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.