ADRs within the TFSA?

Sampson,

The key point with regards to foreign securities held in the TFSA is that even thought you don't pay tax on the investment income earned on securities in the account, you are still effectively paying some tax since the international system of withholding taxes causes tax to be deducted at source. You are not entitled to a tax credit on the foreign tax paid on the securities in your TFSA. Even your RRSP may not be a good location to hold certain foreign securities because the foreign tax paid may not be fully refundable if at all. It all depends on the bilateral tax treaty between Canada and the foreign jurisdiction (if one exists at all).

In general, in Canada the highest taxes are paid on interest income, then dividend income, and finally capital gains in that order. (If you are in the lower tax brackets though, you may pay higher effective taxes on capital gains than dividend income.) In general, interest and dividend income earned on foreign securities is taxed like interest income (at your marginal tax rate), but you normally receive a credit for the foreign tax paid. Capital gains on foreign securities are taxed like other capital gains.

So basically, there is tax a benefit from holding foreign securities in your TFSA and RRSP, but depending on your situation, it may make sense to organize your portfolio such that foreign securities are held in a taxable account, while your Canadian securities are held in your TFSA and/or RRSP.

I hope that this helps. Let me know if it needs further explanation.

thanks robillard, this is an excellent treatment of a topic to which not enough attention is paid.

couple minor points:

- only foreign countries enter into tax treaties with canada; foreign companies do not.

- in some cases an ADR can actually have a double layer of withholding taxes. There is the visible 15% withheld by the US when it remits the dividend to a canadian taxpayer. In addition often there is a hidden withheld tax imposed on the primary dividend stream by the country of origin, where the shares were issued and where they principally trade. Until recently - when they eliminated their dividends - a number of european banks were in this category. I had read that it is possible to identify the micro-portion of this original WT tax that would apply to an individual canadian taxpayer and even claim the same, but in reality the costs of carrying out this work or paying an accountant to do the same would normally exceed any canadian tax credit obtainable.

- as to when it may make sense to organize a portfolio so that "your Canadian securities are held in your TFSA and/or RRSP," offhand i believe there would be very few instances where holding a dividend-paying canadian in an RRSP would make sense, because investor would lose the canadian dividend tax credit. By this i mean real dividends in the narrow sense of the word, not income trust distributions which have unfortunately come to be called dividends but which are generally a package of payouts with varying tax consequences. The only exception i can think of is investor w taxable income so low that he/she cannot benefit from dividend tax credit.

anything that underlines or points up the tax consequences of holding foreign securities, including plain-vanilla US stocks, has value for this forum imo.