In today’s post, I’ll try and answer a question on the new Tax-Free Savings Account that were sent to the Personal Finance Clinic. You may also want to check out Money Gardener and Triaging my way to Financial Success, who have also been fielding questions that were sent to the Clinic.
I have opened a TFSA with BMO InvestorLine and purchased shares of Microsoft. When I received my first dividend I was surprised to see that they took the usual 15% of taxes as in a regular [taxable] account.
I called BMO to ask about it because I was sure that there would be no income taxes and they told me that this rule in TFSA applies only on Canadian investments.
Is it the same for you guys?
The TFSA is a true tax-free account. There are no taxes on interest, dividends or capital gains on investments held in the account. However, if Canadian residents purchase US-based securities (such as Microsoft) in a TFSA, a 15% withholding tax applies. The withholding tax has nothing to do with the Canada Revenue Agency. It is charged by US tax authorities on US investments held by foreigners, including Canadian residents. Withholding tax also applies to other tax-deferred vehicles such as RESPs.
RRSPs, on the other hand, receive special treatment under the Canada-US Tax Treaty because they are “operated exclusively to provide pension, retirement or employee benefits”. However, if you hold non-US foreign investments inside a RRSP, you may pay a withholding tax. For instance, I used to own Nokia (NOK), which is based in Finland, within my RRSP and was subject to a withholding tax.
As US investments held in a TFSA are subject to a withholding tax, it is best to hold these securities within a RRSP. The TFSA is an ideal location for Canadian bonds, Canadian stocks and Canadian income trusts, including REITs.