How are foreign investors taxed when they buy US stocks?

Question

I have a Canadian investment account. If I purchase a US stock do I pay taxes under US tax guidelines or Canadian tax guidelines?

Also I was wondering...In Canada you pay taxes on 50% of net capital gains from equities. Doesn't this mean if you buy and hold a stock for 10 years it will be tax free for those 10 years making it the same as if it were in an RRSP?

Answer 1

Question number 1: You pay tax in Canada, unless you are driving to the US and trading your shares in the US. You made your profits in Canada.

Question number 2: When you realise the gain you are taxed on it, correct.

However, It is not the same as being in an RRSP, because you do not receive a tax break for contributing to your regular stock acount. If it was in a self-directed RRSP you would get a break for buying it (ranging from 16-49% depending on your province and income).

Let's do a simple example. Two brothers, Goofus and Gallant, each want to buy $10K in Company X shares. Goofus contributes the money to a self-directed RRSP and buys the shares, while Gallant purchases them through his regular discount brokerage account. Both of them make $100K per year in Alberta, so they have identical tax situations.

Goofus buys through his RRSP and gets a tax return of $3600, which he contributes again to his self-directed account, which gives him a $1296 return the following year, which he reinvests again, which gives him a $466.56 return the following year, which he reinvests... After ten years, the total amount he's re-invested from tax returns would be $5624.94. In his ten years he would've paid somewhere around $400 in fees to purchase on an annual basis (this is a rough number, as he probably wouldn't have reinvested after year five as his fees would have been more than his return). Assuming Company X continues paying their regular dividend of 1.5%, he would receive $2420 in dividends (assuming the re-investment of dividends).

So, at year 10, Goofus would have $17645 in Company X shares. If he were to cash those in and pay the appropriate income tax (36%) he would shell out $6352 in taxes, with an end result of around $11,293 after tax (assuming the price doesn't change over ten years for simplicity).

Gallant, his cunning brother, buys $10K in Company X through his cash account, and gets no tax break. At the end of year one, he collects his $150 dividend, pays 13.10% on those dividends, and takes the remaining $130.35 and reinvests it. He does this repeatedly for ten years, and assuming he buys his $100 worth of stock each year with the dividend money he pays $550 in fees for his purchases. At the end of ten years, he would have $10,832 and have to pay capital gains on the gain ($832-$550 times 18% tax =$50.76 in capital gains). He'd have roughly $10780.

In this case, Goofus would have done better in his self-directed RRSP. That's a simplified version of the math.

Had the stock value gone up 10% per year, the end result is the same.
Goofus would have $45,475 (dividends and 10% stock move) and would pay $16,371 in taxes when he cashes it in, ending up with $29,104 (assuming the top income bracket at 39% keeps moving and Goofus stays below it including this cashout).
Gallant would have $30,101, and would have paid $339 in taxes on dividends on the way. In this situation, Gallant has a capital gain of around $16,963, and pays $3053 in taxes. He ends up with $26,498.

If, on the other hand, they are both in the lowest income bracket, and the stock gets 10%, then Goofus ends up with $29,456 and Gallant would have $27,388.

This is assuming they stay at their current tax rates (which they wouldn't if they made too much) and that their income is $100K. If their income was lower Goofus' benefit to using an RRSP would not be as great, since the reinvestment of tax savings would be less.

To summarize, an RRSP is a better vehicle in both circumstances as you get more invested up front by reinvesting your tax return. If you don't reinvest your tax returns, the unregistered comes out on top hands down.

Hope this helps.