15% “hit” to ADR dividend payment for “foreign tax”

hank

Just had my first encounter. Here’s a link that explains it.

Questions:

- Since the ADR is held inside a Roth, is there an easy way to recover that tax?

- Is it wiser in tax-sheltered accounts to invest in foreign stocks thru U.S. domiciled funds? Do funds employ measures that mitigate or eliminate the tax for such accounts - or are the taxes simply hidden as “other expenses”?

- If you really liked a foreign stock (and the currency hedging aspect) could you still justify owning the ADR in a tax-deferred account while paying the tax?

rabockma1

The foreign tax withholdings are lost money in an IRA. ADR with foreign tax withholdings should be held in a taxable account. Canadian and UK stocks can be held in an IRA since they do not withhold taxes on dividends held in an tax deferred.

hank

rabockma1 said:

The foreign tax withholdings are lost money in an IRA. ADR with foreign tax withholdings should be held in a taxable account. Canadian and UK stocks can be held in an IRA since they do not withhold taxes on dividends held in an tax deferred.

Sounds reasonable. The only problem I’d have is I trade in & out of this ADR about a dozen times a year, locking-in short term gains and taking profits. To my knowledge there’s been no short-term cap gains taxes reported or paid. Trading like that inside a taxable account might create a lot of short-term cap-gain taxes - and a nightmare at tax time.

Anyone know if U.S. capital gains tax law would be the same for an ADR?

From robockman1 - “The foreign tax withholdings are lost money in an IRA.” - But wouldn’t that also apply to a fund like DODFX? Wondering if that “lost money” just isn’t noticed because it’s hidden inside the “other fund expenses.” ?

Derf

I'm currently selling FMIJX in Roth & buying in Taxable account.

yogibearbull

There may be withholdings of dividends for foreign ADRs. I am not aware of any withholdings related to CGs. The US and Canadian ADRs have friendlier rules.

The US funds with foreign holdings may pay foreign tax that is included in your yearend 1099. You may claim tax credits for those. If more complicated foreign holdings, you may have to include the Form 1116.

While we are at it:

The ADRs can be company-sponsored or noncompany-sponsored.

The US ADRs (tickers ending typically in "Y") are traded normally, without extra exchange fees (about $50 per trade) for foreign listings on the Pink Sheets/OTC (tickers ending typically in "F"). Examples that have both include VW (VWAGY, VWAPY; VLKAF), Porsche Holdings (POAHY, POAHF), SoftBank (SFTBY; SFTBF), etc.

Fido has a basic link on ADRs.
https://www.fidelity.com/learning-center/investment-products/stocks/understanding-american-depositary-receipts

hank

Came across the following elsewhere - which sounds a bit scary. But the fact that I was “only” hit with the 15% tax suggests to me Fido probably has the necessary paperwork on file with the Swiss government (ADR is Swiss based).

“One issue with ADRs is when the tax treaty rate is lower than the foreign country’s domestic withholding rate. Switzerland has a domestic foreign withholding rate of 35% and a 15% tax treaty withholding rate with the U.S. However, to qualify for the 15% tax treaty rate, investors must file paperwork with the Swiss government beforehand or be subject to the full 35%. If they do not do this ahead of time, the Swiss government will withhold 35% ”

Source

From @yogibearbull - ”The US funds with foreign holdings may pay foreign tax that is included in your yearend 1099.” That’s encouraging within the context here. Right? Doubtful many of us file to reclaim taxes our funds pay on holdings outside the U.S.

Thanks for the Fidelity link Yogi. However, it didn’t get very deep into the weeds. As I suggested earlier, the routine trading I do in this holding would likely create a tax nightmare inside a taxable account. In part, it helps offset the once a year tax hit.

After @msf is fully recovered from ingesting smoke I hope he’ll be able to weigh in as well.

hank

Derf said:

I'm currently selling FMIJX in Roth & buying in Taxable account.

@Derf - Is that a result of this discussion or did you have other reasons beforehand?

MikeM

“The foreign tax withholdings are lost money in an IRA.”

I guess I'm confused by this statement. Why should I care that my mutual fund, held in an IRA, has to pay these taxes as normal business expense? It's not lost. It's part of the funds expenses that translates to my total return. I understand tax generated expenses are part of owning a mutual fund. And how is that different than the expenses a domestic fund held in an IRA has to pay in dividend income taxes?

Unless I'm not understanding (which is verrrrry possible), I'm thinking ADR is under-the-covers info I can do without.

yogibearbull

It isn't part of the ER. It is paid from your account (or, you don't get it from the fund) and shows up in brokerage/fund 1099 at the yearend as something paid. As mentioned above, you can claim tax credit on 1040 (directly, or through 1116 with complex foreign holdings).

There is no tax filing to tax-deferred accounts, nor there is any 1099 for them, so that tax paid is lost, or cannot be claimed.

hank

@MikeM - Thanks for your contribution. I’m sure you realize I’m concerned particularly about a single stock in this respect. I don’t really know whether the 15% tax paid on one year’s distribution equates to the same tax (if any) an investor would pay if he owned the stock through a fund instead. But your point is a good one.

If it helps any … The annual dividend payout on my ADR amounted to about 2.5% of its value. So I was hit with a 15% tax on that 2.5% payout. Hardly seems enough reason to sell a stock that’s been a good steady-eddy. Or to move to a taxable account with the (than taxable) trading implications. As a portfolio component this stock equals a bit less than 5% of portfolio.

Not a math genius. But I think the tax we’re talking about amounts to: 15% of 2.5% of 5%

MikeM

Thanks @yogibearbull, but again, why should I care. Does this imply we should not own International funds in an IRA? In a tax deferred account all I can worry about is the total return. And again, tax is paid and "lost" on domestic income inside an IRA too, isn't it? Isn't domestic tax withholdings lost money in an IRA?

MikeM

@hank, I didn't catch you were talking about an individual stock. That would make more sense to me. Thanks.

msf

MikeM said:

“The foreign tax withholdings are lost money in an IRA.”

... Why should I care that my mutual fund, held in an IRA, has to pay these taxes as normal business expense? It's not lost. It's part of the funds expenses that translates to my total return. I understand tax generated expenses are part of owning a mutual fund. And how is that different than the expenses a domestic fund held in an IRA has to pay in dividend income taxes?

Except for the last sentence, I think MikeM has it right. Note he is not saying that the taxes the fund pays is part of the ER. Whether they are part of the ER (like management fees) or not (like trading commissions), it is an expense of the fund doing business and reduces the net return of the fund.

Typically global funds do this. They pay taxes to whatever countries they are invested in.
This reduces their net return (thus size of divs), end of story.

Some (not all) foreign funds pay the taxes but report them on your 1099 somewhat fictitiously. They pretend that the fund did not pay the taxes but rather that they passed the tax bill to you (reported on line 7 of the 1099-DIV - foreign tax paid). So they report a fictitious dividend that equals the real (net) dividend plus the amount of taxes they say that you paid.

In terms of actual cash, you get the same amount either way - whether the fund pays the taxes and says so (reporting divs net of taxes), or the fund pays the taxes but says that you paid them (reporting divs as gross, without netting out the taxes).

If the fund made $10/share (excluding taxes), and paid $2 in taxes, you see $8 in cash. Regardless of how the fund reports it. Inside or outside of an IRA, you get the same $8.

Tax treatment is different. When the fund (or ADR, I assume) says that you paid the taxes, it reports the $10 div and also reports that you paid $2 in taxes. If you choose to take a foreign tax deduction for the taxes, you wind up reporting net income of $8. Same as with the global fund that simply paid out $8 in divs, no muss no fuss. At 22%, you pay $1.76 in taxes.

If instead you choose to take a dollar for dollar foreign tax credit, then you report the $10 div, and pay 22% x $10 = $2.20 in federal taxes. You also get a credit of $2, so you pay only $0.20 in federal taxes. (You'll pay state taxes on the full $10, though.)

It would not surprise me if tax treatment of ADRs were more complicated than mutual funds, since US mutual funds are usually sold only to US investors. So some of the issues raised by the divdend.com page may be specific to ADRs. Haven't researched it though.

Derf

@hank : as for your question , Is that a result of this discussion or did you have other reasons beforehand? So I can take foreign tax credit. A previous buy & today a sell. One more round trip & I'll be done. Now I need to fine MF or stock for the Roth.
Have a good day, Derf

hank

Thank you @msf / Quick read of your dissertation answers a lot of what I was wondering about. Will study it more after getting in a late day bike ride.

I did have 1 additional thought … While none of us likes paying taxes, owning this company inside an actively managed fund would likely command a 1% or greater management fee. Without doing the math, I suspect that would work out to more than a 15% annual foreign tax on just 2-3% of the asset’s value.

Not to deny the benefit to owning said stock in a taxable account (rather than IRA), but the tax headache from frequent trades would be troublesome for me.

Crash

I ran into this only days ago. Created a thread about it, hoping for an explanation. The responders were certainly helpful. I heard no indication from TRP that anything will change in a positive way regarding the way this stuff gets posted (or NOT posted!) to the account.

Reminds me of calling "Customer Service." THERE'S an oxymoron. TRP does not clear the trades. It's Pershing. But I can't get to Pershing. I have to talk to TRP. ...Like all those times when you talk to the phone "specialist" at Customer "Service." They have to put you on hold to find out what to do and what exactly to TELL you, waiting patiently. Because they know nothing. And the ones who hold the cards are not accountable, and are not even connected.

Turns out, I paid a 25% tax "withheld at the source." Norway, in my case. (NHYDY.) Not happy about it, but the dividend is worth keeping. That's on top of the fee that TRP stole from me, as well. (For dealing with a foreign dividend.) NHYDY typically pays the dividend only once per year, in May.
https://www.mutualfundobserver.com/discuss/discussion/61160/ork-wtf-transaction-trp-got-an-answer#latest

hank

Thanks @Crash for sharing your previous thread. Sorry I didn’t pick-up on it. We learn as we go sometimes. At least at Fido it’s very easy to click on “Recent Transactions” and get a quick, clear read-out of everything that’s taken place. I didn’t need to call them. As soon as the transaction cleared it was easy to see what had occurred.

After reading your post, I feel fortunate to have selected to buy a stock a country (Switzerland) that’s signature to a treaty with the U.S. and Canada reducing their customary foreign tax to “only” 15%. It appears from your post that Norway is not part of that pact. Uhhh.

A gleam of optimism lies in the excellent commentary from @msf above. From that I discern that if you invest in a foreign country you’re going to get hit with some type of foreign tax - but that this is disguised (or passed on to you) in different ways by mutual funds and not easily discerned by fund holders.

And @rabokma1 was perfectly correct in that tax-deferred accounts like IRAs are not the right place to own a security that is going to be taxed anyway. However, if you own any foreign securities through a mutual fund, truth is you are also getting hit with a “foreign tax” in some manner. So technically, rabokma1’s tax specific advice might appear to apply to mutual funds as well.

@Crash - That 25% hit you encountered is an eye-opener for us all. As far as TRP goes, on the mutual fund side customer support has been abysmal for a long time. But I can’t speak for their brokerage side, having never dealt with it. BTW - There was a very small “foreign transaction fee” posted at Fidelity related to the dividend payout. Not worth mentioning. Pretty common for fiduciaries.

One correction on my part. My previous assertion that a 15% tax on the asset value of a foreign fund might not be any more oppressive than a 1% ER on a foreign fund was incorrect, Actually, working that through in my head, the 15% tax on dividends would probably amount to 2-3 times as much (in dollar terms) as a 1% ER would.

Crash

Appreciate those thoughts, @hank. Am I shooting myself in the foot? Maybe so... But the dividend, even after taxes, is lovely. And I have deliberately chosen NHYDY to be the stock I own in that investment sector: Aluminum and green energy. They even mine their own bauxite. Did a lot of homework on it. One of the biggest in the world. It's not at all in any financial pressure. They just bought back a lotta shares, last year. Taxes are not an issue for us, in our circumstances, though--- so it pinches when that happens, and there's no way to get it back on the 1040. Nothing to deduct it against, if you know what I mean. So I get credit for paying a bit of foreign tax. It's like a certificate hung on the wall telling me I'm a part-owner of the Green Bay Packers on account of my donation to the team in the lean years.