Easy (and Boring) Money – How to reduce Withholding Tax?

How to reduce Withholding tax

Pay hidden 40%+ overall tax rates or act NOW!

One of the advantages of DIY Investing is that you can optimize for your personal circumstances, including reducing your tax bill.

ETFs are simple, transparent and efficient. But the devil is in the details. Taxes affect returns from dividends, especially, when money flows beyond borders.

Choosing between (i) US domiciled ETF (ii) UCITS ETF domiciled in Ireland or (iii) UCITS ETF domiciled in another country like Luxembourg can have a significant impact on the returns that you will generate from dividends. 

cutting your Withholding Tax bill

To reduce the withholding tax, a global investor must choose an ETF domicile that has an advantageous tax treaty with the US, since US Equities have a weight of over 50% in global Equity Funds.

For European Investors, this domicile is Ireland with a 15%  US withholding tax on US dividends. 

Even more tax benefits

Additional considerations can play a role. For example, the ETF domicile choice only impacts Equity ETFs and not Bond ETFs since there is no withholding taxes on US Bonds.

US ETFs can also be very tax efficient. But to understand the benefit of investing in US ETFs you need to include all other taxes as well.

how taxes can get out of control

Why do we have to deal with withholding tax?

A withholding tax is a tax imposed by a country on outflow of dividends, interest or capital payments from that country. 

This is done because generally, governments are concerned about money outflows from their jurisdiction. 

Withholding taxes is an effective method of measuring and taxing outflows as the tax is paid to the government by the payer of the income (ETF) rather than the recipient of the income (Investor).

In a nutshell, each time there is an outflow outside a country’s borders there is potential for an additional withholding tax.

Typical Dividend Flow - from the US to France via Ireland

 

If you don’t pay close attention and optimize taxes, each country in the chain (where your global Stocks are, the ETF domicile and your home country) will  claim its part

Without you sometimes noticing it.

 

In the example above:

  • Dividends flow out of the US – They are paid by US companies to an ETF outside the US (Ireland) and thus US authorities charge US withholding tax (Level 1 Tax is 15% since the ETF domicile is Ireland)
  • Dividends flow out of IrelandIrish ETF dividends are paid to an investor outside Ireland (France) – normally, another withholding tax would be charged (however, Ireland does not charge anything for European Investors so Level 2 Tax is 0%)
  • Dividends are taxed in the investor’s home country – No Outflow, no Withholding tax. But it’s not over, other taxes await! She pays individual taxes in France on income and capital gains for dividends and when selling the ETF (Level 3 Taxes are individual, in France they are 30%)
The French investor has chosen an Irish ETF, so the overall tax bill is  41.5% (e.g. 100 dividends received taxed at 15% in the US and then 30% in France)

Irish vs. US ETFs

Gaming the system

The popular belief is that the reason why some UCITS ETFs are not beneficial from a tax perspective relates to the lack of a tax treaty and that Ireland has a special deal with the US.

The reality is that all European countries, including Luxembourg, Germany or France have treaties with the US but the quirk is that ETFs are legally structured in a way that they often can’t access these treaties

In Ireland, ETFs are structured like corporations, thus can benefit from the bilateral agreements between the US and Ireland. 

In Germany, is depends whether the fund is a KAG that faces 30% US withholding tax or InvAG with 15% tax. 

French and Luxembourg ETFs face a 30% tax charge.

Why the rest of Europe is irrelevant

Investing through Irish or US ETFs in global Equities (e.g. Vanguard All-World ETF) or more generally in ETFs that have high exposures to US Equities (e.g. S&P 500 ETFs) brings tax benefits.

If you invest through a tax wrapper like an ISA in the UK, the Irish solution is the most convenient choice.

 

Potential domestic tax offset with US ETFs

But, there are cases when US ETFs may be even more beneficial than UCITS ETFs.

You may be able  to trade US ETFs (your broker may have restrictions in place – e.g. post MIFID II regulations, you must prove that you are a professional investor to buy US Funds).

In order to benefit from tax breaks, make sure to request and fill out the W-8BEN form from your broker. 

Here is what you can claim:

  • Claim access the tax treaty that your country has with the US. Similar to a European UCITS ETF you would be charged, 15% not 30%.
  • Claim domestic tax offset on your withholding tax paid. This depends on the tax rules in your country. E.g. in the UK, where high taxpayers have a 32.5% rate, you can claim back the 15% already paid to US tax authorities. Great tax shield.

Before you invest through US ETFs make sure you are familiar with two additional rules. 

First, your family may be liable 40% estate tax above $60k investments in case you pass away.

Certain countries are except below very high thresholds (e.g. $5.45m for the UK).
 
Second, the biggest hassle with US ETFs is for UK Investors, that also need to make sure the US ETF has a reporting status with HMRC for tax purposes (otherwise you may end up paying income tax on disposal instead of capital gains). 

If you’re not in the UK, double check your country doesn’t have a similar requirement.

by how much can i increase returns?

To understand the impact of choosing the wrong ETF, we can calculate the Net Dividends received post all taxes. 

The above example illustrates dividend payments from US companies for a high tax band UK Investor. 

Even if access to US ETF is not available, the savings of using an Irish ETF are considerable. 

When to choose Non-Irish UCITS ETFs

European ETF domiciled outside Ireland may have some merits as well. 

Here are some considerations when choosing an Irish ETF may not necessarily bring much tax advantage:

Ignore the above rules for...

Other methods to reduce taxes

PENSION PLANS vs. SAVING ACCOUNTS

Most saving tax wrappers that are available in your country (ISA, PEA, IKE/IKZE etc.) will remove or significantly reduce Level 3 taxation (aka income tax or/and capital gains tax). 

However, most won’t change the amount of withholding tax you are paying.

There are exceptions including UK’s SIPP that are mentioned in the double taxation agreements between the US and the UK. 

In the case of UK’s SIPP, the 15% may be claimed back for you. 

Distributing oR accumulating etf?

An accumulating fund is a fund that reinvests the investor’s dividends within the fund while a distributing fund is a fund that distributes dividends to its investors.

Is any withholding tax paid on accumulating ETFs?

While the ETF will not pay you any dividend at the fund level, the ETF may still have to pay withholding tax on dividends received from stocks in other jurisdictions at the investment level. 

For instance, Vanguard All-World UCITS ETF is an accumulating ETF. The fund itself does not distribute dividends to investors, but the dividends received from stocks owned by the ETF get taxed in the US.

Thus, whether you are choosing a distributing or accumulating ETF will not impact the withholding tax you are paying.

BUT IT will Reduce your personal tax BILL

Even if choosing between accumulating and distributing ETF may not reduce your withholding taxes, it may have a significant impact on the overall tax bill, through your personal taxes on dividends and capital gains.

Below is a quick decision tree, but if you want to know more, there is a guide dedicated to this topic.

Good Luck & keep’em* rolling!

(* Wheels & Dividends)

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Good luck and keep’em* rolling!

(*Wheels & Dividends)

Raph

 

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Pavel
Pavel
1 month ago

Hi Raph,
Just finished reading all your articles about investing (including comments). I’ve read a lot on the topic of index investing but still found some very useful information.
Much appreciate the work you are doing for the benefit of the ordinary retail investor. I can see that you receive gratitude in the form of comments from many readers. I also wanted to say “Thank you!” and let the good things you do for others light your way forward!

Cheers,
Pavel

Last edited 1 month ago by Pavel
Pires
Pires
1 month ago

Once again, quite insightful and clarifying post Raph, well done! I Have read multiple blogs and articles about the ETF dividend tax retention since I first realized I was getting less that I expected in some of my investments. You post is quite better than I read to date, quite succint and clear to a retail investor like me!

Maciej
Maciej
1 month ago

Hi Raph, Very interesting post. I was surprised that there is no WHT on US Bond ETF given that US citizens are paying dividend tax on bonds (common recommedation for US guys to keep US Bonds in tax wrapper). In my country it was quite popular to optimize taxes via investing through legal entity (people were establishing SPVs) in Estonia as there is no tax if such legal entity keeps profits/gains. But regulations in my country has change (controlled foreing company) and local tax authorities in my country will now charge tax. Any toughts on wash-sale optimization? Guess that it… Read more »

Richard
Richard
1 month ago

Hi Raph, another great article, many thanks. I’ve a few follow-up questions which you may be able to answer.
do you know the WHT situation with funds (etfs and OICS) registered in the UK? And, ina previous article you said you don’t favour synthetic ETFs – do they present a there a genuine risk ? Many thanks in advance. Richard

Richard
Richard
1 month ago

Many thanks – looking forward to reading your views on synthetic ETF’s when you post.

Sundar
Sundar
1 month ago

Hi,
From what I understand from the article, if one invested in US ETFs/Stocks paying dividend via SIPP, even though we may have W8BEN withholding benefit, yet the remainder of the 15% tax needs to be claimed back via tax returns ? Or is this not applicable, a bit confused there.

Sundar
Sundar
1 month ago

Yes, I understood the reduced one from 30% to 15% withholding via W8BEN submission. But If I understood your article right, are you suggesting with lines below : However, most won’t change the amount of withholding tax you are paying. There are exceptions including UK’s SIPP that are mentioned in the double taxation agreements between the US and the UK.  In the case of UK’s SIPP, the 15% may be claimed back for you. Did you mean the remainder 30-15% (i.e.) 15% that needs to be claimed back via Tax returns, ergo making it a zero-tax scenario ? Maybe my… Read more »