfolio at over ten years, has the following ADR’s:

– Statoil (STO) – Norway
– CNOOC (CEO) – China
– China Petroleum (SNP) – China
– Taiwan Semiconductor Manufacturing (TSM) – Taiwan
– Toyota (TM) – Japan
– Canon (CAJ) – Japan

The determination of whether or not there is tax with-holding depends on the country.  The rate also depends on the unique circumstances of the country.

This article has a list of countries that do not withhold taxes at all and the rates that they use for US citizens. Below are some of the rates of countries for which my portfolios either have stocks or may consider to have ADR’s in the future –

No Withholding:
Columbia – 0%
India – 0%
Singapore – 0%
South Africa – 0%
UK – 0%

Taxes Withheld for US Citizens:
Australia – 30%
Brazil – 15%
Canada – 15%
China – 10%
Finland – 28%
France – 25%
Germany – 26.4%
Israel – 20%
Italy – 27%
Japan – 10%
Mexico – 10%
Netherlands – 15%
Norway – 25%
South Korea – 27.5%
Spain – 19%
Sweden – 30%
Switzerland – 35%
Taiwan – 20%
Turkey – 15%

As an investor, you can deduct the tax that you pay to foreign countries on your US tax form. This is a tax “credit” so it reduces your tax liability dollar-for-dollar, the best type of deduction. There is a publication called 514 “Foreign tax Credit for individuals” that explains this in more detail. Like everything else related to taxes, ask a professional for advice or read the form yourself. Here is a layman’s summary:

– If you only have passive income (dividends or income) such as is found on a 1099-DIV or 1099-INT
– You claim less than $300 in foreign tax credits (or $600 if married filing jointly)

If the above 2 items occur, then you can just put the amount of foreign taxes paid on your return and you don’t have to file a form 1116 which also ultimately puts limits on the amount of foreign taxes that you can deduct on your US return and is more complicated, as a result.

Thus you may want to select ADR’s from countries with favorable tax treaties with the US and with low withholding of dividends. For instance, China at 10% (and UK at 0%) are better than Switzerland at 35%. This won’t generally matter at the level of dividend income that my portfolios create each year – for instance portfolio 1 had about $500 of dividends in 2011 – so if all of it was (worst case) withheld at 35%, this would be ($500 * .35%) = $175. You need to own a pretty large portfolio to cross $300 in foreign with-holdings… for instance if you had $50,000 in foreign stocks which returned 4% in dividends at 15% foreign withholding that would mean that $50,000 * 4% * 15% = $300.

Note that whether or not the foreign taxes were withheld, you still owe US taxes. Since the recipients of my portfolios aren’t working full-time they have low (or no) income levels and they have low tax rates, anyways. They also benefit (like all investors) from the dividends received rule which limits dividends to 15% tax rates, and their capital gains are also lower because they are in low income brackets.

I hope this is helpful. I always learn something when I take apart the detail of my brokerage statement and try to recalculate everything (now I can recalculate the withheld taxes on dividends!). I recommend that over time you try to do the same, as well. Financial literacy is your friend.

Like every tax rule, there are exceptions and complications, so do your own research.

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6 thoughts on “Overseas Dividends and Taxation”

  1. I have a similar situation with foreign taxes withheld on dividends for ADRs held in a trust account — but the trust account (and beneficiary) have no earned income or other tax liability yet, so I don’t see any taxes to claim the credit against. I plan on using the carry-forward provisions to apply the credits once the account has enough dividends to incur U.S. tax liability, but was wondering if you had any thoughts on approaches that could realize those credits sooner.

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  2. That is a good question. I am not a tax advisor but here is one approach.

    If you have some winners in your portfolio you could sell them and rather than selling winners and losers to offset you could just sell the winners and end up with a gain for the year.

    If the gains were enough to drive a tax obligation at year end (can’t know this it depends on the trustees total income) then the credits could be applied there, I believe, to offset the total tax obligation.

    I don’t know if it can be carried forward or not. Maybe this is a question that is asked or answered at the Fairmark tax forum there is a link on the web site.

    Thanks for the comments I usually get nothing but spam :<

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  3. Thanks for answering! It’s good to find someone publishing this kind of information for others starting out on the same process.

    I hadn’t considered using the credit to offset capital gains, since I’ve been planning for a long holding period. It would take the sting out of rebalancing, though.

    I read in one of the IRS publications (although I am also not a tax advisor) that a foreign tax credit can be carried forward 11 years, with no small amount of fine print. Given the uncertainty over preferential tax treatment for dividends, maybe looking for more growth stocks is the way to go.

    Cheers!

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