How Foreign Dividend Stocks Can Cost You

With all the interest in dividend-paying stocks, it's only natural that investors have started looking beyond the borders of the U.S. to find promising ways to add to their income-producing portfolios. But before you start counting on reaping some of the juicy yields that foreign stocks offer, you need to understand how some fairly complicated tax provisions could have a big impact on your after-tax returns.

Understanding foreign taxes
Investing in U.S. companies is simple from a tax standpoint. Each year, you receive dividends from the stocks you own, and if you own them in a regular taxable account, then you have to include those dividends on your tax return and pay income tax on them. If you receive dividends on stocks you hold within a tax-favored account like an IRA, then you don't have to pay any tax on them, and you don't have to report that income on your tax return.

Owning foreign stocks is a bit more complicated. Technically, when you receive dividends from a foreign corporation, you earn income that's potentially subject to tax by the country in which that corporation is located. So theoretically, you could end up having to file separate tax returns in each of the countries that you receive income from.

Tax authorities around the world know that expecting investors to comply with such a requirement would be unrealistic. Therefore, in order to ensure that they get their fair share of tax revenue, governments require companies and financial institutions to cooperate to withhold tax from the dividends they pay to foreign shareholders.

The rates on withholding tax differ from country to country, and they also depend on whether the U.S. has a special tax treaty with the particular country. In many cases, tax treaties reduce the rate that would otherwise apply.

Feeling the pain
But even with tax treaties, withholding tax can take a reasonably big bite out of your dividend income. To come up with some good examples, I took a look at the highest-yielding foreign stocks that have stock listings on major U.S. exchanges in several different countries. I then looked up the withholding tax rate for that country and applied it to the current yield. Below, you can see the impact it has on after-tax yield.

Stock

Country

Current Yield

Withholding Tax Rate

After-Tax Yield

Westpac Banking (NYSE: WBK  )

Australia

6.5%

15%

5.5%

BCE (NYSE: BCE  )

Canada

5.5%

15%

4.7%

Nokia (NYSE: NOK  )

Finland

5%

15%

4.3%

France Telecom (NYSE: FTE  )

France

8.6%

15%

7.3%

Telefonos de Mexico (NYSE: TMX  )

Mexico

4.9%

0%*

4.9%

Philippines Long Distance (NYSE: PHI  )

Philippines

8.7%

25%

6.5%

Credit Suisse (NYSE: CS  )

Switzerland

4.6%

15%

3.9%

Source: Capital IQ, a division of Standard and Poor's. Withholding tax rates taken from Deloitte International Tax Source
*10% withholding tax typically applies to Mexico, but Telmex reports that shareholders aren't subject to withholding tax.

As you can see, even with treaties reducing the ordinary levels of withholding tax, the reduction in yields can be quite substantial in some cases.

Get it back
But the good news is that in many cases, you can get all or part of your money back. Under U.S. tax law, taxpayers are entitled to a foreign tax credit for taxes they pay on their overseas income. The form that many taxpayers are required to file to claim a foreign tax credit is extremely complicated. But if you haven't had much foreign tax withheld -- less than $300 for single taxpayers or $600 for joint filers -- then you can often claim a credit without filing the long form.

A further complication, though, is that you're not allowed to claim a foreign tax credit for taxes withheld on stocks held in IRAs. Although some countries have special provisions in their tax treaties that eliminate withholding taxes for stocks held in tax-favored accounts, many do not. As a result, you may end up paying foreign tax on IRA income even while it's tax-deferred for U.S. tax purposes.

The value of diversification
Even with the complications of foreign taxes, you shouldn't let them stop you from investing in dividend stocks overseas. Some of the best investing opportunities are outside the U.S., and if you let tax fears stop you from grabbing them, you'll miss out on some excellent prospects.

ETFs can help investors with investing overseas. Click here to read The Motley Fool's new special free report, "3 ETFs Set to Soar During the Recovery," which includes an international ETF that could bring you big profits.

Fool contributor Dan Caplinger is freakish in his interest in taxes. He doesn't own shares of the companies mentioned in this article. France Telecom and Philippine Long Distance Telephone are Motley Fool Income Investor recommendations. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Fool's disclosure policy never withholds anything from you.


Read/Post Comments (12) | Recommend This Article (23)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On January 27, 2011, at 4:03 PM, Fundament wrote:

    Here is an additional sheet of 25 best yielding foreign stocks and a simple answer why you should invest abroad:

    http://long-term-investments.blogspot.com/2010/12/25-best-di...

    The average dividend-yield of my list amounts to 6.25 percent while the average P/E ratio is 12.95. Price to book ratio is 2.44 and price to sales ratio 1.66.

  • Report this Comment On January 28, 2011, at 1:10 PM, ET69 wrote:

    Thank you for a short but informative article.

  • Report this Comment On January 28, 2011, at 5:03 PM, OmniWraith wrote:

    I purchased a few stocks that are subject to foreign tax withholding for my ROTH IRA. I use Shwab as my broker and I attempted to select "yes" to automatically reinvest my dividends but they said that because their subject to foreign tax withholding they are not eligible for divvy reinvestment. I was kind of annoyed. I may not have purchased them if I knew that, though the underlying businesses are solid. The stocks were CEL and PGH. Anyone face a similar situation? (And, I know PGH has a DRIP. I'm thinking about going that route, but it's just annoying that my broker won't allow this. Though, after reading this article they're probably doing it to save themselves some huge headaches).

  • Report this Comment On January 28, 2011, at 5:06 PM, OmniWraith wrote:

    Shwab=Schwab

    their=they're

    oops! :p

  • Report this Comment On July 20, 2011, at 9:54 AM, blueribbondvd wrote:

    Actually France takes 25% and THEN you have to apply for 10% back. TD Ameritrade, a broker I am leaving due to their intransigence, fails to handle this correction. They refuse to handle the paperwork, even if I submit it to them, doing all the work. Since they are the trustee and holder of my stock shares, how else can I handle this?

    It seems like a class-action lawsuit may be needed.

    I am in the process of moving my holdings to SCHWAB, whom I THINK handles this well for it's clients.

  • Report this Comment On November 15, 2011, at 9:26 AM, jmalachowski wrote:

    I don't understand why people feel such a need to post items that don't directly relate to the topic and are only meant to point out a a typo or spelling error of another person.

    I had no trouble understanding that Shwab=Schwab, did not care about their=they're while reading that post. The criticism made was more of a distraction for me than the original errors.

  • Report this Comment On February 15, 2012, at 4:12 PM, Algae94 wrote:

    Not to derail things further, but that comment about the typo corrections was by the poster of the original comment, not by someone else pointing out mistakes.

    To say something on topic. I have so far found that TD Ameritrade withholds the foreign tax on stocks. I haven't had any foreign stocks that are above the 15% US dividend rate or that have a different rate due to a US tax treaty so I can't say how they would handle a French dividend.

  • Report this Comment On February 15, 2012, at 4:26 PM, Hawmps wrote:

    Good topic. Not much attention is given to foreign withholdings.

  • Report this Comment On March 05, 2012, at 6:31 PM, bretco wrote:

    Morgan Stanley withholds 15% on my foreign stocks. (yeah, I know, why Morgan Stanley ?)

  • Report this Comment On March 09, 2012, at 2:45 PM, BxBruce007 wrote:

    You left out Spain. My TEF stock is taxed at 19%.

    I'm curious about the comment from the poster who said you can apply for 10% back from France. Amazingly, I always assumed there was nothing I could do to reclaim foreign taxes other than getting a credit on my US returns.

    How does this process work and where can I get further information?

  • Report this Comment On May 06, 2012, at 7:29 PM, 666rules wrote:

    I have a Swiss stock, GEBN, the Swiss take out the 35% tax they pay long before my brokerage house gets the dividend, then several months later I get a check for the 20% that they charge that we don't. So, I pay 15%.

    I also get a credit on my taxes, I don't know what that is about.

    But just google Swiss tax reclaim form, or German tax reclaim form. My brokerage house does all the paper work for me, without charge, it's a lot of forms, but well worth it. I use Wm Blair, they've won awards for working for the client.

  • Report this Comment On November 16, 2012, at 12:11 PM, 666rules wrote:

    Wm Blair no longer files the reclaim forms. I wonder if this isn't some rule change in Washinton DC to discourage foreign investment.

    I wish Motley Fool would cover the reclaim process and post forms for us to copy, as there is no place (that I can find) that helps us out in the USA. I only find the Swiss tax authority web site, it isn't in English, and I can't print the forms they have, you must fill them out on line, first downloading two vehicles to show them. 9 pages long, hard to see and my computer won't enable the download of the Swiss "vehilcle".

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